Scaling-in Your Trading Strategies

Most traders have a tendency to consider in terms of one shot in and one shot out when it comes to trade entrance and exit. A better average entry price might be available, though, if the position size is divided into several smaller trade sizes and scaled in gradually. Interested in learning more about the scale-in trading strategy?

Scaling in in trading refers to steadily increasing the size of your position as more entry chances are presented by the market. Instead of being a last-ditch effort to turn around a lost trade, the scale-in technique is an integral part of a well-thought-out trading plan.

The scale-in technique gives you more freedom in determining the best average price for your positions, but it takes a lot of discipline to stay on course when everything else seems to be going wrong. n this post, we take a look at the scale-in and scale-out trading strategies.

What is scaling-in?

Scaling is the practice of gradually changing the quantity of shares or trades to match your trading strategy. Scaling gives you more freedom in determining the best average pricing for positions. Scaling, however, necessitates self-control and strong responses to prevent excessively large positions in the event that the setups fail. Buying when the market is selling or selling when the market is buying is not for everyone.

An investor who uses a scale-in approach has the option of purchasing more stock as the price declines. Using this method, an investor believes that the price drop is brief and that the stock will eventually rise, making the current price a relative bargain. To successfully climb the mountain, you need conviction but not stubbornness. Between the two, there is a very thin line.

The lack of liquidity for some companies, however, can also be a problem if you wish to sell your shares because huge sell orders may encourage other sellers to move in front of your ask, driving the price down and giving you less money for your shares. Scaling out, which is the opposite of scaling out, enters the picture here. Scaling out involves offsetting your position in smaller increments to avoid affecting market activity.

What is scaling-out?

When momentum appears to be waning, an investor might limit exposure to a position by scaling out of a stock. Instead than trying to time the peak price, the investor makes money while the price is rising. However, if the value keeps rising, the investor might be leaving too soon.

There is no incentive to partially close out a trade once it has been shown to be unprofitable, therefore scaling out of positions only makes sense while they are lucrative. An investor can set two or three incremental profit targets as opposed to one overall profit target for the investment. It’s also feasible to let an indicator or a trailing stop determine when to close a portion of the transaction without setting any limits at all.

Because the full position would have been open for the duration of the entire upward advance, using this strategy diminishes overall profit for investors. Scaling out safeguards the profit, and for it to be effective, the market must be trending.

What is dollar-cost averaging?

The scale-in technique can be put into practice in a variety of ways. One popular one among stock market investors is dollar-cost-average, which entails purchasing shares as the price falls.

The practice of investing a set dollar amount on a regular basis, independent of the share price, is known as dollar cost averaging. It’s a popular method to form a disciplined investing habit, increase your investment efficiency, and possibly reduce your stress—as well as your expenses.

Say you put $100 away each month. Your $100 will buy fewer shares when the market is up, but more shares when the market is down. While compared to what you would have paid if you had purchased all of your shares at once when they were more costly than the average, this technique may eventually lower your average cost per share.

Scale-in trading strategy

The scale-in approach involves buying more stock when the price declines for stock investors. Using this method, an investor believes that the price decrease is brief and that the stock will eventually rise, making the current price a relative bargain. It’s one approach—among many—to creating a mean reversion strategy.

Thus, purchasing shares when they decline in price turns into a scheduled trade entry strategy. Scaling up a stock position gradually until it reaches the desired number of shares or the desired dollar value is the essence of the scale-in method.

The scale-in method allows for greater market timing flexibility and helps you arrive at the best average price for your investments.

However, because you would frequently be going against the grain and catching a falling knife — buying when the market is selling or selling when the market is buying — the process demands immense discipline to stick to the strategy when things seem to be coming apart.

The scale-in strategy requires complete conviction and a disregard for the alleged wisdom of the crowd, but you must also be alert enough to frequently evaluate your strategy in light of your parameters and performance indices.

Scaling-in vs scaling-out

The terms “scale in” and “scale out” refer to the same thing. Scale-out is a technique used to gradually close off transactions after using the scale-in strategy to build up your full position. The scale-out strategy operates as follows:

The scale-out method can be used if you have a total stake in the market of 5,000 shares of stock XYZ and wish to close your deal gradually. When the transaction has attained your initial profit target but it appears that the market may move in your favor moving forward, you apply this strategy. You collect profits on a percentage of your transactions by closing them, leaving the rest open to ride the trend. By doing so, you can profit from the trend while also locking in some gains.

The scale-out technique has the advantage of capturing a profit while leaving room for future gains. After collecting profit on a piece of the trade, you can also adjust your stop loss to break even or higher for the remaining portion of the position. The remaining available post would be almost “risk-free” in this manner.

