We know that Day Trading is based on statistics, patterns, and logic… But that doesn’t mean the world of day trading is always perfect. There are also a lot of seemingly random things that happen. It’s a volatile place where things can be hard to predict at times, despite being based on predictions.
This is a predicament that confuses not just beginners but many seasoned traders. The fact of the matter is, even if you’re experienced and know this industry inside and out, this randomness can affect your trades.
You can still fail. You still lose (sometimes).
And anyone who says anything different is simply lying to you!!
The markets are ever-changing and on some days, too many things are happening at once.
As a day trader,
…there is something you should know that will impact how you trade every day: You will never have all the answers, and every day can be different.
This means there is no set price at which you should buy or sell stocks. Knowledge is important, don’t get me wrong. With this, you’re well-equipped to play in this world of trading. But on most days you still have to make calculated moves.
You cannot do this on auto-pilot. You must take into account the inherent uncertainty and volatility of the market, and trade accordingly (and try your best to work with the situation, with some tools).
When there’s so much uncertainty and volatility that we know exists, should we not utilize ways to reduce the impact on our trades? Is there a method that can help us mitigate the risk that arises due to this uncertainty? This is where the concepts of scaling in and out of trading positions come in.
scaling is not a new strategy or an entirely new concept you must learn.
It’s a way to actually perform the strategies that make you a better trader. You already know how to pick stocks and implement your strategy. The question now is, in what fashion should you implement them that makes you a better trader?
Whether you’re testing out new strategies and using your tried and tested strategies in newer markets, it’s important to understand how you should make your trades that achieve your two most important goals: high profits and low risk.
It’s a matter of how you operate, and at what pace.
As the name suggests, to scale in and out of positions essentially means you do it gradually, rather than in one go. Since you are starting a new thing, it’s better to take it slow and be cautious. This is another way to do that.
The pace of trading is something that can determine your returns and risk. Whether you make the trading moves in one go or step by step holds significance, because every trade has consequences and it adds up.
scaling is done to minimize the risks and maximize the potential for profits.
There’s a reason a lot of seasoned traders use the technique over amateurs. Mostly because a lot of amateurs aren’t even aware of what scaling is and if they should do it.
The information out there is not just confusing, it’s inadequate. Scaling doesn’t get the emphasis it should and because of that, many newcomers aren’t aware of it.
That changes today because, in this article, I’ll explain what scaling is… how it works… and when (and why) you need it!!
SCALING IN & OUT
OF DAY TRADING POSITIONS
Scaling into a trade refers to the process of initiating only a partial and not complete position. It is a trading strategy in which you buy shares continually as the price drops. You would set a target price and then invest in incremental volumes as the stock falls below that price.
If the market shows favorable price action, you buy a little more, and so on. The process of buying is carried on until the time the price stops dropping (or the intended trade size is achieved). Let me illustrate this with an example…
Say you buy 25 shares of a 100 share target position. If you see favorable price action, you buy another 25. You now have half of your entire position. If the stock moves down a bit more, you make a move to buy the other 50 shares.
So now you’ve built your position in three buys as opposed to one buy. You will be paying less every time the price falls and so this method will keep lowering the purchase price.
So basically by scaling in, instead of making a big move you make small moves bit by bit. Scaling out works on the same principle…
It’s the process of selling partially the total held shares and in the meantime the price increases. To get out of a position in increments is what scaling out is. This method allows a trader to make profits as the price increases, rather than waiting for the highest price the stock can touch.
Say you’re at a 100 share position. If you see favorable price action, you sell 25. If the price increases further you sell 25 more and now you have sold half of your entire position.
If the stock moves up a bit more, you make a move to sell the other 50 shares.
To summarize: instead of buying or selling your entire position at once, you do it in smaller pieces.
WHY DO TRADERS SCALE IN & OUT
OF DAY TRADING POSITIONS
Scaling in and out is like dipping your toe in the water instead of jumping right in.
