A scale order comprises several limit orders at incrementally increasing or decreasing prices. If it is a buy scale order, the limit orders will decrease in price, triggering buys at lower prices as the price starts to fall. With a sell order, the limit orders will increase in price, allowing the trader to take advantage of increasing prices, thereby locking in higher returns.
A scale order may also be used to get a better average price when entering or exiting a position.
A buy scale order is a series of buy orders at decreasing prices.
A sell scale order is a series of sell orders at increasing prices.
Buying more as the price increases or shorting more as the price falls is sometimes called pyramiding.
Traders often use scale orders as a strategy for buying or selling large blocks of securities, which could be subject to extra price volatility if the whole block was bought or sold in a single market transaction. Scale orders let traders split up large transactions into smaller, more manageable volumes, which furthermore keeps the market more stable since a large block order can create negative price volatility.
Assume a stock does one million shares in daily average volume. A hedge fund needs to buy one million shares. The hedge fund doesn’t want to just go in and buy all the shares at once as that may cause the price to move significantly, forcing the price up as they buy, which increases their average entry price (reducing future profit potential). Instead, they split the order up, buying 100,000 shares each day and splitting up that order further into 10,000 share block purchases at 10 different times or prices throughout each day.
Generally, scale orders exist as buys or sells. A buy scale order introduces a series of buy limit orders that are triggered in turn as the price of the security falls. Sell scale orders work in reverse, with sell limits placed at subsequently higher levels that get filled as the price rises.
If a trader believes that a stock will fall over the course of the day, a scale order can help them take advantage of the lower price if the prediction is correct. If the trader wants to purchase 1,000 shares of the company, they may scale the limit orders so that 100 shares are bought for every $0.50 fall in price.
When scaling, keep commissions in mind. The increments must be large enough to offset the cost of splitting up the order. For example, if commission costs are $10 per trade, there is no point in splitting a 300-share order into three different 100-share increments $0.10 apart. The $10 commission on each order negates the better price.
Traders may also scale into a position in the opposite way. This is sometimes called pyramiding, or scaling in–when a trader increases their position size as the price moves in their direction. For example, a trader may buy a portion of their full position every time the price rises $0.25 (or some other increment). Similarly, a trader may add to a short position, shorting a portion of their full position every time the price falls $0.25 (or some other increment).
Consider a trader that would like to sell 100,000 shares of Alphabet Inc. (GOOG). At the time of the trade, the stock is averaging just over one million shares per day. Trying to sell 100,000 shares represents a significant chunk of the daily volume. The seller wishes to break up the order so that they don’t drive down the price (resulting in an overall lower selling price) with one big sell order.
The price of the stock is currently increasing, so the trader wants to take advantage of this by selling as the price increases. Instead of placing a single block order, they can instead place a good-’til-canceled (GTC) sell scale order:
Total order size = 100,000 shares
Scale order size = 10,000 shares
Price increment = $1
Starting price = $1,200
Ending price = $1,210
Bid-ask spread = $1,199.35 by $1,199.90
The stock is currently just below $1,200. Once the order is entered, the first 10,000 shares will be placed for sale at $1,200. Another order will be placed at $1,201, $1,202, and so on until the entire order is sold by the time the price moves above $1,210.
The price may not reach $1,210, and it may not even fill the order at $1,200. If the order isn’t filled, or is only partially filled, the trader will need to rethink their strategy and possibly adjust the prices of their scale order.