I’ve sat at the feet of two traders who were masters at scaling. One deployed the tactic with options, the other with forex. I caught a glimpse of the idea’s brilliance from the first gunslinger, but it was the second’s explanation and illustration that really sealed the deal for me.
If you’ve paid attention to my Options Reports or participated in a Cash Flow club, you’ve probably seen me mention the tactic. Today we’re taking a closer look.
The fool doth think he is wise, but the wise man knows himself to be a fool. – William Shakespeare
Here’s a bold statement. Buying all at once smacks of arrogance. Like tromping through a minefield with clown shoes. What, you think you know something? You don’t know where those leg-blasting, arm-stealing bombs lie! So tread carefully. Use scaling.
Novice traders are getting their very first lessons in the dangers of market volatility. If 2017 was the hero, 2018 is the villain, one hellbent on undoing much that was done. It also is requiring you rookies to adapt or die because what did work now doesn’t. As one who’s been stung many a time by the volatility wasp, I offer my sympathy and understanding. Want to use volatility to your advantage, to exploit adverse moves? Use scaling.
At the dawn of trading the phrase “buy low, sell high” was born. It sounds simple, but oh-so-hard to implement. Blame it on your mother (or her mom – whichever you love least). She endowed you with emotions that encourage dumb decisions. You’re wired to buy high and sell low. It’s what feels good. Want to make it easier to buy low and sell high? Use scaling.
The ranks of bottom buyers and top sellers are filled with liars and lucky ducks. That’s because it can’t be done, not consistently at least. If you did nail a turning point, you were lucky so don’t count on a repeat because luck has a short shelf life and lacks any loyalty. Fortunately, there’s a tactic that can increase your chances of entering close to the turn. Want to give yourself two, three, or four chances to game a reversal? Use scaling.
Scaling involves splitting your position into separate tiers and entering at different prices. You enter some now and then wait for a better price before entering the rest later. Typically we refer to it as scaling in. It works particularly well with option selling strategies like naked puts, credit spreads and calendars. Here’s a quick example using a bear call.
Scaling with Facebook
Suppose you’re looking to make Facebook’s pain your gain. The stock is in a downtrend, below major support, and may flounder for weeks yet. To embrace the odds, you’re toying with selling the May $180/$185 bear call spread. Right now it’s trading for 60 cents, and let’s say you can sell three spreads based on your risk tolerance. Instead of entering your entire position immediately, what if you scaled in? That is, sell one spread now at 60 cents but wait until the price rises to 90 cents before entering your second and $1.20 before deploying the third.
If FB behaves, moving immediately lower in price, then you’ll simply wait to take profits with your first tier. If it rallies further from here (an adverse move) then you can use it to your advantage by adding a second and third tier which raises your average credit to 75 cents and then 90 cents. That way when FB finally does drop you’ll return to a profit that much quicker.
You’ll have to decide when to enter the second and third tier. I like the idea of opening the second when the premium has risen to 1.5x the original credit and the third if it rises toward double the original credit.
Financial freedom is a journey
The Options Theory series is brought to you by Tackle Trading.
Sign up now and gain unfettered access to all of the quality content and powerful Scouting Reports that our Pro Members enjoy for 15-days absolutely free with no strings attached and let us show you what your trading has been missing.
Tackle Trading LLC (“Tackle Trading”) is providing this website and any related materials, including newsletters, blog posts, videos, social media postings and any other communications (collectively, the “Materials”) on an “as-is” basis. This means that although Tackle Trading strives to make the information accurate, thorough and current, neither Tackle Trading nor the author(s) of the Materials or the moderators guarantee or warrant the Materials or accept liability for any damage, loss or expense arising from the use of the Materials, whether based in tort, contract, or otherwise. Tackle Trading is providing the Materials for educational purposes only. We are not providing legal, accounting, or financial advisory services, and this is not a solicitation or recommendation to buy or sell any stocks, options, or other financial instruments or investments. Examples that address specific assets, stocks, options or other financial instrument transactions are for illustrative purposes only and are not intended to represent specific trades or transactions that we have conducted. In fact, for the purpose of illustration, we may use examples that are different from or contrary to transactions we have conducted or positions we hold. Furthermore, this website and any information or training herein are not intended as a solicitation for any future relationship, business or otherwise, between the users and the moderators. No express or implied warranties are being made with respect to these services and products. By using the Materials, each user agrees to indemnify and hold Tackle Trading harmless from all losses, expenses and costs, including reasonable attorneys’ fees, arising out of or resulting from user’s use of the Materials. In no event shall Tackle Trading or the author(s) or moderators be liable for any direct, special, consequential or incidental damages arising out of or related to the Materials. If this limitation on damages is not enforceable in some states, the total amount of Tackle Trading’s liability to the user or others shall not exceed the amount paid by the user for such Materials.
All investing and trading in the securities market involve a high degree of risk. Any decisions to place trades in the financial markets, including trading in stocks, options or other financial instruments, is a personal decision that should only be made after conducting thorough independent research, including a personal risk and financial assessment, and prior consultation with the user’s investment, legal, tax, and accounting advisers, to determine whether such trading or investment is appropriate for that user.