What Is Scale Trading?
Scale trading uses a simple principle of buying low and selling high. When trading commodities, it is often difficult to figure out when a commodity is trading at a low enough price to buy, but scale trading has some fairly simple guidelines to find good buying levels.
The first thing you want to do is look through historical charts of commodities and find the ones that are trading at the low end of their historical ranges – preferably within the lower 25 percent of their historical price range. You should look back at least 10 years for the historical range. Another thing worth noting is that scale trading works best for physical commodities like corn, crude oil, live cattle, etc. Scale trading was not necessarily meant for financial futures like the E-mini S&P, currencies or Treasury notes.
Scale Trading Strategy
You only initiate trades buy buying when you scale trading commodities. You do not look to sell or short commodities. The reasoning is that physical commodities will always hold a certain amount of value. When the price gets too cheap, producers of a commodity will eventually produce less and this will eventually stabilize prices.
Once you have identified a commodity in the bottom 25 percent of its historical range, you will need to setup levels where you will buy and sell futures contracts on that commodity.
For example, if corn is trading at $2.00 a bushel, while the price range for the last 20 years is $1.80 to $5.50, this would be an ideal candidate for scale trading. You could setup levels to start buying every 10 cents lower - $1.90, $1.80, $1.70, etc. Once your first order is filled at $1.90, you would place an order to sell that contract at $2.00 for a profit of $500 (10 cents times 5,000 bushels).
Now, if the market keeps moving down to $1.80, you would buy another contract and place an order to sell that futures contract at $1.90. Then you would still be holding the other contract you bought at $1.90 with an order to sell at $2.00. The basic theory of scale trading is that you scale into the market at already depressed prices and you sell at predefined prices until all your contracts are closed.
Scale trading a market could take a couple weeks or it could last several years. It is important to make sure you commit yourself to the strategy and follow the rules. More importantly, you have to calculate to maximum amount of futures margin and drawdown losses this strategy could incur if the market keeps moving lower. You can also change the price levels to suit your trading style.
