Price action scaling
Say the trader bought one contract at the bar 12 high and was willing to add at one-point intervals down to the stop below bar 3, which is 4.5 points lower. The trader would be risking 4.75 points on his first entry, 3.75 on his second, 2.75 on his third, 1.75 on his fourth and 0.75 on his fifth. If the stop were hit, the total loss would be 13.75 points, or about $700, and is less than the maximum allowable loss.
Most individual traders would not want five separate entries in a trade and would stop after adding one or two times. If the trader would have added on at one and two points down, fills would have been on bars 13 and 19 and total risk would have been 11.75 points. The trade would have achieved an 11.75-point profit later in the day; or, the trader could have exited the entire position once the market returned to the original entry price at the bar 12 high, which is what many successful traders do. This is one reason markets often pull back at new highs — bulls use them to take profits.
Another approach would be not to buy the high of bar 12 and simply wait to buy a one- or two-point pullback and add on one or two points lower, with a position size that would keep the total risk to under $1,000. The expected reward could have been at least as much as the risk, but many exit at their first entry price.
This process can be repeated. Say a trader was eager to get long and bought the exact high at bar 23 in “High risk” (below). The stop would be one tick below the bar 19 low, which was 3.75 points down, so his risk would be four points. If he planned to scale in one point below, and at every additional one point lower, he would have been filled on bars 26 and 37 in the green boxes. Although the bar 39 low was three points down, the limit order probably would not have been filled; the market usually has to fall a tick below a buy limit order for a fill.
Alternatively, the trader could have planned on a pullback and waited to take his first entry at two points below the bar 23 high. The fill would have been on bar 37. The trader then could plan not to scale in and simply place a stop below the bar 19 low. Because risk was two points, five contracts could be purchased.
The trader also could plan to add on a bigger position lower, as long as total risk remained below the $1,000 (20-point) maximum. For example, if four contracts were bought on a two-point pullback, he could buy eight more contracts one point lower. Risk would be to below the bar 19 low. This would be two points of risk times four contracts from initial entry, and one point times eight contracts on the second entry, for a total risk of 16 points; this is below the maximum to be risked on any trade.
The trader could then hold for a profit of 16 points. Because the position is 14 contracts, he could exit at just one point above the average entry price. Alternatively, half the position could be exited there and the other half at a new high. Many traders obviously had this idea, creating the reversal at the bar 50 high. Our trader is confident in the profit potential and therefore believes that the probability is at least 60%.