As I said earlier, there’s a large percentage of randomness in the markets on most days. This can easily distract you and lead you to make wrong moves. So, one of the ways to avoid that is to make smaller moves rather than one big move.
There’s no 100% set price to buy or sell at. You predict this price based on historical statistics or you take it step by step. Traders scale in and out of positions to achieve this. This means your moves don’t have to be perfect. You can take it one move at a time. This takes off a lot of the pressure from beginners, meaning you’re able to trade more comfortably and confidently.
It’s easier psychologically when you don’t have to accurately decide exactly where to get in or out of the market. Scaling in and out also protects your profits in case the price suddenly reverses.
You don’t know where the market will turn but you have a zone of interest where it might. Where your predictions might hit the mark. That’s when you use scale in and out.
Another instance where you might want to use scaling in and out is when you test strategies and patterns. This is something you want to do step by step, to see how the strategies and patterns actually perform.
A big reason to actually follow scaling in and out is to build enough confidence in your strategy before you go all out. When you’re testing new strategies this is a good way to go about your trades before you can find the confidence to rely on them.
THE PROS AND CONS
OF SCALING IN AND OUT
While there are some significant advantages of scaling, there are a few cons too. It’s good to be aware of both so you can make an informed decision. Let us look at the advantages and disadvantages of scaling in and out of positions.
- You can test the waters beforehand when you’re not confident what the markets will exactly behave like.
- While every trade may not be a winner, with scaling in and out the possibilities of extracting the maximum profits out of each trade increases.
- It gives flexibility to your trading.
- It gives you more freedom as you’re not bound by the very first trade you’ve made. There’s still room to make some changes if required.
- It gives you more time to observe the market and prepare your next moves.
- You will miss fewer opportunities.
- While scaling in and out makes you miss fewer opportunities, it might make you miss the best ones. The best opportunities may pass you by before you make your next move.
- It can complicate the process if you’re new to trading.
- It can mask the fact that you don’t have a proven pattern. You can keep making these small moves haphazardly and they might even work, but this only makes you ignore the fact that you don’t have a pattern that works.
If you take a closer look at the pros, they’re mostly about giving you the freedom, flexibility, and confidence to trade.
of one factor: time
Scaling gives you enough time to understand the changes in the market, make calculated moves, and spread out any gains or losses.
Scaling in ensures you take the time to observe the changes, to keep your losses in check, when they happen, and not lead to you blowing up your entire account. It helps you spread out your returns so that if and when something goes wrong you don’t get hit by a huge loss all of a sudden.
A huge loss can wipe out your entire account if you’re not careful.
Whether to scale or not is a trader’s personal choice. So while you may want to think over it, discuss it with your mentor and see if scaling works for you, it cannot be denied that the pros clearly outweigh the cons. Especially for beginners, scaling seems to make a lot of sense.
Ultimately, it’s a matter of analyzing the situation and your personal style to see if scaling would work for you.
Whereas if you are someone who likes to jump right in, scaling may not be your thing. This is something you need to figure out during your paper trading.
Speaking of the cons, they can be a deterrent but if you know what you’re doing, and as a beginner, if you work with a good mentor, the cons can be easily managed. So if a situation calls for scaling, it’s better to go for it despite the cons. The pros outweigh the cons if you do this properly.
Just like other trading techniques, nothing is set in stone and would depend a lot on the situation and the state of the market.
scaling in & out
In a nutshell, while scaling in and out can be a brilliant technique, use it carefully and cautiously.
It has to be said that even when you use scaling, you need to use it in conjunction with good patterns and strategies. Even if you become great at scaling, you need patterns that work.
Scaling in and out doesn’t override this!! Ultimately your goal is to use scaling in and out less and less as you go on. If you don’t, it tells me you don’t have a pattern that works. That’s a big issue that will follow you throughout your trading career.
So how do you find these patterns? Through a mentor of course! This brings me to…