Scaling in and out of trades can be a real game changer when it comes to consistently profitable trading. No matter if you trade stocks, options, futures, forex or whatever, if you are currently entering and exiting your trades in one step, you are making trading much harder for yourself. In this article, you won’t only learn what scaling in and out of trades is. You will also learn why and how you should scale in to a trade instead of opening it in one go.
What is scaling in and out of trades
First of all, let me present what scaling in and out of trades is. Scaling in and out of trades is also often referred to as averaging in and out trades. The main difference between a ‘normal’ trade entry and a scaling entry is that when scaling, you build your position in multiple steps.
Let me give you an example:
Let’s say, you want to open a 1000 share long position in stock XYZ. The most straightforward way to do this is to send a 1000 share buy order. However, what you could do instead is split up the opening process into multiple parts. For instance, buy 500 shares twice or 200 shares 5 times, 100 shares 10 times etc… If you would do this, you would scale in to a trade.
The same can be done when exiting your trades. Instead of selling the entire position at once, you can split up the process into more than one step. The following chart shows how you could scale in and out of a trade:
You’re probably asking yourself why this is better than just opening the entire position in one step. So let me present you the advantages of scaling in and out of trades next.
Pros and cons of scaling in and out of trades
1. Smaller losses
Generally speaking, scaling in and out of trades leads to fewer and smaller losses. One main reason for this is that your initial entry is with a much smaller size than if you would go in with full size right away. Let me give you a concrete example:
Once again, you want to buy 1000 shares of XYZ which is trading at $25. If you scale into the position, you could split it up into 3 steps (400, 400 and 200 shares). Your first order is a buy order for 400 shares. Now let’s say XYZ’s price immediately goes against you and drops down to $24 which is your max risk level. Therefore, you exit the position and cut the loss. Your total loss is $400 (400 * $1).
If you would have opened that position with the full 1000 shares right away, that loss would have been $1000 instead of $400 (1000 * $1).
2. Bigger gains
In addition to smaller losses, scaling in and out of trades, often also leads to bigger profits. One reason for this is that when scaling out of positions, you give your trades the opportunity to make (more) money.
Once again, I will give you an example:
You bought 100 shares of stock ABC at $150 and ABC’s current price is $155. If you would close the entire position at once right away, your total profit (without commissions) would be $500 (100 * $5). However, let’s say you only sell half of the position at $155 and hold on to the remanding 50 shares a little longer. Now ABC’s price continues to rise to $158 at which you sell the last 50 shares. Now the total profit would be $700 (50 * $5 + 50 * $9) which is $200 more than before.
All of the advantages that I am going to present next are related to the two just-mentioned ones as they lead to bigger profits and smaller losses. In other words, they lead to better, more consistently profitable trading results.
3. Room for error
One more major advantage of scaling in and out of trades is that it allows for imperfection. If you always open and close all your trades in one go, you have to be correct right away. If the position goes against you, you will likely take the entire position off to cut losses. This leaves little room for error.
However, if you scale
The same goes for when closing your positions. If you take off your entire position at once, you immediately eliminate the entire profit potential. But if you scale out of your position, you give your positions more time to work as you only lock in the loss or profit of a small part of your overall position.
4. Improved trading psychology
Another advantage of scaling is that it helps to cope with emotional trading. A few examples of aspects that are improved by scaling in and out of trades are patience, confidence/conviction, stubbornness…
Patience is probably the most straightforward. A common problem amongst traders is that as soon as they see a profit, they begin wanting to lock in the profits so that they can’t turn into losses. The problem with this is that this often leads to people leaving a lot of money on the table which leads to overall smaller profits. This can often be a reason for the lack of profitability.
The way that scaling out of trades helps against this is that it allows you to lock in profits without eliminating the entire remaining profit potential. When taking partial profits, you still give your positions the chance to make more money.
Furthermore, scaling helps with your confidence in your own trades because you slowly build your position instead of putting on the entire thing at once. This means that you should only be in a position with the full intended size if it already has proven itself. Otherwise, you should only be in the trade with a small position.
