The term ‘add and reduce’ is one that is heard quite a bit in our VCM Proprietary Trading Room. There are two parts to this concept. The word "add" refers to adding more shares to your current position. The word "reduce" refers to changing the actual stop to a new area on the chart that is less than the original stop. You can't "add" unless you "reduce", unless you intentionally took fewer shares than you should have, at the time of your original entry. The reason is because this would increase your risk on the trade beyond what you originally intended to take, and that is something that traders should never do.

For example, let's say the original strategy was to enter stock XYZ as a long position over $32.50, with a protective stop loss under $32.20, giving us a $0.30 stop.

   $32.50 entry price

 - $32.20 stop price 

   $  0.30 total stop amount

In this example, we are only willing to risk $300.00, and therefore we can share size this trade with 1000 shares.

   $300.00 ÷ $0.30 total stop amount = 1000 shares

As the trade develops, you may look back on the chart and see that this stock has moved in your favor. It may have also formed a new higher support area, which allows you to raise the stop, because trading under this new support area would change the trend of the stock, and if that happened, you would want to be out of this trade.

In some cases, when you find this new higher support area on the chart, the size of the stop is actually less than the original stop. For this example, you may have the opportunity to raise the stop to a higher pivot low, which formed at $32.40. This means that your new stop will only be $0.10 (one third of what the original stop was). Again, if you are risking $300 on this trade, your new stop would have you losing only $100 (1000 shares × $0.10 = $100.00). Naturally, a great moment in any trade is when the stop becomes breakeven or better.

At the moment in time when a new stop is available, traders would typically be reducing their stop. They can do two things, when moving to this new stop. They can "put the money in the bank", which means to just let the trade continue with a new stop in place, and know that they have either locked in some profit, or in this case, they can at least decrease their loss by $200.00. The second option is that traders could choose to invest that money ($200.00) into new additional shares. See below, as how to calculate additional shares.

$200.00 ÷ $0.10 new stop amount = 2000 additional shares

In other words, add enough shares so that if the new stop triggers, the original risk amount of $300.00 is still the maximum that can be lost on this trade.

(Again, your original 1000 shares now has only a $0.10 stop, which would equate to losing only $100.00 on that 1000 shares, and the additional 2000 shares also have a $0.10 stop, which would equate to a $200.00 loss for the additional shares, and the total of all 3000 shares would still equate to only $300.00)

This means that the original risk parameters of the trade are still in place, as no additional money will be lost. However, the traders share size was increased, which allows for greater profit if the stock reaches its target.

A slightly different scenario could be that at the moment in time when stock XYZ formed an area in which the stop could be raised to $32.40, it also formed a new strategy with an entry over $32.55. (Again, when you moved your stop to only a $0.10 stop, the most you could lose was only $100.00 on the original 1000 shares, and therefore you have $200.00 available to buy additional shares, if you choose to). If you choose to add shares at $32.55 (with the stop at $32.40), the stop on the additional shares would only be $0.15. This means the additional shares can be sized to a $.15 stop ($200.00 ÷ $0.15 = 1333 additional shares), while still maintaining the original $300.00 risk.

Let’s look at an actual example on a chart of how these concepts work. Below, is a recent five minute chart of Broadcom.

On this chart, the drop to "1" begins a new downtrend, and we are now beneath the 200 period moving average (ma), as well as the declining 20 period ma. The next rally to “2" retraces about half the distance of the prior drop and forms a Velez Sell Setup (VSS), and stays in the area of the declining 20 period ma. If the entry and stop are based on the topping tail bar, there would be a $0.10 stop involved in this play. The entry, stop, and first target (Tgt 1) are shown on the chart above. We are going to choose to manage this particular trade by using "pivots". This means that every time a new down-trending pivot forms, we will lower the stop.

Let’s say for this example, you are keeping your risk at $300.00 per trade, which is consistent with the previous example. That means that we could short 3000 shares of Broadcom ($300.00 ÷ $0.10 = 3000 shares). If the trade were to stop, we would lose our $300.00 (plus any slippage and also commissions, of course). If we were to cover the entire position at target one, our profit would be $600.00 (3000 shares × $0.20 = $600.00). In that scenario, it would be called a "2R" trade, which means that we achieved a target that was twice our original risk amount.

However, for this example, we will not cover the entire position at target one, but instead, we will apply the “add and reduce” strategy. Our first target is $0.20 away at $21.27, and we intend to hold the second half of the position until the end of the day (target 2).

As the chart develops, we see the stock price drop to "3", and we have achieved our first target. This means we have covered 1500 of the 3000 shares, and that money, $300.00 (1500 shares × $0.20 profit move = $300.00) is in the bank. We are still short 1500 shares with the same original stop.

As the stock rallies back to the declining 20 period ma, a new VSS forms at "4". As we continue lower, we look back on the chart and see a pivot has formed and we can now lower the stop of the original position to 21.40. This means that we can continue to let the remaining 1500 shares play out, knowing that if the remaining shares "stop out", the remaining shares will still make an additional $105.00, on top of the $300.00 already in the bank, for a total profit of $405.00. This style of managing the trade would simply be known as “reducing the stop”, according to our management plan.

However, we have another option at this point. The pivot at "4" is also a new VSS. The entry and stop are shown on the chart above. We could opt to "invest" the money we have made towards new shares, rather than putting the money in the bank. Meaning, we could take the profits from the first 1500 shares, which was $300.00, plus the current profit of our second 1500 shares (locked in by our new stop), which is $105.00, and use that total of $405.00 to share size additional shares into the position. This of course would be known as the "add and reduce" play.

Notice that this add and reduce play could also stand on its own as a new VSS, even if you were not already trading this stock from the previous VSS position. However, if you were already trading it, you would then be able to add additional shares, with calculations that the total number of shares would stop out at the new stop, for an overall loss of no more than your original risk amount, which in this case was $300.00. Again, the secondary 1500 shares will be profitable by $105.00, even if they stop out at this new stop location. This means that in our new position, you can lose a total of $405.00. If you share size $405.00 with a $0.07 stop, it equates to approx. 5700 total shares. This means that we can have a new total position at 5700 shares, and if the position were to immediately stop out, we would only lose $294.00, which is less than our original $300.00 stop. See example below for more detail…

Example: 5700 total shares × -$0.07 stop = -$399.00, but let’s not forget that…

1500 shares of that 5700 total shares still have a +$0.07 profit per share, that equals $105 profit locked in on those shares.

Bottom line = -$399.00 + $105.00 = -$294.00 balance, which is less than our original risk amount.

If this position makes it to the next target, the profit achieved will be far greater, because we are carrying 5700 shares at "no additional risk" to the target.

Since our next target was to hold until the end of the day (EOD), we can see that shortly before EOD, a wide red bar developed after multiple down bars. Traders know that this is time to take profits, especially since it is minutes before closing. Profits should be taken as the next bar begins to turn green. Let’s say for this example, the whole trade was covered at $21.01. This would be a profit of $0.32 on the 5700 share position, which would be over $1800.00, but remember, we had $405.00 profit before adding the additional shares, so the total is $2205.00 profit.

Remember that this $2205.00 gain was achieved without ever incurring more than the initial $300.00 risk amount intended for this trade. This is the type of tactic that professional traders use on a regular basis to accelerate profits, without increasing risk.