Scaling in and out of trades
What is scaling?
Scaling is a method of trade management that allows you to reduce potential losses and maximise potential profits, despite the fact that the future price movement in the market is unknown. There are two types of scaling: scaling in and scaling out.
Scaling into a trade means that when you enter the market, you initially enter just a fraction of the total position that you intend to trade and then observe how this initial market entry develops. If the trade works out as intended, then you can enter further positions in the market and take advantage of the price moving in your favour.
The following chart demonstrates an example of multiple entries as the uptrend develops.
- First entry
- Second entry
- Third entry
The first position is entered when the market has shown a clear trend to the upside. A second position is entered after a pull back in the market and then started to continue on in the original direction. As the trade continues to go well, a third position is entered after a second pull back.
The benefits of scaling in
Let’s say that you wished to enter into the above trade with a standard lot. The trade will either win or lose, however by entering just a fraction of the standard lot, you reduce the total risk.
By breaking down this position into mini lots and only initially risking, say, 5 mini lots (half a standard lot) on the first entry, you will lose much less if the trade does not work out compared to if you entered with a full standard lot.
If the trade starts to go in your favour, such as the example shown above, then you can add to the position – for example, another 3 mini lots. If the trade continues to go well, as above, then you can enter two more mini lots.
Without scaling into the trade, you would enter the market with your entire position (in this case a full lot) which means that more would rest on your judgement of the trade being correct.
You can also add more than just the intended amount. Let’s say that the trade is successful and the initial position that you entered is now in profit. If you bring your stop loss up to the initial entry point, then you have taken any risk you had out of the market. This means that you can continue to increase the position size and keep adding to the winning trade beyond the amount that you initially intended to enter.
The risks of scaling in
The most prominent risk of scaling into a trade is that it can increase the overall exposure of your account, which is why it is essential to apply appropriate money management, that means only risking 1-2% of your trading capital on a single trade.
Even if the market is trending in your favour, there is always a danger of the trade reversing against you and the more positions you have open, the more you can potentially lose.
Also, as you enter positions while the trend develops, the later positions that you enter with may be closer to the end of the trend. It is advisable to be cautious when you are getting into a trend that has already been established for a while, as demonstrated in the chart below.
- First entry could end up with a small profit
- Second entry would probably end up with a loss
Scaling out of trades
Scaling out is a similar concept. Let’s say that you have a total position of one standard lot in the market, and the trade is in profit. You may have reached your initial profit target, but it seems like the market could continue to go in your direction. In this instance, you can close some positions to take profit and leave some positions open in order to take advantage of potential further price movement . By doing this, you maximise your gains by locking in the profit you have, while still having a position to take advantage of further price runs. You can see an example of this in the chart below.
- First exit
- Second exit
- Third exit
The chart above shows a winning trade was scaled out as part of the position was taken off at each stage of the upward move. The first exit was taken out of the market once the initial move upward had finished, leaving two further positions to take advantage of the continued upward trend.
This technique reduces your overall profit, because, of course, you would have made more if you had left the entire position open for the duration of the entire upward move. However, scaling out protects the profit you have. For scaling out to work well, the market needs to be trending.
So far, you have learned that:
- scaling is a method of trade management that maximises profits and reduces risk.
- scaling into a trade means that you enter with just a fraction of the intended amount that you wish to trade and then add to the position as the trade develops.
- scaling out means that you exit fractions of your position to lock in profit and leave in positions to take advantage of any further price runs.
- there are certain risks to scaling if you do not apply money management as this can increase the overall exposure of your account.
- caution is also advised when scaling in after a trend has been firmly established, as the later positions entered may be close to the end of a trend.