Scale-In Trading Strategy: Overview, Rules, Backtest Analysis

When it comes to trade entry and exit, most traders tend to think in singular terms — one shot in and one shot out. But breaking the position size into multiple smaller trade sizes and scaling in gradually may offer a better average entry price. Want to know about the scale-in trading strategy?

In trading, to scale in means to gradually build up your position size as the market creates more entry opportunities. The scale-in strategy is a part of a well-thought-out trading plan, rather than a reactionary attempt to salvage a losing trade.

The scale-in strategy enables more flexibility in terms of attaining the most optimal average price for positions, but it requires enormous discipline to stick to the plan when things seem to be falling apart. In fact, it is better implemented with a trading algo.

In this post, we take a look at the scale-in and scale-out trading strategies. At the end of the article, we make a backtest of how you can use a scale-in strategy.

Table of contents:

What is scale-in?

But first, let’s look at what scale-in actually means:

For stock investors, the scale-in strategy is buying additional stock as the price drops. An investor using this strategy assumes that the price decline is temporary and the stock will ultimately rebound, making the lower price a relative bargain. It’s one method (of many) of how to make a mean reversion strategy.

So, buying as the stock price drops becomes a planned trade entry strategy. In essence, the scale-in strategy is the process of gradually increasing a stock position until it reaches the number of shares or you have invested the dollar amount you planned to invest.

The scale-in strategy offers more flexibility in market timing and enables you to achieve the most optimal average price for their positions.

However, the process requires enormous discipline to stick to the plan when things seem to be falling apart because most of the time, you would be going against the grain and catching a falling knife — buying when the market is selling or selling when the market is buying.

To be successful with the scale-in strategy, you need to be totally convinced and not bother about the so-called wisdom of the masses, but you must be present enough to regularly assess your strategy based on your parameters and performance indices.

Dollar-cost averaging

There are different ways of implementing the scale-in strategy. One common one among investors in the stock market is dollar-cost-average, which involves buying shares as the price decreases.

Dollar Cost Averaging vs. Lump Sum Investing Backtest

In this case, you set a target price and then invest in volumes as the stock falls below that price. This buying continues until the price stops falling or when you have reached the intended position size. Scaling in, therefore, allows you to lower the average purchase price since you pay less each time the price drops.

Buying into selloffs often goes against the grain when trading momentum (any momentum strategy), and if the stock does not come back to the target price, you may end up with a losing position. But when it works and the stock price rebounds, scaling in is a great way to optimize pricing, minimize the downside, and maximize upside potential.

Scaling is especially useful when you want to buy a large number of shares, and the stock is not very liquid — that is, a stock with smaller daily trading volumes and a wide ask/bid spread. If you buy a huge volume at once, you would move the market by a lot and end up paying a higher price per share. With the scale-in strategy, you have a better average position price upon entry.

Scale-out

However, for such stocks, low liquidity can also be an issue when you want to sell your shares, as large sell orders can invite other sellers to step in front of your ask and push the price lower, offering you less amount for your shares. This is where scaling out comes in – the opposite of scaling out. Scaling out is to offset your position in smaller pieces so as not to impact market action.

Scale-in and different trading strategies

All we have discussed so far about purchasing as the price drops further may apply mostly to investors who have the patience to wait for the price to rebound.

For day traders, especially in the forex market but also in stocks, scaling in means a different thing entirely. Of course, as with investors, many traders use the scale-in strategy to increase their position sizes, but the way they do that differ.

Let’s look at how different type of traders might use a scale-in trading strategy:

Scale-in trading strategy for day traders

While the investors think of scaling in as a way to lower their average purchase price by buying as the price drops lower, day traders might consider scaling in as a way of testing the market’s disposition first and increasing their position size if the market is favorable so as to make more money.

In other words, a day trader who uses the scale-in strategy only adds to a winning position and hopes that the market would continue moving favorably.

Day traders’ method of scaling in is to test the market with a small trade size first and then add more trades if the market is moving favorably. This testing with a smaller size and loading up at a higher price may seem like a lack of trust in their trading approach. But to understand day traders’ idea of scaling in, you have to understand that, unlike investors who have the luxury of waiting for a stock to rise, day traders trade on a very short time frame and like to be profitable the moment they enter a trade.

Which Time Frame Is Best In Trading?

With their method of scaling in, if their initial market timing is wrong, their losses won’t be much with smaller position size. That is why they test to see that the market is ready to move as they anticipated before adding more positions at higher prices, as the market continues to move in their favor. By adding to a winning position, they can use the floating profit from the already winning position to bear the risk of the new position.

However, no method is without its risks. Buying at higher prices or selling at lower prices comes with the risk of a sudden market reversal draining out the floating profits, and the trade ending in a loss if the trader is not careful. Even for a careful trader, a sudden reversal can result in a loss in the later positions and at most a lesser profit in the initial position.

Scale-in trading strategy for institutional traders

Another group with a different perspective on scaling in is institutional traders who often trade huge orders. Because of their huge order size, they have to enter their trades gradually until they load up their full position size. While they may not be overly concerned about getting in at lower prices like the retail investor who seeks dollar-cost averaging, they