The process of scalingin entails entering your position in increments, slowly adding more volume over time. And on the other side, scaling out is exiting your position in small increments.
Scaling requires confidence in your actions. If you decide to add to your position, it should happen for the right reasons. Often, traders let their own stubbornness get in the way, which often leads to painful mistakes. Scaling should be done from a place of conviction, and trying to stick to a plan that has no ground will yield poor results.
Additionally, liquidity may become an issue. If the stock only has low volume orders, you can’t sell off a larger position without impacting the price. For example, if you are holding 10,000 shares, and the largest offer is for 500 shares, you’ll need to break down your position and scale out slowly so that you do not impact the stock price as much. That means that you’ll need to gradually get rid of your stock in small increments, 500 shares or so at a time. Otherwise, the increased supply may drop the price, and you will make less money on the trade or take a loss. The same concept applies if you’re trying to take a position on a stock. Again, scale in gradually if you want to avoid a price hike, and be patient with the process.
Average daily volume has a huge impact on the scaling process, and it is especially true if you’re trading on the OTC market. Picture a stock that averages a million shares per day that suddenly trades several million shares, and you want to hold it overnight. The volume will likely return to its daily average the next day. Holding 250,000 shares on a 3-million day is less impactful than trading the same amount on a day when the volume is only one million. Because a 250,000 position would be a quarter of the total volume, trying to exit completely is much more likely to affect the price, even if you scale out gradually.
Short sellers occasionally face another problem with the scaling strategy. If you’re a short seller, you need to borrow shares in order to enter the trade. Sometimes you may find there are no shares of that stock to borrow, or you can only find a very limited amount at a time. This is the case where a strategy that would lead to profits at a smaller size simply wouldn’t work with a larger position.
Sometimes, you can solve that issue by looking for the shares way in advance. At Cobra Trading, we are happy to assist you in locating hard-to-borrow shares.
However, there are some cases where it makes more sense to stay small and not scale. If the stock you’re trying to short into is increasing rapidly in price, scaling your position can sometimes make matters worse.
This is why you always want to have a strategy and an exit plan before you execute your trades. The market is volatile, and it’s important to have a clear understanding of the situation at hand and react accordingly. And don’t be afraid to take a break; if the trade goes against you, it’s always good to pause, assess what’s happening, and change your course as necessary.
Slippage is when you receive an execution price that you didn’t expect. This can certainly occur if you’re trading in a volatile market and there’s a lot of constant price movement. Simply put, the more shares you’re trading, the worse the slippage may get. However, that doesn’t mean you shouldn’t scale at all. You simply need to account for slippage and include it into your trading plan.
And, of course, we must address the emotional response traders experience. We often recommend that beginner traders start with a small size because trading small means less risk. But what happens when a trader gains experience and becomes more confident? They slowly increase their position over time, so facing the challenge of scaling is inevitable. Going into trading gradually seems to be effective for most people. Increasing the position slowly helps traders get more comfortable with a new level of risk and allows them to feel more at ease regarding the outcome.
However, some people start increasing their size far too quickly. Someone who traded 1000 shares yesterday may find themselves tempted to trade 10,000 shares the next day. Scaling too rapidly tends to backfire because traders are human, and it is a natural, human response to react emotionally when outside of their comfort zone.
So even if the strategy is solid, facing a larger risk may trigger an irrational response. Realizing just how much money is at stake may be detrimental to one’s mentality and strategy, and even damage their confidence and progress.
While a slow, incremental increase won’t multiply trading profits overnight, it is a sustainable way of taking your day trading career to a new level without completely overwhelming yourself.
Move at your own pace. You are not competing with other traders. And while it’s great to learn from mentors and peers, sizing up to someone who’s in a totally different place than you are will not help your situation. Ignore the position other traders have, how much they are making, and how much they are trading with. Only compare yourself to yesterday’s version of yourself.