Monday, 15 September 2014
Scaling In is not the same as Averaging Down
Scaling in is simply the building up a core investment or sizable trading position through a series of entries.
It's usually practiced by those who have been humbled by the market and realised they are not so great at picking tops and bottoms. By spreading their entries, they hope to get a reasonably good average entry price - the shotgun approach.
This is the opposite of the 100% all-in entry normally practiced by those with a smaller portfolio or trading account.
Having said that, there are of course exceptions where big investors and traders who are great at market timing, will just skip the scaling in process and go all-in with one big giant high conviction entry - the rifle approach.
Let's take the example of an investor who has a rule where no single stock position can be max more than 10% of his total portfolio as a risk management control.
This investor has high conviction on stock ABC.
He allocates $50,000 for this stock ABC since his total portfolio is half a million dollars.
Since he likes to enter in multiples of $10,000, for broker's trade commission efficiency, he has 5 arrows for this stock ABC. (Some people prefer 10 arrows, some 2 arrows, it's an individual's choice!)
This firing of all his arrows may range from several days, weeks, months, and even years! It all depends on his criteria for entry.
The execution of Scaling in, depending on the entry price of the first arrow, may look like a combination of averaging up and averaging down.
It can just as well be the case it's all averaging up or all averaging down in execution - the investor is agnostic whether he is buying at higher prices or at lower prices - just as long the criteria for entries are met.
I shall stop here.
Readers, you have to figure it out yourself whether you can see the difference between Averaging down and Scaling in.
It's entirely plausible and perfectly OK for you to say I am just engaging in wordplay - A rose by any other name is still a rose!
And if your conclusion is derived from your own investing experience and/r trading track record, it's more POWER to you!
I'll say purge what you've just read and don't let me poison your mind.
Don't you dare change a winning strategy just because of my personal musing nonsense!
P.S. For traders, it may be easier for you since Scaling in is frequently found in trading's parlance.
For investors who have never experienced a > 20% plus bear market, it could be harder for you since you could be mistaking Buying-the-dip in a rising bull market with Averaging down...
LOL! Confused yet?
Tip for potential snake-oil salesperson wannebe: If you can't win them over, confuse them!
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Hi SMOL
ReplyDeleteIm still trying to learn the art of shooting arrow. I know uncle cw has an absolute percentage number which point to shoot which arrow. I dont hv such cases and I will be hoping to create one should my portfolio goes bigger like his.
Patience, I shall go to the mountain next to where uncle cw is meditating. Lol
B,
DeleteYup. CW's variation is at total portfolio level (not individual stock level) and the entry trigger points are positioned at STI levels.
He got a very nice diagram where scaling in and averaging down can both have epic fails.
If our last arrow is fired at STI 1,000 and STI drops even more to 500, then it's to the mad house....
Do note that scaling in at individual stock level can be complemented by risk management techniques at total portfolio level.
If you go scaling in at total portfolio level, how to you do risk management when all cash has been committed? It's all-in time;)
Of course you can! But that's another topic for another day.
Tip: You'll be more likely to find CW near the jetty or the sea ;)
STI INDEX is at trigger point but the stock you are eyeing is not. How? Wait some more?
ReplyDeletetemperament,
DeleteDon't look at me!
I not that advanced to use STI trigger points for the very reason you mentioned ;)
That's why I only blog about what I can handle within my skillsets - scaling in at individual stock position level; complementing it with risk management tools at total portfolio level.
STI trigger points is easier if you only have one position at total portfolio level - STI ETF?
But if using STI ETF, there's another technique called Dollar cost averaging...
Stay tuned.
Interesting read. I wholly agree. In my humble opinion, the difference between scaling and averaging down is that the former is planned for - you had made a conscious decision to execute the series of buying actions. Averaging down is more of a reaction to circumstances.
ReplyDeleteS-Reit System Investor,
DeleteWelcome to my watering hole!
Looking at the trades or entries, we can't tell whether it's averaging down or scaling in - only the person doing it knows (hopefully).
It's all inside his/her Mind - the motivations, the emotional state, the reasons for entries, etc.
Yes, you can also say, like what you have said above, Averaging down appears unplanned and is a emotional REACTION to the market; while Scaling in is a planned cerebral RESPONSE to the market ;)
I only allow myself 1 arrow for each stock. Coz my multiple shots fail most of the time. Whahahha.....
ReplyDeleteExcept my ocbc bcip.
Not greedy, cap the downside...of coz, also cap upside.
Ah!
Deletepf, you're the sniper.
One shot; one kill ;)
Then, is Averaging down a subset of Scaling in?
ReplyDeleteRainbow girl,
DeleteNice to hear from you again ;)
I would rather say it's not the same nor a sub-set. Although the execution may be similar.
Averaging down is more about emotions.
For eg: We don't enter into a position at a price which we think is not fair right?
Price drop 20% we say cannot be! Market must be wrong. Oversold! So we buy some more to "get even". To prove we are "right".
Then price drops another 20%? We sell our family jewels to scrounge enough funds to buy more....
Now the "goal" is not to make money. Now the "hope" is that by bringing the average price down, we just need the market price to move up so we can "break-even".
When we do something just to "break-even" - we are not investing or trading anymore.... A small paper cut has turned into a gangrenous humongous all-in gamble of hope!
Scaling in is more about logic, thinking, having a plan, etc.
Things can go horribly wrong still with Scaling in Hence the risk management from the onset - max risk 10% of portfolio, etc. You set the max risk from the start. An important difference from Averaging down.
If we have only 5 arrows, there's only 5 arrows to fire. Period.
Stock goes to zero, you lick your wounds; but you won't bust your investment account ;)