One of the most popular techniques for maximising profits and minimising losses when forex trading is to ‘scale’ in and out of your positions. If you are trading multiple position sizes, scaling allows you a greater degree of flexibility about how you manage your risk.
Essentially, scaling involves adding or removing units from a position that you have open. It can be incorporated into your original trade plan, or you can do it on the hoof to react to changing conditions of your trade. It can help you to adjust your risk exposure, maximise profits, or lock in profits that have already been made. Of course, there are also some potential disadvantages when you increase or decrease the size of your position.
Perhaps the biggest benefit of scaling is that it removes the need to get your entry or exit absolutely right. This is just as well, because it’s impossible to consistently predict price movements and turning points, which means that even the most experienced traders will set up less-than-optimal entry points on a fairly regular basis.
The best that you can hope for is to identify rough areas of support/resistance, momentum change, breakout, reversal etc. and enter a number of slightly different positions around these areas. This gives you the flexibility to ‘scale out’ of the trade by ending some of these positions early to lock in profits while retaining the potential for more.
This makes it a lot easier to make profits without having to be super-accurate in catching moves at their point of inflection. When used in conjunction with a trailing stop, scaling out of winning positions can help you to protect your profits just in case of a sudden price reversal.
The converse is true of ‘scaling in’ by adding more units to your open position, as if the trade continues to go your way, the increased size of your position will increase the amount of profit you make from every pip.
There is a fairly obvious drawback to scaling in, however, in that by adding to your position you increase your overall risk. If you scale into a trade, and it goes against you, you could incur much heavier losses than you otherwise might have. Thankfully, there are things that you can do to scale into an open position without exposing yourself to more risk than you can handle.
Scaling out also has a major drawback, in that you reduce your profit potential when you remove parts of an open position. However, given the notorious volatility of the forex market, it is worth sacrificing a little potential gain in order to reduce your risk exposure.
In the next part of this series, we will be looking at some worked examples to show you the correct way to scale into and out of your open positions.