Generally, the aspect of trading that has the biggest effect on your emotions is the size of your positions. To make this point clear, answer this question honestly:
Would your emotions impact your decision making when you trade a $20 stock with 1 share?
Probably not, because 1 share is a tiny position. The smaller your position, the less emotional you usually are. Scaling in and out of trades leads to you, on average, being in your trades with full size less and for shorter periods than if you wouldn’t scale in to a trade. This alone, leads to more rational and mechanical trading.
5. Better entry and exit prices
Another advantage of scaling in and out of trades that I could think of is that it often helps you get better average entry and exit prices. This is the case because not all your buy orders or sell orders will be at the same prices. Let me give you an example:
ABC is trading at $10.5 and you want to buy 1000 shares. If you just buy the 1000 shares in one go, your average entry price will be $10.5. However, if you begin by buying 500 shares at $10.5 and then ABC’s price drops to $10.0 which is where you buy 500 shares more, your new average entry price will be $10.25 ((500 * $10.5 + 500 * $10.0) / 1000). This is a significantly better breakeven-point than before.
Summed up, scaling in and out of trades allows you to be less perfect and more flexible with your trading.
The following graphic compares scaling in/out of trades and opening/closing your trades at once:
The main disadvantage of scaling in and out of trades is commission costs. Depending on your broker and on your commission structure, scaling in and out of trades can be more expensive than opening and closing everything in one go. If you, for instance, have a flat-fee that you have to pay to open a trade, scaling into trades will cost more than not scaling into trades.
Due to commissions, scaling in and out of trades is especially useful in larger accounts where commissions don’t play a big role. With that being said, I still think that scaling in and out of trades can be beneficial for small accounts.
To show that scaling in/out of trades can be done in small accounts, take a look at the commission structure of my favorite broker tastyworks:
- $5 to open a stock position (regardless of size)
- $0 to close a stock position
- $1 (per contract) to open an option position
- $0 to close an option position
As you can see, tastyworks’ commissions are very competitive. Due to tastyworks’ commission structure, it is very possible to, at least, scale out of your trades even if you only have a very small account. Tastyworks does not charge any commissions when you close your positions. Therefore, it does not affect your trading cost whether you close your positions in one, two, three or even more orders.
Tips for scaling in and out of trades
Scaling in and out of trades has many advantages. Nevertheless, it is still important to have rules in place when scaling in or out of trades. Furthermore, there are some things that should be avoided when you scale
- Proper risk management: Just because you are scaling in and out of trades, does not mean that you shouldn’t actively manage your risk. Regardless of your entry and exit style, you should always have a plan and define your max risk before you open a trade.
- Don’t just add and add to losing positions: Adding to your position after it has already gone against you allows you to move your average entry price closer to the current price. But this does not mean that you should just continue to add and add to a position that has clearly already gone too far against you. Always remember that for each time you increase your position size, you are increasing your risk as well!
- Remember to take profits: Scaling out of trades allows you to be more patient with your positions. With that being said, it is still important to not be overpatient.
- Let your position prove itself: Before adding to a position, let it prove itself. Everything should be going according to your anticipated plan. If things aren’t going as expected, do not increase your position size and risk!
Scaling in and/or out of trades can be very beneficial to your trading. Nevertheless, it is important to understand that scaling in and out of trades won’t always lead to better results. There will be some trades where you might have had a better outcome if you wouldn’t have scaled. But this does not mean that you should never scale
Scaling in and/or out of trades just allows you to be less perfect and more flexible. However, if a certain trade would have been perfect (e.g. you bought at the low and sold at the high), scaling does not help. But let’s be honest, it is rare to execute a trade completely flawless.
In other words, scaling is not for you if you are a perfect trader that always hits the tops and bottoms perfectly.
For everyone else, I at least recommend trying to scale in and/or out of trades. A good beginning is to start by closing your positions in more than one step. This is especially useful if your broker is tastyworks because there are no commissions on closing orders at tastyworks.
If you want to learn more about tastyworks, make sure to check out my tastyworks review.