Discussion on a compounding trade idea

[np88]

Hi all,

This is a basic strategy for a single trade that I have been deliberating for a little while and I think it has many drawbacks but would like your ideas on these so I can work around this and make a more solid strategy.

The idea is based around compounding on a single trade. Let's assume you have found a trend and a resistance point. You know (as an assumption) the market is likely to fall by 5 points if it passes this point. I am deliberating the best way to maximise a single trade on this using compounding.

The idea is that you set a limit order at each point so that the amount per point is 10% higher at each point.

Let's say the starting value is £100 per point and the security being traded is at 100 and likely to drop to 95.

Therefore there are orders as follows:

100 - £100 per point
99 - £110 per point
98 - £121 per point
97 - £133.10 per point
96 - £146.41 per point
95 - close trade for £610.51 instead of £500 if only £100 was used

Potential drawbacks:
- as the trade compounds, a move in the opposite direction will have a bigger effect than if it was not compounded.
- the price may 'slip' past the order price before it is executed.
- margin requirements may mean that more margin is required than the profit made up until that point from compounding.


I have an idea of ways to overcome the above points. Can anyone else provide other potential drawbacks and ways to combat this and the above points?


Thank you very much in advance for your help


NP88

 

[barjon]

long as you shift your stop as you make your additions so that your initial risk is not exceeded it'd be alright

 

[Shakone]

Definitely worth testing out np88.

For systems where you are adding either to losers or winners, for me you have to consider whether this is better than going all in at one point.

Some food for thought. Lets say you have an edge on the order at 100. You haven't mentioned stops, but lets keep it simple and say your target is 95, and your stop is 105, but that it will hit 95 with >50% probability. Then you add in some more to your short at 99. Does this increase or decrease the edge? Does this trade from 99, with target of 95, and stop (still at 105 or wherever you now have it) have an edge on its own? If it doesn't, why trade there? After all, you can view this second trade at 99 as a separate trade. If it has no edge, you shouldn't be adding to your position there should you?

Alternatively if the trade from 99 has a greater edge than the one from 100, then why not go in both positions at 99? This applies all the way down to the position at 96. Even if you are happy to enter with a smaller edge each time, this seems to make a hard task (that of finding a good edge), even harder, because you now have to find an edge where you can continually add with each new addition having a positive edge too.

Adding in as you go, or even scaling out, seems to be more about the psychological advantages.

 

[np88]

Thanks for the feedback.

Shakone - I get what you are saying but the reason for the compounding idea is to use the profit made from the previous pip to fund the increase on the next pip