Key Takeaways
- Scaling out of a trade means selling portions of shares as the stock price rises to lock in profits and reduce potential loss exposure.
- The scaling-out strategy helps minimize the risk of missing peak market prices but may result in selling shares too early.
- To scale out effectively, set multiple incremental profit targets rather than a single target and consider using a trailing stop.
- While scaling out, investors lower risk if the market trends downward after selling some shares at rising prices.
- Critics argue that scaling out can mask initial sizing errors and might limit potential higher returns if shares continue to climb.
Get personalized, AI-powered answers built on 27+ years of trusted expertise.
Scaling out of a trade involves investors selling portions of their shares gradually as stock prices rise. This method secures profits while avoiding market peaks and limiting the risk of exiting too early.
What Is to Scale Out?
To scale out is the process of selling off portions of total shares held while the price increases. To scale out, or scaling out, means to exit a position by selling in increments as the price of the stock climbs.
Scaling Out Explained
Scaling out of a stock lets an investor reduce exposure to a position when momentum seems to be slowing. The investor takes profits while the price is increasing, rather than attempting to time the peak price. If the value continues to increase, however, the investor could be exiting too early.
To scale out of positions makes sense only when they are profitable as there is no reason to partially close out a trade once it’s proven unprofitable. Rather than setting a single profit target for the entire trade, an investor can set two or three incremental targets. It’s also possible to leave a part of the trade open without a limit at all and let an indicator or a trailing stop decide when it should be closed.
This technique reduces overall profit because investors would have gained more if the entire position remained open for the duration of the entire upward move. Scaling out protects the profit and for scaling out to work well, the market needs to be trending.
For example, an investor holds 600 shares of a company that has an average price of $20 and is currently on an upswing, but the investor believes the price will stop climbing or will drop to $40. In order to benefit, the investor could scale out by selling 200 shares at $39, another 200 shares at $39.50, and another 200 shares at $39.75. The average selling price would therefore be $39.42, thus reducing the risk of losing profits if the price did decrease.
Drawbacks of Scaling Out
Some critics say traders and investors who scale out do so because they took a larger position than they were comfortable with initially. A scale-out simply resizes a position to a more correct size for their account and risk tolerance. Such a trader or investor, critics say, was scared when the original position was on and now has been lucky enough to gleen some profit.
However, what happens to this mindset when the initial trade goes lower than the entry price? Sometimes they let the losses run. As such, it’s a better strategy, critics contend, to size correctly at the start and let a profitable run go wherever the investor or trader feels comfortable cashing out.
What Does Scaling Refer to in Trading?
Scaling, or a scale order, is the trading strategy of buying multiple orders of the same financial security at incrementally increasing or decreasing prices, so as to benefit from either the rising or falling price, rather than buying the intended amount all at once.
What Is Scaling in?
To scale in to a position means to enter the position with just a small part of the amount that you actually want to trade, and then to add to the position as the price decreases. Scaling in, when effective, lowers the average purchase price, as the trader is paying less each time the security declines. A trader using this strategy assumes that the price will ultimately stop falling and rebound, making the lower price they bought the shares at a comparatively good deal.
Why Do Traders Use Scaling?
Scale orders are often used so that a market participant can buy or sell a large block of securities without causing increased volatility in the price of the underlying issue or even the market itself. By splitting up large transactions into more manageable chunks, the impact of the trade is less disruptive.
The Bottom Line
Scaling is a strategy in which an investor buys multiple orders of the same security at incrementally increasing or decreasing prices, rather than making one big purchase all at once. Scaling out allows a market participant to reduce their exposure to a particular stock in smaller volumes, rather than all at once, and therefore take profits while the stock is on the rise, but the upward momentum is slowing down.
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.