What are the benefits of scaling-in?

The scale-in technique has a lot of advantages. Some of these include lowering the average entry price for long-term investors who aim to use dollar-cost averaging and shielding institutional traders from significant slippage and front-running. It allows short-term traders who utilize it to increase winning positions to start off with little risk and increase their profits on a transaction that has already started to look like a good idea. They only increase their trading when it is profitable and begin with lower transaction sizes.

When trading momentum (any momentum straetgy), buying into selloffs frequently goes against the grain and may result in a losing position if the stock does not return to the target price. Scaling in is a popular approach to optimize pricing, reduce the risk of the downside, and increase the upside potential, but it only works when the stock price recovers.

When you need to purchase a big number of shares of a stock that is not highly liquid—that is, a stock with lower daily trading volumes and a wide ask/bid spread—scaling is very helpful. A large volume purchase would cause the market to move significantly, resulting in a higher price per share. You enter with a superior average position price when using the scale-in technique.

What are the drawbacks of scaling-in?

The scale-in technique includes several drawbacks in addition to its advantages, regardless of how you use it. There is a chance that individuals who utilize it to lower the average entry price won’t enter their entire position before the market turns and accelerates, leaving them with an unfavorable position size. There is a chance that the market could turn against users of the approach to add to winning positions, which could result in an overall losing position.

Day trading scale-in strategy

While investors view scaling in as a technique to buy as prices decline in order to lower their average purchase price, day traders may view scaling in as a way to test the market’s mood first and increase their position size if the market is favorable in order to try and profit more.

In other words, a day trader who employs the scale-in approach just increases a profitable position and anticipates further positive market movement.

Scaling in for day traders involves initially testing the market with a small transaction size and then adding larger trades if the market is trending positively. It can appear that they don’t have confidence in their trading strategy because they are testing with a lower size and loading up at a larger price. However, you must realize that day traders operate on a very short time frame and prefer to be lucrative as soon as they initiate a deal, in contrast to investors who have the luxury of waiting for a stock to grow.

If their initial market timing is off, they can mitigate their losses by scaling in and taking smaller positions. As the market keeps moving in their favor, they test to make sure it is ready to move as they predicted before placing more positions at greater prices. By doubling down on a winning trade, they can use the float from the winning trade to cover the risk of the new trade.

No technique, however, is without dangers. If the trader is not diligent, buying at higher prices or selling at lower prices run the danger of a rapid market reversal depleting the floating profits and the deal ending in a loss. A quick reversal can result in a loss in the subsequent positions and, at most, a smaller profit in the first position, even for a cautious trader.

Institutional trader scale-in strategy

Institutional traders, who frequently trade very large orders, are another group with a distinct viewpoint on scaling in. They usually start their trades gradually till they load up their full position size due to their enormous order size. They might not be as worried about buying at a discount as a retail investor who wants to dollar-cost average, but they can still negotiate for a cheaper price in an effort to fill their position. They care about completing their requests discreetly because they don’t want anyone to attempt to bypass them. Scale-in methods are frequently employed by large hedge funds.

In conclusion, retail investors employ the scale-in technique to buy at various intervals as the price declines in order to reduce the average purchase price. In order to potentially improve their profit potential while assuming the risk of the additional transactions, short-term traders utilize the scale-in approach to add to a winning position. On the other side, institutional traders use the scale-in method to conceal their actions in order to prevent front-running and significant price influence.

Scaling-in vs martingale strategy

It is crucial that we briefly describe how these three trading techniques differ from one another. The double down and Martingale methods, which are truly desperate attempts to turn around a losing trade by adding more in the hopes that a smaller increase might assist bring the total trade to breakeven, should not be confused with the scale-in technique.

The scale-in strategy is a carefully considered trade entry strategy whereby a trader gradually builds up their position for various reasons, primarily to have a lower average entry price, whereas the double-down method involves adding another position to a losing position in the hope that a smaller favorable price move would bring the position to breakeven.

The next trade added under the Martingale approach is twice as large as the current position, which is an adaptation of the double-down strategy. Throwing good money after bad is all that either the straightforward double-down method or the riskier Martingale strategy involves while trying to prevent losing money.

Final thoughts

You may want to scale-in for a variety of reasons, some of which are discussed in this article. Picking peaks and bottoms is a common obsession among traders and investors, but it is a fruitless endeavour. Scaling in can increase your risk-adjusted return, therefore it might be a good choice for many of your trading techniques. However, everyone if different so it is vitally important that you only trade or invest in a way that meets your own risk preferences.