Scaling into Positions

Sometimes you want to place more money on a trade than you know you should. In trading, it is very important not to risk too much, because you can’t tell which trades are going to go against you. That means you must work out your “expected” loss, the downside of any trade, if it goes against you. You can figure that out from the size of the trade and where you position your stop loss order, which you should always have on every trade you make.

Scaling into a position gives you an opportunity to finish up with a larger stake in the trade than you could reasonably do at one time. You do this by entering the trade in instalments, so that you do not risk too much of your funds. It is also sometimes called pyramiding into a position.

The way it works is simple in principle. You select your trade using whatever criteria you have chosen. For scaling, you want a trade that is likely to continue for some time, that is a strong trend. It is not designed for the short sharp move. When you work out your stop loss position, using your risk criteria you can figure how large a trade is the maximum you can place.

If the trade goes in your direction, at some point you will be able to move your stop loss up to a breakeven position, which means you are unlikely to lose any of your risk capital, barring unusual circumstances. This allows you to place a second trade on the same security, taking on the same amount of risk as before.

By continuing this process, placing a new trade once the stop loss for the previous one can be raised to a breakeven level, you never take on more risk of monetary loss than your initial trade, yet you are building a larger and larger position in the security, and this will increase your profits when you cash out.

Of course, this is easy in principle but there are some practicalities to decide on and take care of in order for it to work. You might choose to place equal trades each time, or you could decide to work out the size of each trade based on the new stop loss position that you will be using. As your trade progresses, the stoploss level should be raised to the same level on all of the positions.

Instead of placing the next trade once the previous one has reached a breakeven point, technical traders may decide to time each trade according to price movement. As the price trends upwards, there will inevitably be some pullbacks. Some traders would place the next position, scaling up their holding, after the price has pulled back and then started up again. The trade would go on when the price reaches a new high on its way up. This has the advantage of knowing by definition that the trend is continuing, even though it does not capture the gain from the low of the retracement.

While this seems like an ideal method to gain the most from a strong trend, scaling into a larger and larger position, you need to apply it with common sense. For instance, you do not want to continue ro use it if the trend seems to be faltering. Similarly, some financial securities are inclined to gap at the open, and this tendency could catch you out with an oversize holding, losing more than you would wish.

Provided you are prepared to analyze the trend, and confirm its likely continuation, then scaling into a position holds the promise of greater gains with no increase in risk of loss.

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