Reverse scale trading

[longjohnsilver]

Hi, has anyone had any experience with reverse scale trading came across it at http://invest-faq.com/fiveminute/ looks like a viable strategy? thinking of using this in conjunction with CFD's to increase leverage and diversify my portfolio a bit more keeping it well within controllable limits ie nothing higher than about 40% leverage. This strategy involves investing fixed dollar sizes in a stock for every 50% increase in share price, I can see it taking a long time for stocks to increase 50% though and fees would eat away at my CFD account. Would it be too risky to decrease this down to 25%, could anyone offer some insight?

[OldRider]

I'm not sure, but from the brief description given seems this may have some similarities to systems
devised by Lichello, there were a number of calculators written, and some popularity a few years ago.
I played round with them and saw some merit.

Google Lichello for more info

[Phaedrus]

LJS, "Reverse Scale Trading" appears to be an inherently sound system in that it at least follows the basic dictum of "Cut your losers and let your winners run". Some of the discussion in his article is interesting - take a look at Chapter 6 for example, entitled The World's Worst Trading Strategy.
"The next step down our road to investment success involves briefly reviewing the worst stock trading strategy I can imagine, a simple strategy known as "Scale Trading". Why would we want to learn about the worst strategy? Because once we know the worst possible strategy, one that is destined to maximize losses over the long run, then we can reverse its ideas to craft a strategy which does just the opposite. "Scale Trading" is accomplished by taking an inital position and then adding to it in predetermined increments as the position declines in value..... Of course, not every scale trade results in a disaster, in fact most of them probably result in a profit sooner or later. But the potential for profit is small considering the time, worry, and capital invested. The typical pattern with scale trades is a series of small profits followed by one gigantic and inevitable loss."
Sound familiar? It should, because this is just averaging down as practiced by some ST posters. The author, Braden Glett, includes a nice comparison chart, featuring the differences between Scale Trading (averaging down) and "Reverse Scale Trading" (averaging up or pyramiding) :-

http://i602.photobucket.com/albums/tt102/PhaedrusPB/ScaleTrading.gif

The author also has some interesting views on Fundamental Analysis :-
"You may have noticed that there is nothing in this chapter regarding how to perform fundamental analysis of industries, companies within that industry, financial analysis of earnings statements and balance sheets, etc. Perhaps you expected any book on stock picking to include these topics, but Five Minute Investing does not. The simple reason for this is that if the market is saying that a certain company's earnings are expected to grow (evidenced by an accelerating upward stock trend), why should we find reason to dispute what the market is saying? As long as we have a loss-cutting mechanism in place, we do not need to use fundamental analysis to validate what the market already has told us about the future earnings of the company. The opinion of the aggregate marketplace has far more credibility in my eyes than does the opinion of any fundamental analyst, no matter how good. So I will always go with the opinion of the market, as opposed to anyone else's opinion, including my own. To me, anyone who tells me that a stock which is moving up (or down!) shouldn't be moving up (down), has by definition missed something in his analysis.To make my point on the futility of fundamental analysis for the average investor, think of how you would determine if the grass in your lawn was growing quickly. Wouldn't you just measure the grass today, wait a few days, then measure it again and subtract? If you did this and discovered that the grass was growing quickly, would you then go out and conduct a survey of the temperature, rainfall and hours of sunlight per day to validate that the conditions for growing grass are indeed good? Of course not! You would rightly conclude that the conditions for grass growth are good based soley on the fact that the grass is growing. Even if you did cook up some formula to predict grass growth based on environmental conditions, would you trust your formula more than your direct measurement of the grass's actual growth? If your formula said that grass shouldn't be growing and yet it was growing, would you stop mowing your lawn? Again, to do so would be preposterous. You would have to conclude that something is wrong with your formula.Unfortunately, common sense of this sort does not get applied in the stock market by many people. Even though we can directly measure through a stock's price trend what the company's growth prospects must be, there is always someone there to try to make us lose sight of that simple fact by pointing to his "analysis." You can be sure that for every fantasticly bullish trend, there is some analyst somewhere saying why it shouldn't be happening all along the way.The best you can do is to not listen to such opinions, and, again, go back to the market as your one source of advice."

Well worth reading, whether you agree with him or not. Essentially, this guy is a trend-follower.
Using a slightly different approach and slightly different methodology, I do exactly the same thing.

[longjohnsilver]

Thanks Old rider and Phaedrus. Looks kind of similar to Lichello, but I think Lichello is more of a risk management system and from what I read involves selling part of the position as the value increases and buying as it decreases, as opposed to increasing the size of performing positions as the value of the portfolio grows which has a snowballing effect. Good to know you follow the same type of system Phaedrus, I think trend following is the way to go. Was wondering if anyone could offer some advice on setting stop losses as well? Braden Glett from the article uses an initial stop loss of around 30% which is quite large. Are fixed dollar stop losses a good idea?