The simplest concepts in trading are often times the hardest to follow. Greed and fear control the minds of 90% of new traders, and even affect the well established from time to time. That’s the main reason people fail. Position sizing is a key aspect of this. If you get in too heavy too early, you create a larger window of failure for yourself.
Always remember, profit is profit.
So scaling. What is it? In simple terms, scaling is buying and selling in specifically priced chunks instead of just loading full from the get go.
The first step in entering any position is knowing your goals. You should have 3 basic goals when you look at any purchase opportunity.
How much am I buying?
Where am I going to cut the trade if it turns south?
Where am I going to take profits?
These sound self explanatory, but lets make sure we know what were talking about.
How much am I buying?
This is literal. How much of your account are you wanting to invest in this particular trade? What’s your conviction? What’s your time frame? All of those should be factors in to how much of your capital you’re going to lock up. This is all up to you. No two traders have the exact same accounts, convictions, or own personal rules. For me, the longer the swing, the more cash it gets. If I know I’m going to ride the wave for a few months, it’s going to get more cash than something I’m buying for a few hours.
Where am I going to cut the trade if it turns south?
Any time you get into a trade, you should know how much you are willing to lose. That may be a dollar amount from your account or a specific percentage or just a specific resistance level on the chart. Look at the chart, and see where your point of no return is. Whether you’re trading a specific pattern, or just want to use a mental exit point, you have to decide this before you enter. Your position size should correlate with this also. If you only want to lose 10% max on your trade, then 10% from below your entry is going to be your exit. Keep in mind that that 10% should be at a broken support. No sense in setting up a stop in no mans land where a bounce is possible.
Where am I going to take profits?
Similar to 2, you have to know your goals for profit. It is ill advised to just hold on to a stock without knowing this unless you are long term investing and don’t want to look at it for years.
Lets put it into action now. Lets use the chart below as reference.
Step one. How much do you want to buy? Lets go with 10k shares. Step two, Where am I going to cut the trade if it turns south? This chart has a $2 point of no return. If you cross that, you’re in no mans land. Step three, Where am I going to take profits? This chart shows highs of $3.5+, but heavy resistance at $3. Those are my two exit points.
Now lets learn how to scale.
I know you probably purchase your entire position at one time, but stop that. How often does a stock dip after you buy it and you get annoyed? Probably often.
So there are a few different methods, and to each his own, but I personally trade in halves or thirds, depending on momentum. If a stock is moving slow, Ill add in thirds. For a halves example on the chart above, I would add 5k to start with at the current $2.80 price, then I’ll wait and see how the price fluctuates.
Remember, we always want to add at support and sell at resistance. Do you see the next support on the chart? The next add after our initial $2.8 is the $2.5 range where it reversed a few days prior. Not only do you add your shares at strong zones, but this also lowers your average. Now if you get back to your original $2.8 purchase price, you are green instead of even.
Now you have a full position of 10k shares at an average of $2.65.
So when do you sell?
DO NOT, ride your full position from start to finish. Always, always, always scale profits the same way you scale into a trade.
Now I know what you’re thinking. “But Cardinal.. I’ll miss out on profits if I have less shares wont I?” Yes.. Yes you will, BUT if the stock hits your first target and reverses like a rocket, you wont be stuck looking at a loss when you had a profit just a minute ago.
If you sell half your shares at $3 like the plan, you lock in profit from $2.65 to $3 on 5k shares ($1750). If the stock keeps going, well guess what? You still have 5k shares that are still profiting, BUT if the stock shoots back to $2.7 from $3 (rejection at resistance is a very real thing), then only 5k shares are losing money instead of the full 10k. If that happens and you still like the stock, you can add back your 5k shares at the same $2.65 average or next support. You still have 10k shares and locked in a sweet scalp of $1,750.
You should do this the entire swing. Have a final “full out” goal, and then scale out on the way to it. You can do this over and over if a stock is bouncy or if it has a hard time getting through a specific resistance. Too many people ride their full positions and just hope for the best. This will also teach you how to scalp properly.
I hope this helps some of you. As always, this is just a tool in the belt.
Feel free to reach out if I missed something, or if something doesn’t make sense.
Best.