What is scalping trading?
Though numerous small profits can swiftly compound into significant gains, scalping requires strict exit strategies to prevent large losses that could wipe out dozens of successful trades. Therefore, having the right tools, such as a live feed, a direct-access broker, as well as stringent adherence to your trading method, are crucial prerequisites for this strategy to be lucrative. Recommended video: What is scalping? Investing for beginners:
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How to scalp trade?
Scalpers believe that small asset price moves are easier to catch than large ones. Therefore, they aim to make many small winning trades instead of a few successful trades with large winning sizes. This requires setting tight trading windows regarding both price movement and time frame. Scalping requires strict trading discipline. For example, scalpers exit trades once they have achieved their profit target instead of waiting to see whether they can profit more. Moreover, they also leave trades once they have touched their profit loss level rather than waiting for the trend to turn around. Scalping relies on the notion of lower exposure risk as the actual time in the market on each trade is relatively short, lowering the risk of an adverse event causing an undesirable move. In addition, it proposes that smaller moves are easier to catch than larger ones, as well as more frequent.
Scalping trading example
A scalper enters a limit order (an order to buy/sell an asset at a specified price or better) to buy a specific number of shares at a predetermined price. The trade is automatically executed once the price falls to the limit order. The scalper then waits for positive movements. The price rises a minute later, and the trader exits the trade. So, if they bought 1,000 shares, and the price increased by $0.05, they made $50.
Key characteristics of scalping
Scalping is a fast-paced trading method for skillful traders. It demands precision timing and execution. Newbies to scalping need to ensure that this particular style suits their character, as it requires a highly disciplined approach. If you think you’re the right trader for scalping, here are a few tips to keep in mind:
Order execution: Because of frequent turnover, you must be able to execute orders efficiently, i.e., make swift decisions, spot opportunities, and constantly monitor your positions; Supporting systems: Scalpers rely on automatic, instant execution of orders, so utilizing supporting systems such as Direct Access Trading (a system that allows traders to trade directly with another client without broker interference) and Level 2 (a service that provides real-time access to the NASDAQ order book) quotations is essential; Technical analysis: Scalpers rely on technical analysis to make predictions on future price moves, helping them find trading events and create entry and exit points; Spotting trends and momentum: To execute the strategy effectively, a trader must anticipate upticks and downswings and understand the psychology behind a bull and bear market; Read and analyze short-term charts: You must be able to make decisions based on charting that is within 1- to 5-minute intervals. Scalpers look for key indicators such as moving averages (MA) and pivot points in the market to determine if they can execute a trade quickly; Keeping on top of costs: A novice scalper must keep costs in mind while making trades. Because scalping involves numerous trades (as many as hundreds during a trading session), commissions can add up quickly and shrink your profits; Maintain enough liquidity in your account: Traders must have sufficient capital in their portfolio to trade, as scalping requires frequent and quick entry and exit decisions. High-volume trades offer much-needed liquidity; Discipline: It is recommended to close all positions at the end of the day’s session rather than carry them over to the next day, even if you could generate potentially bigger profit. Scalping is based on small opportunities found in the market, and a scalper should not deviate from its core principle of holding a position for a very short period; Go long: Beginners should keep to trading on the buy-side before they gain proficiency to handle the short side; Risk management: An easy way to limit loss or lock in a profit on a current position is to place a stop-loss order. It triggers the sale of a stock (or a purchase for a short position) once the stock’s price reaches a certain value.
Scalping trading strategies
There are five primary types of scalp trading to choose from:
1. Market making
Market making happens when a scalper tries to profit off the spread by simultaneously posting a bid and an offer price for a specific contract. This strategy succeeds mainly with immobile stocks that can trade significant volumes without massive price changes. Market making is the most challenging scalping strategy to execute successfully, as the scalper must compete with market makers for the shares on both bids and offers. In addition, any stock movement opposite the trader’s position can result in a loss exceeding their original profit target.
2. Arbitrage
This type of scalp trading is done by purchasing a considerable amount of shares and then reselling them for a gain on a tiny price difference. Arbitrage sees the trader enter into trades for thousands of shares, waiting for a small move, typically measured in cents. This approach demands a highly liquid stock (to allow for trading 3,000 to 10,000 shares easily).
3. Price action
Scalping the markets with price action is similar to trading with other price action strategies. This strategy is based on analyzing the asset’s price movement. It involves buying shares on any setup from your system and leaving the position as soon as the first exit signal is generated close to the 1:1 risk/reward ratio. Scalpers who adopt this trading style depend on technical analysis rather than fundamental analysis. In particular, by using technical indicators and chart patterns, scalpers can forecast how a price will move in the next few minutes or seconds and place their entry and exit points accordingly. In contrast, fundamental analysis involves examining both macro- and microeconomic factors to determine a stock’s intrinsic value, such as the overall state of the economic landscape, the strength of the particular industry, as well as the financial performance of the specific company. This lets traders assess a company and manage risk for growing their wealth over time. While scalpers may trade on news events or small fundamental changes, they primarily focus on technical indicators and charts.
4. Margin trading
Scalpers can trade derivative products, such as contracts for difference (CFDs), on an underlying asset’s price movements, whether a currency pair, stock, or commodity, allowing them to trade with leverage. And while this can provide huge profits if the trade is successful, losses will also be magnified if the markets move in an unfavorable direction.
5. High-frequency scalping strategy
High-frequency trading (HFT) is a fast-paced trading method that uses automated software to initiate hundreds of orders in seconds. It uses complex algorithms to study multiple markets and execute orders based on market conditions. In addition, high-frequency trading requires a powerful computer, ultra-high-speed internet, complex algorithmic trading software, and servers often located near an exchange. For this reason, high-frequency trading is practiced by large financial institutions (e.g., hedge funds) rather than retail investors.
Best technical indicators for scalping
Technical analysis tools help investors identify specific trends and patterns before they place their trade. For example, the most common technical indicators for a successful scalping strategy include the following:
Bollinger Bands: Bollinger Bands offer unique price and volatility insights. They can help traders determine overbought and oversold levels, spot trends and breakouts, as well as decide on entry and exit points. The optimal timeframe for scalp trading with Bollinger Bands is around 1 to 5 minutes; Moving averages: Moving averages are essential for scalpers to identify price trends or the potential for a reversal. Traders usually use a short-term MA to highlight the recent variance in price trends or a long-term MA to identify a trend pattern of whether the price is increasing or decreasing as a whole; Stochastic oscillator: The stochastic oscillator can help scalpers forecast trend reversals, making it an effective indicator for highlighting possible warning signs rather than only opportunities. This may make traders more cautious about placing a trade if the price is predicted to turn in an unfavorable direction; Relative strength index (RSI): Scalpers utilize the RSI to find entry points that go with the prevailing trend or as an indicator of a trend reversal or corrective pullbacks in price; Parabolic SAR: The parabolic SAR can highlight the direction an asset is moving, as well as provide entry and exit points. The indicator is a series of dots placed above or below the price bars, depending on the asset’s momentum. A dot below the price is bullish, and one above is bearish. A change in the position of the dots suggests that a reversal is underway.
Pros and cons of scalping
In conclusion
All in all, for traders who adhere to a strict trading discipline with effective execution and exit strategies, scalping can be very lucrative as small profits compound quickly into heftier gains. However, no trading method is guaranteed to provide profits only. Therefore, it is paramount for scalpers to have a risk management strategy in place. Disclaimer: The content on this site should not be considered investment advice. Investing is speculative. When investing, your capital is at risk.
