Day traders adopt a mindset of swift closure, focusing on single entry and exit points – one shot in, one shot out.
This approach is also prevalent among many investors. Nevertheless, dividing that one-shot trade into multiple smaller trades could potentially yield a more favorable average price for both the position and the exits.
The concept of dollar-cost averaging represents the typical method for scaling entries. However, it necessitates buying during selloffs, which often contradicts the momentum-based trading strategy.
Day traders prefer to see immediate profits upon entering a trade, but scaling in often means initiating the trade with a negative balance.
What Exactly is Scaling?
Scaling in trading refers to the gradual adjustment of the number of crypto assets in a position based on one’s trading strategy. (in other words a more fancy dollar-cost average)
This approach provides traders with greater adaptability, allowing them to aim for the most favorable average pricing on their positions.
However, practicing scaling demands a disciplined and assertive approach to ensure positions do not become excessively large in case the market conditions deteriorate.
Moreover, it requires the willingness to act against the prevailing trends, either buying when others are selling or selling when others are buying. Achieving success with scaling depends on striking the right balance between conviction and flexibility – a delicate equilibrium that traders must carefully navigate.
Examples of Scaling
Scaling in usually means buying multiple positions at different times to reduce the risk of your trade, while scaling out just happens by selling multiple positions at different times to reduce the risk of a change in price action.
In the above picture, the trader scaled a position 3 times according to his trading strategy (moving average, dollar-cost averaging, liquidity grab, etc), and exited 3 times to minimize risk.
As a rule of thumb most trader’s usually only risk about 2% of their capital when scaling in. This is because losing all your capital is the easiest way to make losses when trading. This is because it’s easier to trade with a larger sum of money as compared to a smaller sum of money.
Scaling is one of the best ways to trade safely and properly, and minimize both upside and downside.
Scaling however does not constitute to increase your capital at each position. This sounds good in theory because you have larger purchasing power, but in reality, there are a lot of issues that arise with this.
Top Mistakes When Scaling
The main concern with scaling in trading lies in the liquidity of your position. As you gradually increase your position size, there is a risk that your trades could backfire, inadvertently causing a market impact when it comes time to exit.
For example, if you scale into a significant 10,000 coin position of a coin using smaller increments of 300 to 500 coins, you may achieve a better average price per coin.
However, attempting to sell all 10,000 coins with a market order after the coin rises by $0.25 could lead to bids collapsing as other sellers panic, ultimately resulting in getting filled at a loss.
To address the challenges associated with scaling in trading, a prudent solution is to scale out of the position gradually, while carefully timing your exits with momentum spikes in your favor.
Additionally, it’s crucial to choose coins that offer sufficient liquidity to support your position, even during periods of low volatility.
Rather than selling all 10,000 coins at the market, having the right tools to gauge momentum allows you to scale out of the position in smaller increments of 500 to 1,000 shares over the course of a day or two, thus taking advantage of potential buyers and reducing the risk of a market impact during the exit process.
By implementing this approach, traders can navigate the challenges of scaling more effectively and increase their chances of successful trades.
Issue: One potential problem a trader may encounter is that their trading strategy may not perform as effectively at larger scales.
There could be a limitation on the growth potential of the strategy, especially in the case of a very large successful trade when facing the challenge of limited liquidity, making it nearly impossible to achieve significant growth, such as 10X gains.
For instance, mid to large-cap cryptocurrencies such as BTC and ETH generally offer more liquidity, making it feasible to execute larger trades.
On the other hand, small-cap cryptocurrencies often have thinner liquidity, and traders can unknowingly become “bag holders” when they mistakenly assume higher liquidity during a high-volume day that quickly dries up the next day.
This is why trading meme coins often have huge returns and huge losses, because the liquidity is low, and the growth cap exponential is incredibly high with just a small amount of liquidity. (Just that not everyone can exit)
To navigate growth cap issues, traders should always assess the historical and average volume of the underlying cryptocurrency and consider the type of growth cap they might encounter.
A good website to check this is CoinMarketCap. This is especially important when trading lower cap coins that are not on centralized exchanges like Binance or Crypto.com
Cryptocurrencies falling in the small-cap category with an average daily volume under 500,000 USDT should raise a warning flag due to their thin liquidity. Trade at your own risk.
In addition, it is essential to be aware that small-cap stocks may exhibit heavy volume on days with catalyst-based price movements, creating the illusion of substantial liquidity.
However, this elevated volume and liquidity can quickly evaporate the very next day due to rotational trading. To avoid potential pitfalls, traders must always check the average daily trading volume beforehand to gauge the normal liquidity levels.
Never assume that elevated volume and liquidity will persist in small-cap stocks, as they can be highly unpredictable in this regard.
Being cautious and well-informed about liquidity will help traders make more informed decisions and avoid undesirable outcomes when dealing with growth cap challenges.
This issue generally doesn’t happen to most people, but can still happen when you’re executing larger trades in the market. This also usually happens to lower cap coins
As you become more adept at the intricacies of scaling in and out of positions, you start noticing instances of slippage during your order executions.
Despite your efforts to fine-tune entries and improve the timing of your orders, you observe discrepancies in fills, availability of borrows, and delays with trade confirmations.
There isn’t really a very clear solution for this. When you trade on an exchange, you will always go through a market maker, in this case the exchange’s market maker.
To explain it a little better, let’s bring in traditional finance.
In stocks, there are commission brokers and non-commision brokers.
Although zero-commission brokers may seem attractive for scaling into positions, it’s essential to recognize that their interests are tied to order flow agreements with third-party liquidity providers.
Consequently, your orders will always be routed at the broker’s discretion, which means that your order can be easily front-runned.
To gain more control over your orders, seasoned traders opt for direct access brokerage platforms that allow them to route orders to Electronic Communication Networks (ECNs) of their own preference.
In crypto, professional scalers or frequent traders sometimes establish their own blockchain node.
This is a similar strategy that is seen with MEV trading, a combination of MEV bots and blockchain nodes.
To prevent this, the rule of time is to execute large volume trades on high liquidity coins, but try to avoid large volume trades on low-liquidity coins as there is often significant slippage.
Scaling in and/or out of trades can offer significant benefits to your trading approach. However, it’s essential to acknowledge that this technique may not always guarantee improved results.
There will be instances where refraining from scaling could have led to better outcomes. Nonetheless, it doesn’t imply that scaling should never be utilized. In my view, more often than not, scaling proves advantageous.
Scaling in and/or out of trades introduces an element of flexibility and allows for imperfection in execution. Nevertheless, in situations where a trade could have been executed flawlessly (e.g., buying at the low and selling at the high), scaling might not provide additional benefits.
[Editor’s Note: This article does not represent financial advice. Please do your research before investing.]
Featured Image Credit: Chain Debrief