Scaling In
Scaling in is the process of buying shares as the price decreases. To scale in a trader sets a target price but enters the market using just a fraction of their total position. As the stock moves below the target price, the trader continues to invest in increments. The purchasing continues until the price stops falling or the trader reaches his or her predetermined trade size. This type of trading is considered a method of trade management as it allows you to reduce possible losses and maximise potential profits. Scaling in will, ideally, lower the average purchase price but if the security does not return to its target price, the investor ends up purchasing a losing stock.
Here’s an example:
If the security is worth $40 and an investor wants 2,000 shares, he or she can scale in, rather than purchasing the shares all at once. When the price reaches $40, the investor could buy 350 shares right away, then 350 shares at $39.90, 250 at $39.80 and 350 at $39.70. If the stock price stops falling, the investor will stop scaling in. The average purchase price would then be $39.85, rather than $40.
Scaling Out
Scaling out of the trade is similar in concept to scaling in, but in reverse. If a trader has already reached their profit target but sees that the market may continue to go in that direction, rather than closing out an entire position, an investor will partially close the trade in parts to allow for the rest of the shares to ride the stock’s move further into a profitable area. This strategy will enable traders to capture their original profit target while still leaving opportunities for additional gains by taking advantage of further price movements.
Pros of Scaling In
Reduces Risk
Regardless of what you do trades will either win or lose, but by entering a little at a time, you cut your total risk. Breaking down your trade position into mini portions gives you extra control over your gains or losses as the market can move in any direction at any time. If you enter a trade with just 25% of your position and the market begins to trend in the opposite direction, losing 25% is better than losing 50, 75 or 100% of your position.
Opportunity to Increase Gains
With scaling in, this method allows you to add more than just the intended trade amount. Let’s say that the trade is thriving and your entry position is now in profit. If you bring your stop loss up to the initial entry point, that eliminates your risk in the market. With this strategy, you can continue to increase the position size and keep adding to the profitable trade beyond the amount that you initially intended to enter.
Risks of Scaling
The most significant risk of scaling into a trade is that it can increase the overall exposure of your account. The use of different currencies while trading the US markets can cause a change in value to a trader’s position, gains and losses. Exposure makes it essential to apply appropriate money management, that means only risking 1-2% of your trading capital on a single trade.
The risk of scaling out is that if the market changes direction causing the trade to go against you, the more positions you have open, the more you can potentially lose. Always use proper money management when scaling out.
Quick Recap
- Scaling in or out is a type of trade management that helps to increase profits and reduces risk.
- To scale in means to enter the trade with just a portion of your predetermined trade amount and if the entry is successful continue to add to your position as the trade develops.
- To scale out means to exit the trade with just a fraction of the position to take already made profits and leave in positions to gain from continued market movements.
- To avoid the risks that come with scaling, apply and stick to your money management strategies.
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