What it means
Investopedia explains that a trader who scales in sets a target price and then buys in steps as the stock falls below it. The trader assumes the dip is temporary, so the lower prices look like a bargain.
If the stock keeps falling and never recovers, the trader ends up holding a bigger losing position. The approach has a second form.
A trader can add to a position as it moves in their favour, which is often called pyramiding. The trade starts small, so early risk is low, and it grows only when the trade is working.
Large orders can move the market, and Investopedia says scaling in can reduce slippage when opening a large trade and keep a big position less visible to others. The trader pays for this with more orders and more costs, since Investopedia notes that multiple trades can cost more than one larger trade.
FINRA makes a similar point about investing in steps, saying that fees on each transaction can erode returns. Scaling in differs from dollar-cost averaging.
Dollar-cost averaging invests equal amounts on a fixed schedule whatever the price, as FINRA describes. Scaling in is tied to price levels or to how the trade is going, so it needs rules that are set before the first order.
The opposite is scaling out, where a trader closes part of a position at a time as the price rises. It locks in some profit and leaves some shares exposed to further gains.
Many traders pair both with a stop loss, so that adding to a position does not add unlimited risk. Scaling in is not a guarantee of a better price and does not remove the risk of a falling stock.
Margin rules and order types differ by broker and country, so check them before using borrowed money.
In practice
Real-world examples.
Example
A fictional investor wants 1,000 shares of a stock at $20. They buy 250 at $20.00, 250 at $19.90, 250 at $19.80 and 250 at $19.70, then stop. The average cost is $19.85, not $20.00.
Example
A fictional trader plans 1,000 shares and starts with 500 at $50. The price rises, so she adds 300 at $52 and 200 at $54. The total cost is $51,400 and the average price is $51.40, higher than the first entry because she added only as the trade worked.
Example
A fictional investor scales into 1,000 shares in four orders and pays a flat fee of $5 per order, $20 in total. One order would have cost $5, so the extra fees are $15. The lower average price saved $0.15 a share, or $150, so the fees were small here but could be larger on a small trade.
Formula
Calculation
Average price = Total cost / Total shares. Extra fees = (Number of orders - 1) x Fee per order.
Worked example, scaling in on the way down. An investor buys 250 shares at $20.00, 250 at $19.90, 250 at $19.80 and 250 at $19.70.
- Total cost = $5,000 + $4,975 + $4,950 + $4,925 = $19,850.
- Average price = $19,850 / 1,000 = $19.85, which is $0.15 below a single purchase at $20.00, a saving of $0.15 x 1,000 = $150.
- Extra fees with a $5 flat fee per order = (4 - 1) x $5 = $15, so the net benefit is $150 - $15 = $135.
Worked example, pyramiding on the way up. A trader buys 500 shares at $50, adds 300 at $52 and adds 200 at $54.
- Total cost = $25,000 + $15,600 + $10,800 = $51,400.
- Average price = $51,400 / 1,000 = $51.40, higher than the first entry because she added only as the trade worked.Case study
Seen in the real world.
This case study is fictional and illustrative. Tomas, 38, in Warsaw, wants to build a 1,000-share position in a company he likes at about $20. He worries that the stock could drop after his first purchase. He sets four equal orders at $20.00, $19.90, $19.80 and $19.70.
He also decides that he will not buy below $19.50, since a fall past that level would change his view of the company. The price reaches $19.70 and then recovers. His average cost is $19.85 and the fees come to $20 in total. He keeps a note of each order and the reason for the stop.
He reviews it after the trade to see whether the plan worked. In his review Tomas notes that the saving of $150 against a single purchase at $20.00 was real but modest, and that the plan mattered more for what it prevented. Because the stop and the maximum size were written down first, a further fall would have ended the buying instead of tempting him to add more. The investor and the prices are invented for illustration and are not a recommendation.
Watch out
Common mistakes.
- Adding to a falling position without a stop or a maximum size, so a small mistake becomes a large loss.
- Ignoring the cost of many small orders, which can outweigh the saving on price.
- Confusing scaling in with dollar-cost averaging, which buys on a fixed schedule rather than at price levels.
Questions
People also ask.
What does scale in mean?
It means building a position in several steps at different prices instead of one order. It is often used to lower the average cost.
What is the risk of scaling in?
If the price keeps falling, you hold a larger losing position. Fees on many orders can also reduce the benefit.
What is scaling out?
It is the reverse, closing a position in parts as the price rises so that some profit is locked in.
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