Scaling in/out refers to the process of entering (scaling in) or exiting (scaling out) an increasingly favorable trading position.
Scaling In/Out Example
Suppose that a day trader wishes to buy 100 shares of Company A. He expects the shares to drop around $5 per share over the course of the trading day, but is not completely confident that they will fall that far.
Therefore, instead of waiting until the shares drop $5 to buy in for the entire 100 shares, he decides to scale in the position by buying 20 shares each time the share price falls by $1.
By the time the share price falls $5, the day trader will have bought the entire 100 shares that they intended to in the first place, though they will have paid a higher price for the entire position.
However, if the share price never drops the entire $5, they will at least have bought some amount of shares at a favorable price.
Now suppose that the day trader wishes to exit this position and expects the shares to rise $10 by the end of the trading day, though he is once again not completely confident that the shares will reach this $10 increase target.
Therefore, the day trader decides to exit the position gradually, selling 50 shares after a $5 increase in the price and the other 50 shares when the price increases $10 on the day.
This way if the shares never reach the full increase of $10, the day trader will still have sold 50 shares at a $5 increase per share.
Scaling out is a technique used to mitigate risk in trading.
Scaling In/Out and Trading
Day traders use scaling in/out when they are not completely confident in their price forecasts. The scaling in/out technique allows them to capture favorable trading conditions without trying to time the absolute peak in the profitability of their trade.
In essence they are sacrificing potentially superior yet risky profits in the future for less favorable yet risk-free profits in the present.
While scaling in/out is an excellent technique in those scenarios where a day trader is opening or closing a position they are unsure of in favorable conditions, they should beware using this technique too often.
Scaling in/out can often turn into simply lazy trading, where day traders are either taking risks they shouldn’t and attempting to mitigate this risk using scaling in/out or not fully analyzing their trades beforehand and using scaling in/out as a replacement for solid trade execution.
Scaling in/out can also be used by day traders when they have concerns that their orders may move the market unfavorably if they enter or exit a position all at once.
Generally day traders do not need to worry about moving the market, but in some cases of low liquidity or small market capitalization scaling in/out may be a prudent precaution.
Final Thoughts
Scaling in/out is yet another excellent tool for the day trader’s toolkit that allows them to execute a nuanced trade in certain abnormal trading scenarios. However, day traders should be cautious not to use scaling in/out as a cover for lazy or incomplete trading.