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 in🌱crements as the price of the stock climbs.

Understanding Scaling Out

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 i💃ncreasing, 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 foಌr thཧe 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 c🎀limbing 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.

Criticism 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 corꦉrect size foꦫr 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.

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.

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