Splitting trades (have your cake, and eat it)

 

I’ve been discussing splitting trades this week with Fight Back Trader members, and it’s raised a lot of questions, so I figured a general how-to on splitting trades would be useful, alongside a look at the pros and cons of this style of trading …

As I’ve often discussed in Traders Bulletin, the signal is just a fraction of a successful trading method – how we manage entering and exiting those trades that can really make the difference in your profit curve.

Beating failure

One of the main causes of failure for traders, that I see again and again, is the psychological pressure it puts on us.

The things that hurt are: losing runs and watching open profits evaporate.

Both these things are a key part of trading, yet they make us feel dreadful and lead many of us to doubt our abilities and throw in the towel altogether.

Splitting trades is a great way to overcome these psychological pressures – it can enable us to push our profits further than we’d usually feel comfortable with … and it can smooth out the bumps by making reducing losses.

Here’s how it works …

Taking partial profits

You know that feeling when your trade is showing a really good profit …

Does it feel great?

Well, often it just feels sickening. Should we take it off the table? Or wait until our target is hit? What if there’s a pullback?

What should feel positive turns into a torment.

The solution is to take partial profits.

This means that we close out a percentage of that trade at one profit target, and the remaining percentage at a higher profit target.

Let’s say that you’re trading with a target of 100 points, but you’re finding it very stressful waiting for that target to be hit, and often the price gets halfway, and reverts into a loss …

In this instance, instead of opening one trade, you could open two trades with half stakes. One trade will have the full 100-point target; the second trade has a 50-point target.

That way, if it reaches 50 points profit, the journey to 100 points is a lot less stressful, because you’ve already secured some profits in the bank.

Here’s an example

Let’s say that you’ve been trading with a 40-point target, and a 20-point stop, but you’d like to introduce partial profit-taking, because you feel that the gaps between your winning trades are just too uncomfortable for you.

To do this, with most brokers, you’ll need to create two separate trades, which means that you’ll have to half your stakes on each.

If you were staking £1/point previously, then you’ll have two trades at 50p/point each instead.

And they’ll look something like this …

In this example, rather than place a trade at £1, with a 40-point target and a 20-point stop, we’ve split this trade into two parts …

One 50p stake has a profit target of 20 and a stop distance of 20; the second 50p stake has a profit target of 40, and a stop distance of 20.

The result is that a trade which would have lost £20, instead ends up at breakeven, with one part making £10 (20 points x 50p), and the second part losing £10.

Protecting profits

This kind of partial profit taking often goes hand-in-hand with tightening in stop levels.

In the example above, this could mean that the stop is moved to breakeven as soon as the first profit target is hit. This would mean that the second half of this trade would have closed out at breakeven, turning a losing trade into a £10 profit.

(To be able to adjust stops like this, you’d need to either be at your screen to manage it manually, or using a form of automated trading. If you receive notifications from your broker when a trade closes, this can be a trigger for you to move the stop on your other trade.)

But partial profits won’t necessarily make us richer

Here’s another example …

Here, two buy trades are entered at 5536. Both have a 20-point stop loss. One has a 40-point target at 5576; the other has a 20-point target at 5556.

In this case, if we’re stuck with a single target, it would have been hit and we’ve have made more money than we have by splitting trades.

But taking partial profits isn’t just about maximizing profits.

Generally speaking, the further out we push our profit targets in trading, the more profitable we’ll be, but the more volatile our returns and the deeper our pockets need to be to cope with the losing runs.

For most of us, it’s about finding a balance, where the ups and downs of trading aren’t too painful, or too expensive – that way, we can stick it out for long-term profitability.

Splitting trades can help in two distinct ways here:

1 • If we want to boost our returns, it can encourage us to push our profit targets further than we might otherwise feel comfortable with (because we know we’ve got something already in the bank with the first profits taken)

2 • If our trading already feels too volatile, it can give us stability by taking some of our profits sooner.

It’s also worth remembering that – over the long term – smoother, but gentler profit curves can out-perform those with steep ups and downs.

(Please see THIS POST for more information on the effects of volatility combined with long-term compound investing.)

Splitting it further

Of course, there’s no law that splitting trades has to be done 50:50 … or profits taken at a halfway point.

You could close out 20% of your trade early … or you could take push your second profit level out to 1.5x your first target. You could split your trade into 3, or 4 different parts.

But bear in mind, that if you’re placing multiple trades, you must reduce your stakes accordingly, and you may run into issues with minimum staking levels.

This style of trading is about boosting your success rate, so you have fewer losses … it’s about pushing your profit targets to a level where YOU feel comfortable … and it’s about making trading less stressful, because the value of a good night’s sleep while you have open trades can’t be measured with a spreadsheet!

 

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