SCALING YOUR POSITIONS
Scaling is a trade management method where you add or remove from your positions over time to control risk or take profits. It seems counterintuitive because you are making more trades, which requires more fees. Furthermore, if we believe a trade will profit, shouldn’t we be committed to that trade so that we can maximize the profit, buying at the lowest price and selling at the highest (or vice versa), instead of adding more to our position along the way? Well, not if we want to control risk while also keeping options open, and I’ll show you why.
The way scaling works is that when you enter a trade, you enter with only a portion of the total position size that you intend to trade. You then monitor the market and if the trade continues to match your expectations, you then enter more trades at statistically optimal points to do so, such as after pullbacks when the market continues to move in your favor.
Consider the figure of USD/JPY from April 2018 below, where we enter the position at the first highlight at around 113. We then add to our position after the pullback and continuation around 111 and the same with the highlight around 109.4.
By scaling into our position, we really have three trades going on, each with three different entry points. We could close all the trades at the same time, or we could scale out of our position just as we scaled in. Since the market entered a range at a point after the last trade, we may feel that it’s time to close that portion of our position but leave the other two portions open to wait and see what happens. If the trade turns against us, we could take profit on the second portion as well, leaving the first one open.
Pros and Cons of Using Scaling
As you can see from the example above, scaling in allows you to take profits on a portion of your position and leave the other portions open to run and see what happens. Even if the market turns against you and you allow the first two portions that we added to our position to break even, you would still have made a profit on the third portion that we closed.
In our specific example, you might wonder why we didn’t just enter our full position when we bought the first portion and then we’d have a profit of around 700 pips on our one large position (if we sold at the bottom). And you’d be right, we would. But we would have also lost more money if the trade had turned against us.
One benefit of using scaling is a psychological one. Scaling in and out of the market eliminates the necessity of being perfect in your entry and exit points. While we definitely try to succeed in the markets, and some of us are pretty good, none of us are perfect. By ratcheting our trades down closer to the action of the market, we can control risk, but also leave open the possibility for greater profit.
This scaling in and out frees us from the worry of whether we are right or not, a fact which some may or may not like. Some may feel that the worrying about whether we are right or wrong is an inherent part of trading in the market, or at least inherent of their own personal trading style. If this is what works for you and what you subscribe to, no one is forcing you to trade this way. But it is a flexible option that can enhance our trading.
It is vital to pair scaling with sensible money management. If you dedicate yourself to only risk 2-5% per position, you should spread that 2-5% out among all your trades that add to a position. If you risk 2-5% of your account for each time you add to your position, after three trades, you would be in 6-15% of your account in one position, and this is way too much risk if you seek to abide by the principles of good money management.
Some traders prefer to keep their trading simple: they get into the market, buy their full position at the entry point, and exit at the planned exit point. There is nothing wrong with this if that works for you. Trading only your full positions keeps your trading plan simpler and easier to follow. There is only one entry point and one exit point to keep track of, and you can anticipate where it will be. With scaling, these points are more dynamic and move around a lot depending on market performance. Keeping track of multiple stops, multiple take-profit points, and multiple break-even points can get quite confusing.
Scaling does represent a way to manage your trades in a way that controls risk. If the benefits of managing your trades this way appeals to you, go for it. Otherwise, don’t feel that you need to do so. The determining factor in deciding whether you should adopt a trade management strategy is your own trading personality, your appetite for your risk, and your performance goals. As long as we have money in our account, a reliable broker, and time to trade, we can trade in a way that suits us.