What is Scaling?

Now that you know how to set proper stops and calculate the correct position size, here's a lesson on how you can get a little creative in your trading.

For those trading multiple position sizes, you can get really flexible and creative on how you manage your risk by "scaling" in and out of your positions.

What is "scaling" and why would you use it?

Scaling in doesn't mean weighing yourself before, during and after a trade (although it doesn't hurt to monitor that too!).

Scaling basically means adding or removing units from your original open position.

This technique can be incorporated into your original trade plan OR for the more experienced trader, if the conditions of your trade changes then you can add or remove from your position in the middle of your trade.

Scaling can help you to adjust your overall risk, lock in profits, or maximize your profit potential. Of course, when you add or remove from your position, there are potential downsides to be aware of as well.

In the following lessons, we'll teach you all about the benefits and drawbacks of scaling in and out of trades. We'll teach you the CORRECT way to do this so that you don't go crazy because you took on too much risk and blew out your account.

Benefits

Probably the biggest benefit is a psychological one. Scaling in and out of your position takes away the need to be absolutely perfect in your entry or exit.

Let's face it - no one can consistently predict price action or the exact turning point of a market. It's way too difficult to keep expecting to get the best entry possible all the time. You are setting yourself up for a lot of heartache. 

The best we can do is identify an "area" of potential support/resistance, reversal, momentum change, breakout, etc. You can enter your position in bits and pieces around those areas and/or take your trade off at different levels to lock in profits.

How much easier would it be on you psychologically if you didn't have to accurately pinpoint exactly where to get in or out of the market? A lot easier right?! Plus you don't have to be a accurate like a sniper and catch a move from its inflection point (ooohhh, big word!) to grab some pips!

It also takes a lot of weight off of your shoulders anytime you can reduce risk right? How about locking in profits? Properly executed with a trailing stop, scaling out of winning positions can help you protect your profits just in case price suddenly reverses.

Finally, if you add more to your open position, and the market continues to go your way, your bigger position size will increase the amount you will make for every pip.

Drawbacks

The major drawback of scaling is when you add more to your position. Can anyone guess what that drawback is? You got it....YOU INCREASE YOUR OVERALL RISK!! Remember, traders are "risk managers" first, and if done incorrectly, "scaling in" can wipe out your account!! Lucky for you, we'll explain how to SAFELY add to an open position.

The second drawback is when you remove portions of your open position, you reduce your max potential profit. Who wants to do that? Well, in markets as fast and dynamic as the foreign exchange market, it may benefit you to reduce your risk and "take some off the table."

Scaling Out

As mentioned earlier, scaling out has the obvious benefit of reducing your risk as you are taking away exposure to the market...whether you are in a winning or losing position.

When used with trailing stops, there is also the benefit of locking in profits and creating a "nearly" risk-free trade. We'll go through a trade example to show you how this can be done.

Example:

Let's say you have a $10,000 account and you shorted 10k units of EUR/USD at 1.3000. You placed your stop at 1.3100 and your profit target is 300 pips below your entry at 1.2700.

With 10k units of EUR/USD (pip value of this position is $1) and a stop of 100 pips, your total risk is $100, or 1% of your account.

A few days later, the EUR/USD has moved lower to 1.2900, or 100 pips in your favor. This means you have a total profit of $100, or 1% gain.

All of a sudden, the Fed releases dovish comments that may weaken the USD in the short term.

You think to yourself, "This may bring dollar sellers back into the market, and I don't know if EUR/USD will keep going down... I should lock in some profits."

You decide to close half of your position by buying 5k units of EUR/USD at the current exchange rate of 1.2900.

This locks in $50 of profit into your account [at 5k units of EUR/USD, 1 pip is valued at $0.50.... you have closed a profit of 100 pips (100 pips x $0.50 = $50)]

This leaves you with an open position of 5k units short EUR/USD at 1.3000. From here, you can adjust your stop to breakeven (1.3000) to create a "risk-free" trade.

If the pair moves back higher and triggers your adjusted stop at 1.3000, then you close out the remaining position with no loss, and if it moves lower then you can just ride the trade to more profits.

