Scaling in and out of trades

Instead of entering and exiting entire positions in one go, many traders use scaling to manage their risk.

You can achieve this in two ways: scaling into positions and scaling out of them.

What is scaling in?

Scaling in is a method of opening trades that involves starting with a small total exposure and adding to it gradually over time. Doing this can reduce your risk, because if you get your entry wrong and your trade fails early, you won’t lose as much capital.

How to scale in to trades

To scale in, you select two or more entry levels for a trade instead of one. You open your position at the first entry level with a small total size, then add to it at each subsequent one.

This is particularly useful if, say, you have identified two possible entry points – one that offers a higher return but comes with more risk, and a safer option with lower potential profits.

By scaling in, you don't have to choose between the two. You can open your position when you think a trend is just beginning to form, then add capital as the trade earns profit.

When doing this, there are three general guidelines to follow:

1. Plan your entries beforehand

You'll need to ensure that you define your entry targets ahead of time. Don't just randomly decide to add more to a winning trade, identify key areas of support or resistance that signal a continuation if they are broken.

2. Watch your risk and reward

As you add capital to a position, your risk will increase. The market will be further from your stop, and closer to your profit level. To see how this works in practice, let's take a look at an example trade on the FTSE 100:

As you can see, each subsequent new position has a drastically worse ratio of risk to reward. However, it's easy to remedy this. All you have to do is move your stop loss.

3. Move your stop loss to control risk

If we move our stop loss each time we increase exposure, then total risk can be kept in check. Returning to our example above:

Entry 1

Total risk vs reward: 1:2

Entry 2

Total risk vs reward: 1:2:6

Entry3

Total risk vs reward: 1:3

By moving our stop loss, we lowered overall risk on the trade while increasing potential return. And along the way, we locked in some profits for good measure.

Benefits of scaling in

There are three main benefits to scaling in.

Firstly, it means that you don’t have to worry too much about getting your entry 100% correct every time.

It also enables you to target higher profits without taking on too much additional risk – as long as you do it correctly, as outlined above.

And finally, by scaling in you can reduce your exposure and risk less on each new trade. This opens up a strategy of taking multiple new positions, then building on the successful ones and closing off the losers. Some traders refer to as ‘pyramiding’ into a trade, and it can be a highly-effective strategy in strongly trending markets.

As well as increasing diversification, such a strategy is a useful way of exploring new ideas without losing too much capital if they don't come off.

Drawbacks

However, scaling in isn't foolproof.

For one thing, you'll need to ensure that you don't end up risking too much on a position by your final entry. For instance, if you're allocating 3% of your trading balance to each trade, then don't scale in beyond that point. Plan out your entries beforehand – for example, by setting three entries and adding 1% of your balance at each point – to ensure that you keep your risk in check.

Scaling in can also be tricky for short-term traders. Day traders and scalpers tend to look for small profit horizons, not the strongly trending markets required.

What is scaling out?

Scaling out is the opposite of scaling in – it's a method you can use to close positions gradually, instead of with a single trade. By partially closing a position early, you can realise some profits without exiting it entirely.

By ‘booking in’ some profits as a trade moves in your favour, you can alleviate the psychological stress of trying to exit trades at the ‘perfect’ level.

How to scale out of trades

To scale out of a trade, you close a portion of it without exiting the position entirely. How much you close is up to you.

For example, say that you have a long position on 100 Apple CFDs that is £5000 in profit. You're worried that Apple stock may be in for a reversal before it hits your profit target, so you sell 50 CFDs, realising a £2500 return in the process.

Apple's share price continues to rise. You earn further profits on your remaining 50 CFDs, but are still worried about an impending bear run. So you sell a further 25. This locks in more profits, before you eventually close the position entirely by selling the remaining 25 contracts.

Like scaling in, this works best if you adjust your stop loss at the same time. By moving your stop up closer to the current price of the market, you can further reduce potential losses and may even be able to create a 'risk-free' trade – especially if you are using guaranteed stops.

Of course, if you'd kept all 100 CFDs throughout then your final profit would have been higher. However, you would have also taken on more risk.

Scaling out after your target

In our example above, we partially closed a position early to lower our overall risk on a trade. That works well, but isn’t the only reason for scaling out.

If you have a position that has hit your profit target, but where you suspect that an extra return could be possible, you can scale out as a method of running profits. Essentially, all you do is close most of your position, but leave a portion of it open to capture any possible continuation.

If your original move peters out, you can close the rest of your position to keep the profits. You may want to consider placing a stop loss at or near your original profit target – that way, you shouldn’t lose anything from scaling out.