Why You WILL Go Broke Taking a Quick Profit

When you scalp, you lose. Here’s Why

Co-Locate ServersThe art of scalping is becoming more and more difficult. Dominated by large volume, high frequency trading firms, these firms have the ability to trade huge size in fractions of a second.

Without getting into the technical jargon these high big firms can get in and out of the markets lightning fast because they co-locate their servers (house them right next to the exchange servers) giving them the fastest fills possible and least amount of latency.

How to Identify YOUR Advantage (Trading Edge)

Whether you call yourself a retail trader, at home trader, or independent trader the advantage we have is the ability to ride the coat tails of these big players. In trading smaller size (relative to the big firms) we can jump in and be taken along for the ride to meaningful profits. The trick is to not fall victim to the bandwagon effect.

Go Along for the RideLooking at the E-mini S&P, I consider anything under 1 point ($50 per contract) scalping. Typically you need a market to trade through your order to get filled so in order to profit 1 tick ($12.50) you really need the market to have a trading range of 3 ticks.

Taking quick, small profits lead to insurmountable odds. The goal here is to profit in the form of multiple points, targeting a reward to risk ratio of 3:1 with the expectation that some of our trades will result in larger winners.

(More information related to my own trade setups can be found under the ‘trading rules’ tab at the top of the page).

How to Put the Odds in Your Favor

A Football Analogy

As a trader you are like an offensive player in football. You get multiple attempts to carry the football and try to score a touchdown; your objective is to take the trade it as far as possible. 3:1 reward/risk ratio should be your target. In doing so, you can be right less than 50% of the time and still make money.

For those that don’t know much about the American game of football here’s a quick overview:

Players charge down a 100 yard field trying to get to the ball into the end zone. They get four downs (attempts) in which to move the ball forward at least 10 yards. This leads to a rest of downs (another 4 tries). If they can’t move the ball forward 10 yards in these 4 attempts they give up possession to the other team. In other words first downs lead to touch downs.

In trading, just like in football you get multiple opportunities to score. It is your job as a trader to try and maximize these opportunities. We must use money management techniques like scaling out of our positions and trailing our stops to prevent us from going backwards.

American Football

Which Has More Value?

It’s not about how many plays you run (trades you take) it’s about scoring touchdowns and getting the most out of each trade.

Take two players…

#1 has 20 carries for 100 yards and 0 touchdowns
#2 has 10 carries for 50 yards and 1 touchdown.

Player #2 is clearly more productive in scoring meaningful points. While each yard gained is of value, it’s the touchdowns that have the biggest impact on winning the game.

Quick Profits Lead to Losing in the Long-term

Unless the market immediately rips in your favor, taking quick, small profits is not sustainable over the long term. Instead of taking quick profits, execute patient and focus on trailing your stop.

How many times do you find yourself saying “if I just left my profit target where it was and didn’t mess with the trade it would have worked out and been a big winner?” Leave your profit target alone, manage your stop.

In Summary

A football player always trying to break through tackles going for the touchdown. As a trader you should be doing the same. Put emphasis on getting the most out of each trade. Don’t exit the trade early for a quick (and small) profit. If you must do something focus on managing your stop and leave your original profit objective where it was.

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About Tim Racette

Tim is a full-time trader in the futures and stock markets and founder of EminiMind.com. He is also a Chicago-land native, competitive mountain biker, adventurer, and ASU Sun Devil.

11 Responses to “Why You WILL Go Broke Taking a Quick Profit”

  1. I can’t agree enough on that analogy. Well said Tim

  2. Very true, I knew somebody in the same boat marry that with overtrading and she owed more in round trip fees and generally down or at best scratch – she was an fx trader.
    Great advice as always Tim!

  3. Tim,

    Take the ES for example, what amount would not be scalping?

    Also, do you go over anywhere on the blog or in the ebook what you think is the most appropriate stop loss strategy?

    Thanks,
    Neal

    • Hi Neal, on the ES I would consider anything under 1 PT scalping. Looking at it from a risk to reward standpoint, if you’re exiting for 1 PT profit and risking anymore than say 2 ticks, you would need to be right close to 80% of the time to make money. That being said, there is no one ‘correct’ to trade, but to the retail scalper you’re competing with big firms scalping HUGE size for these 1 and 2 tick profits (or pennies in the case of stocks).

      And I do go through my stop placements and trail stop management in the eBook.

  4. My apologies to all those who left comments after this point. In transferring servers Monday I lost some of the comments that were left.

  5. I’m assuming taking off one or two contracts early to provide a reduced risk runner is not a form of scalping? I trade better using this reduced risk method, however, most will argue all in and all out works best mathematically or from a profit basis. To some point I agree. However, targets are always subjective so risk vs reward is at best a “guess” anyway. It’s about what you “think” price will do. I’ve just had too many come back on me in the past. Maybe it’s a personality thing? There’s a blog post for you: All In or All Out…What’s most profitable? BTW Love the football analogy. Great site keep it up!

    • Thanks TTW, yeah on the Euro I prefer to take a small portion off, less than half usually about 1/3 of the position. As for the ES I’ve found especially in 2012 that only tightening my stop and not taking any off the table early to be more profitable. That being said the ES has had a lot of days where we get an entry and run 10+ points so it all depends on the market and the conditions.

  6. I trade the ES and I like to do all-in all out at 6 tick profit. When the price is up four ticks I will trail my stop 4 ticks under my buy point. I find this better than reduced risk trading. i did a 6 month experiment with reduced risk trading and just broke even with that method vs all in. If you have 2 contracts and it doesnt hit your 2 tick then you are up for a big loss vs 1 contract all in and all out.

    • Hi Jim, Ya I’ve found that to work well, that is, NOT scaling out with the ES, just moving your stop accordingly. It can depend on the time of year as well, but in general I like this approach.

    • Jim, I have been working towards your approach. when you get filled, how many ticks below do you set your stop (on average?) Ex. I will play 3 contracts for a 6 tick move. I often place my opening stop at 8 ticks and then move it up. Jim / Tim, is this a viable approach or am I not getting my stop in the right place to start with? I do move it up to a tick above breakeven like Jim does.

  7. I think a 6-8 ticks stop for the ES is plenty. I would encourage you to look at the NYSE Tick when “scalping” on the ES as this allows you to get away with a really tight stop, pin point entry’s and quick moves in your favor.

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