Obviously, the trade-off for "taking some off the table" is that your original max profit is reduced.

Now, if EUR/USD ended up falling to 1.2700 and you had caught the 300-pip move with a 10k unit position of EUR/USD, then your profit would be $300.

Instead, you closed 5k units at a 100-pip gain for $50, and then you closed your remaining 5k at a 300-pip gain for a $150 gain ($0.50 per pip * 300 pips = $150). Together, this makes a $200 gain versus your original $300 max profit.

The decision to take some profit off the table is always up to you... you just have to weigh the pros and cons.

In this example, the trade-off is a better profit versus the peace of mind of a smaller locked-in profit and creating a risk-free trade.

Which is better for you?

50% more profit or being able to better sleep at night?

Remember, there is the possibility of the market moving beyond your profit target and adding more bling-bling to your account.

There's always much to consider when adjusting trades, and with practice over many trades, you'll find a process of taking off trades most comfortable to you.

Next up, we'll teach you how to scale into positions.

You may be asking, "Why? Why would I wanna scale into trade?"

Scaling into positions, if done correctly, will give you the benefit of increasing your max profit.

But as they say, "Higher reward means higher risk."

If done incorrectly, the value of your account could drop faster than you can even think about clicking the close button on your trade. Before you know it, you'll be staring at your computer screen, eyes wide open watching your account get margin called.

Now we don't want that to happen right?

So pay attention in class!

What separates "the correct way" from "the incorrect way" is the profitability of your open position when you add, how much more you add, and how you adjust your stops.

In the next two sections, we'll teach you two potential scenarios for scaling into a position. Since traders are "risk managers" first, we'll also touch upon the "No, No's" of adding to an open position.

Scaling Into Losing Positions

The first scenario involves adding to your positions when your trade is going against you. Adding more units to a losing position is tricky business and in our view, it pretty much should never, ever be done by a new trader. If your trade is clearly a loser, then why add more and lose more??? Doesn't make any sense right?

Now we say "pretty much" because if you can add to a losing position, and if the combination of risk of your original position and the risk of your new position stays within your risk comfort level, then it is ok to do so. To make this happen, a certain set of rules has to be followed to make this trade adjustment safe. Here are the rules:

1. A stop loss is necessary and MUST be followed.
2. The levels of position entry must be pre-planned before the trade was put on.
3. Position sizes must be pre-calculated and the total risk of the combined positions is still within your risk comfort level.

Let's take a look at simple trade example of how to do this:

From the chart above, we can see that the pair moved lower from 1.3200, and then the market saw a bit of consolidation between 1.2900 to 1.3000 before breaking lower. After bottoming out around 1.2700 to 1.2800, the pair retraced to the area of recent consolidation. Now let's say you think that the pair will return to the down side, but you're not confident of picking an exact turning point. There are a few scenarios of how you could enter the trade:

Short at the broken support-turned-resistance level of 1.2900, the bottom of the consolidation level. The downside of entering at 1.2900 is that the pair may move higher, and you could have potentially gotten in at a better price.

Wait until the pair reaches the top of the consolidation area, 1.3000, which also happens to be a psychologically significant level - potentially great resistance level. But if you do wait to see if the market reaches 1.3000, then you run the risk of the market not making it all the way up there and it drops back down lower, and you'd miss the return to the downtrend.

You can wait until the pair tests the potential resistance area, then moves back below 1.2900 into the downtrend before entering. This is probably the most conservative play as you get a confirmation that sellers are back in control, but then again you miss out on getting in the downtrend at a better price.

What to do? Why not enter at both 1.2900 and 1.3000? That's doable right? Sure it is! Just as long as you write this all down before the trade and follow the plan!

Let's determine our stop level. For simplicity, let's say you pick 1.3100 as the level that signals you were wrong and that the market will continue higher. That is where you exit your trade.

Second, let's determine our entry levels. There was support/resistance at both 1.2900 and 1.3000, so you'll add positions there.

