Sometimes, the difference between a winning and losing trade can boil down to one concept – Scaling.
When used properly, this simple idea can help reduce risk and maximize gains.
It’s a topic I speak regularly about in my Weekly Money Multiplier service.
Just the other day, I cleaned house on Wayfair (W)— by scaling in and out of my trade.
Of course, scaling in and out of a position is not something which you should look to do with every trade or strategy.
To better clarify what I mean, I’ve put together these scaling guidelines.
How many times have you entered a trade only to be immediately at a loss? You look at it, frustrated that you didn’t get a better start.
Happens to everyone at some point.
Thing is, you can’t always predict when a stock will stop to the penny. Sure, we all have ideas, but those are based on probabilities. Stocks can and do run further than expected all the time.
When they run too far, we stop out of a trade.
Scaling helps limit risk exposure while helping to maximize profits.
It works off one simple premise – on average, you’ll never get the entry or exit right.
Rather than beating your head against the wall to find a way to hit your orders to the tic, work with what’s in front of you.
Imagine you wanted to buy Netflix’s stock at $300. Based on the setup, your target is $305 and a stop loss of $295. In total, you want to risk $500.
If you bought all 100 shares at $300, you would risk $500 to make $500. Seems like a decent trade.
Now, what if you bought stock at two separate entries, say $300 and $297.50, and still wanted to risk $500 max?
Well, you’d buy 50 shares at $300 and 100 shares at $297.50.
Quick math: ($300 -$295) x 50 + ($297.50 – $295) x 100 = $500
Now, what would your payouts be?
If Netflix just hits $300 and then moves to $305, you’d make $250. But, if Netlfix hits $297.50 and then moves to $305, you’d make $1,000!
By scaling into the trade, I kept my risk the same but increased my potential profit to $1,000.
When scaling won’t work
I mentioned that sometimes scaling isn’t suitable for some strategies. In particular, it doesn’t benefit scalping traders.
Scalps are trades that have well-defined stops, entries, and targets. They are intraday trades that may last seconds to minutes.
Because scalping trades move so fast, there often isn’t time to scale into the trades. Additionally, these trades work best as simple math probabilities. Traders make money on these by tweaking their risk/reward parameters and win-rates.
Another place scaling won’t work is when you’ve already put in the max capital for your plan. I always tell Weekly Money Multiplier members to limit their trade size to something their comfortable managing.
However, small accounts often struggle to do this. That’s why scaling doesn’t necessarily work for them. You don’t want to overleverage your account and blow it up by scaling into a trade.
There are a few different methods for scaling into and out of trades. With all of them, you want to understand the maximum amount you plan to risk before entering the trade.
Scaling into and out of trades requires multiple entries and exits. How many you choose is up to you. Think of it as diversification. It’s good up to a point, but too much can take away your edge.
Here’s a few ways to think about scaling:
- The same number of shares for each order
- Putting in the same amount of money for each order (or pulling out the same amount for each exit)
- Using a percentage of your total capital
When I scale into trades, I always do so between my initial entry and my stop-loss. I never want to add anything beyond my stop-loss. That is the line in the sand for me that finishes the trade.
Scaling out of trades is a bit different. You never know how far a trade can run. That’s why I like to use multiple profit targets. At each, I’ll exit a portion of the trade. As I exit each position, I’ll set a stop loss at breakeven for the remainder. That allows me to lock in profits and ride out any further gains.
Learn through practice
Scaling takes a little finesse. You can always practice with a paper/simulated account without losing a dime.
One place that I use scaling all the time is with my LottoX service. Access to my streaming account and trade alerts let you see how I apply this concept in my trading.