Although many have searched, there is actually no such thing as ‘the holy grail’ in trading, however, as it relates to management, “Add & Reduce” is certainly one of the most potent strategies out there. Let’s take a deeper look into this powerful technique.
The basic concept of Add & Reduce Management is to add to winning positions without incurring any more risk on the trade.
Essentially it helps to accelerate winners and maximize profits. The reason it is a powerful technique is because it gives us the ability to double and even triple our potential profits without increasing risk.
In life, as in trading, this is a rare “win/win” combination. Most of the time we have to give-up something or increase our exposure in order to gain a bigger edge or obtain bigger profits, however with Add & Reduce this is not the case.
There are various ways this can be done; however, there is one key component to this type of management: it requires confidence and winning trades.
What this means is that if you are a newer trader and you haven’t yet honed your skills, then you are likely still struggling to find basic winning trades, thus being in the position to add to a trade will probably be a rare occurrence. However if you have some more market experience and confidence, Add & Reduce is a fantastic way to accelerate profits without giving up much in return.
In order for this to work, we must have additional areas on the chart to add to our trade. This means that we DO NOT randomly add to our trades simply because they are moving in our direction.
If our initial entry is on a pullback buy set-up, then we will ride this up until we are presented with another possible entry point, such as a breakout or a 3 bar play. When we do this we will add shares at the new entry point, then raise our stop to the new stop area, and in doing so, gain a better position cost average, with potentially double the shares (or more).
We are not ‘obligated’ to double our share size, in fact it’s entirely up to the trader. We can add an extra 1/3rd lot, or perhaps an extra ½ lot, and sometimes even more than double our current share size. How much we add is solely up to us, and our comfort level.
Also note there are times when we will have multiple areas to add to our position throughout a trade, thus it’s possible to have 3 to 4 times more shares than we started with, YET, without increasing our risk exposure. This is also known as pyramiding.
See the example below to see just how powerful this technique can be,
As you can see in the example above from a trade that we took in our trading room, the initial entry was a nice controlled breakdown with a $250 risk level (1000 shares).
Then after the stock began to move lower another entry presented itself in the form of a 3 bar play (3BP). This gave us the opportunity to add shares, and tighten our stop loss. Ultimately this allowed us to literally DOUBLE our profits, without being exposed to any additional risk. This is powerful stuff.
Here is another example of a trade that we took live in our trading room,
In this example there is an initial entry at $43.15, with not one, but two areas to add to our position. The initial entry is a nice 5’ buy set-up at the r21ema with a BT, a NBB, at L2 Support and on a 50% retracement.
After moving higher, a consolidation area forms that allows us to add to our position and tighten our stop loss, thus incurring no additional risk.
Finally there is a 3 Bar Play that forms shortly after the breakout, once again allowing us to add even more shares without adding to our risk level.
Ultimately this trade began with a $250 risk level (2500 shares) and though we ended up with 7500 shares we never incurred another penny of risk, while ultimately doubling our profits.
There aren’t too many instances in life where we can increase our bottom-line while decreasing our risk exposure. Add & Reduce can be one of them.
All in all, Add & Reduce Management can be an effective way to increase/accelerate profits; however we must not forget four key points:
- You have to be a good enough trader to find and ‘be in’ stocks that move.
- You have to be willing to ‘re-invest’ some of your profits to make this work (takes confidence)
- You should only be adding on recognizable patters.
- How much you add is up to you; however it should never be ‘more’ than your initial risk if you stop out.
When used properly by disciplined traders this can be a powerful tool to have in your tool box. It’s usually best to start small when adding, and as you gain confidence and comfort you can begin to add more and more.
This article was originally published on StockTrader.com