How to Take Larger Profits with Scaling
Many traders have heard of ‘scaling’ (also known as ‘pyramiding’) their trades in the market, but few understand it and fewer still know how to do it correctly.
So what is it?
Scaling means adding to already profitable positions to take advantage of a continued strong trend.
Instead of just one initial trade, you might have two, three or even more positions in the same stock or currency pair.
A scaling strategy works well in trending markets and will give you greater profits without increasing your original risk -- if you do it right.
I’ll explain how in just a moment. But first, let’s address a couple of myths about scaling so you’re clear on what it isn’t.
Scaling is not “averaging down”. That’s when you add to a losing position (long or short) to give yourself a better average cost on your trade.
While there are times when I want to accumulate a large position prior to a breakout (the yen pairs currently come to mind here), that’s NOT scaling.
A scaling strategy is when you add to an already winning position because the existing trend is strong and looks to continue for the foreseeable future.
Another myth: scaling is not that risky as long as you objectively understand when to add positions and when to adjust your stop loss.
Now here’s how it works ...
You only add to a position that’s already profitable and showing continued strength or weakness (depending on whether you’re long or short).
Because I typically get into trades with stop orders, that means entering each new trade when it breaks out (or breaks down in the case of a short) and continues the existing trend.
You follow the same rigorous entry rules for new entries as you did the first time around. Don’t jump in just because you’re greedy for more. Analyze the new trade setup exactly the way you did the first one.
That means ensuring you’re entering with the trend, backed by a pattern that supports it, and supported by corresponding price action with the momentum in your favor.
There’s one additional rule, though.
Your original and any previous scaling additions must ALL show profit before you enter a new position.
This is very important because those earlier profits will offset any loss on your newest position.
Most traders fail to do this analysis objectively.
You have to carry out your analysis and make your decisions with the same rational detachment you had before you got into the initial trade.
But most traders can’t. Once they have profits sitting in their account, they start to panic once they see some of those profits slipping away. Then they’re out of the market at the first pullback and they’ve missed most of the big move.
So think it through carefully.
Where did you set your first stop loss? If you were smart, you placed it where it wouldn’t get touched unless you were totally wrong about the trade.
And how do you set your new stop losses after each successive scaling entry?
By following exactly the same rule.
You don’t move your stop until your new trade is profitable AND there’s a place on the chart where the market won’t go unless the trend is truly over.
And when you move your stop, you move it for the ENTIRE position, not just the latest addition. That’s how you protect your earlier gains while giving the newest position room to breathe and add even more profit to your overall trade.
Remember, the stop loss on your entire position only gets moved when it makes objective sense to do so. Not because you’re scared of losing.
The moment emotion starts to run rampant in your mind is the moment your scaling strategy is doomed to failure.
One more thing ...
You’re probably wondering how you can be confident a strong trend will keep running in your favor.
This is where looking at higher timeframes comes into play. If you’re trading on a daily chart, is there evidence for a BIG trend on the weekly chart? The monthly?
Such evidence would include a long-term trend and/or big reversal pattern at that level.
For example, think of a head and shoulders. That’s typically a trend reversal pattern. A big head and shoulders can reverse a long-term trend.
But it can also signal the continuation of a big trend if it’s arresting a short-term countertrend. That would suggest the next leg of the bigger, longer-term trend is about to begin.
You won’t see any of this if you only look at one timeframe. And it’s why I recommend consulting longer timeframe charts regularly to get the big picture.
Is there a clear trend in place? A clear reversal?
Then (and only then) you can use a scaling strategy with confidence it will generate far larger profits than one initial position alone.
I hoped this helped you understand what scaling is and when to use it.
Do you have any questions or comments? Let me know ...