When to Scale In and Scale Out in Penny Stocks - dummies

When to Scale In and Scale Out in Penny Stocks

By Peter Leeds

Too often penny stock investors, especially newer ones, think that they need to buy or sell their shares all at once. Another option is scaling in and out of position. Normally, they want 10,000 shares, so they buy 10,000 shares in one fell swoop. Or perhaps they want to sell a penny stock investment worth $2,000, so they sell all $2,000 worth in a single trade.

Besides being a good way to incur the fewest broker commissions, there aren’t a lot of advantages to buying or selling your shares in a company all at once. Scaling in and scaling out of positions in penny stocks simply means buying and selling in portions rather than a single trade.

For example, if you want buy $3,000 worth of a specific penny stock, you may want to spread the purchases out over three or four trading orders and enter them over the course of weeks or months.

The benefits to scaling in and out of positions are as follows:

  • You can more easily change your mind. Rather than jump in with both feet and your entire bankroll, you can ease into the purchase. You minimize the energy, time, and cost of backing out of a position should you change your mind.

  • You gain consideration time. You’ve heard the expression “sleep on it.” Over time, you will gain more clarity, which may strengthen your decision and resolve or convince you to change your mind.

  • You have a chance to react to events. Between the time when you make your first investment and when you commit more money to the stock, events may occur that affect the company’s value. The company may issue press releases, or the shares may drop or double in price. If you’re only partially committed, you have the luxury of reacting to events however you see fit.

  • You minimize potential losses and mistakes. Sometimes you may just be plain wrong. You could buy a penny stock only to watch the shares slide toward new lows almost immediately. Investors who buy in with everything they have lose a lot more than those who scale in.

  • Dollar cost averaging. Penny stocks can be very volatile and unpredictable. To avoid the major and short-term ups and downs, investors can benefit by dollar cost averaging (DCA), which is the process of buying more of the shares at set intervals, regardless of the share price activity. You will pay more of an average price for the shares over the time period you DCA.

  • You can lock in results. After a major price run-up, you may not be able to tell whether the penny stock will maintain its huge gain, go even higher, or come crashing back down to earth. Investors in this fortunate situation sometimes opt to sell a portion of their holdings. In this way, they lock in some gains, while letting the rest ride.

  • You keep your options open. New opportunities can arise at any time. You may start scaling in to one penny stock only to have another, more compelling, alternative surface. Or maybe your kid needs braces, or you decide to buy a hot tub, or you need the money for something else.

Scaling in has many benefits, and the better penny stock investors always trade in this fashion. However, the strategy of scaling in also two downsides:

  • You must pay broker commissions for each trade. By buying or selling over three (or more) separate orders rather than one, you will have to pay three (or more) broker commissions rather than one.

  • You could potentially miss out on upside. By not buying in all at once, you will miss out if the shares leap higher between when you purchase the first portion and before you buy the rest. Most investors fear just such an incident, but that it rarely happens.

The minimal and rare negatives to scaling in are outweighed by the positives. Trading penny stocks in this fashion is much more forgiving, and profits tend to increase.