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To scale in a stock means to continue buying more shares as the price falls, working under the expectation it will then rise. The idea of the tactic is to pay as low a price as possible for the stock while protecting against the possibility that it won't dip as low as expected before recovering. While the tactic is very simple to use, and can make money in a particularly turbulent market, critics argue that the scale in system limits potential returns while still leaving the investor exposed to a collapse.
An investor would use a scale in tactic where he expects a stock to fall in price before rising back to, or above, its original level. In some cases, this could be an expectation based on business events. For example, a company that is about to suffer bad publicity that should soon fade away. In other cases, it can simply be an expectation based on the market fluctuating, the idea being that if a stock drops in price, it will "correct" itself. The tactic doesn't necessarily assume the price will increase above and beyond its starting point; it targets recoveries, rather than net gains.
The aim of an investor who has chosen to scale in is to avoid two contrasting risks. If the investor buys the stock too quickly in the price drop process, he will miss out on some of the potential gains if and when it returns to its previous levels. If the investor waits too long, he may not buy before the price starts recovering, meaning he makes little or no return.
To scale in, the investor decides how many shares he wants to buy as the price falls, then breaks this down into price points. For example, if the stock price starts at $10 United States Dollars (USD) and the investor wants to buy 500 shares, he might decide to buy 100 shares when the price falls to $9.90 USD, another 100 shares when the price falls to $9.80 USD and so on, buying the last 100 shares if and when the price falls to $9.50 USD. In this example, if the price does indeed fall to $9.50 USD and then recover to $10 USD, the trader will have spent $4,850 USD and then be able to sell the stocks for $5,000 USD, making a profit of $150 USD before transaction costs.
The main benefits of the scale in tactic are that it strikes a balance between risk and stability, that it allows the investor to have a clear and objective plan for when to buy and sell, and that it can make money simply from small market variations. The main drawbacks are that the investor doesn't make any extra money if a stock increases past its starting point, that the gains are relatively low, and that the tactic can prove very costly if the stock fails to recover as expected.
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