Third, we will calculate the correct position sizes to stay within the comfortable risk level.

Let's say you have a $5,000 account and you only want to risk 2%. That means you are comfortable risking $100 ($5,000 account balance x 0.02 risk) on this trade.

Here is one way to setup this trade: Short 2,500 units of EUR/USD at 1.2900. According to our pip value calculator, 2,500 units of EUR/USD means your value per pip movement is $0.25. With your stop at 1.3100, you have a 200 pip stop on this position and if it hits your stop that is a $50 loss (value per pip movement ($0.25) x stop loss (200 pips)).

Short 5,000 units of EUR/USD at 1.3000. Again, according to our pip value calculator, 5,000 units of EUR/USD means your value per pip movement is $0.50. With your stop at 1.3100, you have a 100 pip stop on this position and if it hits your stop that is a $50 loss (value per pip movement ($0.50) x stop loss (200 pips)).

Combined, this is a $100 loss if you are stopped out.

Pretty easy right? We have created a trade where we can enter at 1.2900, and even if the market went higher and created a losing position, we can enter another position and stay safely within normal risk parameters.

And just in case you were wondering, the combination of the two trades creates a short position of 7,500 units of EUR/USD, with an average price of 1.2966, and a stop loss spread of 134 pips.

If the market went down after both positions were triggered, then a 1:1 reward-to-risk profit ($100) would be achieved if the market hit 1.2832 (1.2966(avg. entry level) - 134 pips (your stop)). Because the bulk of your position was entered at the "better" price of 1.3000, EUR/USD doesn't have to fall too far from the resistance area to make a great profit. Very nice!!!

Adding to an Open Winning Position

Now on to the fun stuff. If you catch a great trending move, scaling into it is a great trade adjustment to increase your max profit.

Again, just like Peter Parker, with greater reward, there is great risk, so there are rules to follow to safely add to open position. Let's go over those rules.

Rules to safely add to winning positions:

1. Pre-determine levels entry for additional units.
2. Calculate your risk with the additional units added.
3. Trail stop loss to keep growing position within comfortable risk parameters.

To explain this strategy a little better, let's go through a simple trade example...shall we????

We have Tom the "trend trader" closely watching EUR/USD, and after a bit of consolidation he thinks traders will push the pair higher which leads him to plan to on buying some euros against the U.S. dollar at 1.2700.

First, he sees that recent consolidation never really traded below 1.2650, so he decides his stop will be below that level at 1.2600.

Tom also thinks that because it is a psychologically significant resistant level, 1.3000 would be a great level to take profits because a rally may stall there.

With a 100 pip stop and a 300 pip profit target, his risk-to-reward ratio is 1:3. Pretty awesome right?

He usually only risks 2% of his account per trade, but this time he's really confident with this trade and with the great risk-to-reward ratio, he decides he will add more if the market moves in his favor.

He decides that he will add more units every 100 pips and trail his stop 100 pips. Because he plans on adding more units, he decides to start with an initial risk of 1%.

With a starting account balance of $10,000, Tom's initial risk will be $100 ($10,000 x 0.01).

With a 100 pip stop and $100 risk, he has determined his initial position size to be 10,000 units (position sizes can be calculated with our position sizing calculator), he will add 10,000 units every 100 pips, and trail his stop every 100 pips.

Let's take a step-by-step look at the change in risk-to-reward with each addition.

This simplified example shows the basic technique of how to safely add to winning positions and how effective it can be to maximizing your profits.

Now before you go pressing up every winning position you have, you have to be aware that adding to winning positions may not be the best tool for every market environment or situation.

In general, scaling into winning positions is best suited for trending markets or strong intraday moves.

Because you are adding to a position as it goes your way, your average opening price moves in the direction of the move as well. What this means is that if the market pulls back against you after you have added, it doesn't have to move as far to get your trade into negative territory.

Also, you should know that scaling into winning positions in range bound markets or periods of low liquidity leaves you open to being stopped out often.

Lastly, by adding to your position, you are also using up any available margin. This eats up into margin that can be used for other trades! You have been warned!!