Scalping (scalp trading) is a trading strategy that is characterized by profiting from small price changes in the underlying asset. Scalping profits on these trades are quickly taken once a trade has become profitable. Scalping has one of the shortest time frames in trading. For this reason, a pure scalper trader may make a significant number of trades per day, possibly in the hundreds or even thousands for fully automated systems. Trades can be made in the stock market, FOREX, commodities, cryptocurrencies, bonds, CFD‘s or wherever the requirements for trading are fulfilled.
Scalpers look to turn many small profits and avoid running any winners. Therefore, gains are seized almost as soon as they appear. The scalper views a successful trading strategy as having a large number of small winners, as opposed to few successful trades with a significant winning magnitude. Because the quantity of trades is so large, coupled with the gains from each individual trade being so small, scalpers must strictly abide by stringent risk management system. Carelessness or greed may lead to one large loss that could wipe out a number of successful trades.
The profit for each transaction (depending on the product) may only be measured as a few basis points (bips) or cents. As such, scalping is typically implemented using a large amount of capital and high leverage. Since the actual time spent active in the market is quite small, scalping may in one sense incur a reduced risk exposure level. Even positions held for a few minutes would be considered relatively long term. Risk of an adverse event causing a big unexpected move is greatly reduced. Additionally, smaller moves are easier to obtain and profit from and are more frequent than larger ones.
The role of a scalper is remarkably similar (if not identical) to the role of a market maker or specialist. These traders maintain liquidity in the market place and order flow of the underlying asset. Scalpers therefore attempt to trade like traditional market makers or specialists. In this instance, to make the spread means to buy on the bid price and sell at the offer price. The gain, or profit is the bid ask difference. This strategy allows traders or scalpers to profit even when the bid and ask prices have not moved. All that is required is other traders willing to hit (bid) or take (ask) market prices. It is not necessary for a long positon to be initiated first. Traders may begin by shorting the asset as required. Naturally, this involves initiating and liquidating positions quickly. This invokes certain similarities to spread betting strategies. In fact, the basics of scalping, when applied over a longer time frame, have similarities to the Merger Arbitrage Limited active arbitrage strategy.
Reasons to Use Scalping
- Reduced market exposure limits risk
- A shorter holding period reduces the probability of holding a positon during an adverse market event or shock.
- Smaller price movements are easier to obtain
- Larger price movements require a larger imbalance of supply and demand. Therefore, stock price movements of just a few cents may be achieved via the bid ask spread and without the stock actually moving.
- Smaller moves are more frequently observed
- Scalpers can exploit small price movements during quiet markets where larger moves may not occur.
- Reduced market exposure limits risk
Requirements for Scalping
A successful scalping trading strategy depends on a number of contributing factors amongst which are
Tools
- A live feed – Level 2 quotations are essential for this type of strategy
- Direct Access Trading (DAT) – automatic and instant execution of orders is vital
- Adequate computer hardware and software technology – minimize latency related slippage and interact within the marketplace efficiently. Slippage on both entry and exit trades can destroy overall profitability of a scalping strategy and is magnified when potential profits on each trade are small.
- Scalper will mostly use tick or one-minute charts due to the small duration of the trade
- Stamina – concentration and discipline are key
Services
- The trader needs to see the setups as they formulate in as close to real-time as possible.
- Low transaction costs – Commissions and fees must to be minimized due to the high volume approach to trading in all potential markets.
- High volume trade identification – A major part of a scalping strategy is to repeat small profits again and again. Therefore, it is vital to be able to consistently recognize a high volume of possible trades.
- Market liquidity – The ability to enter and exit the market quickly and efficiently is dependent upon not only the technology used, but also the number of market participants willing to trade at the scalper’s desired price. Markets exhibiting high liquidity, will also often exhibit tight bid / ask spreads and as such are prime candidates for scalping.
Popular Scalping Strategies
The following list is a collection of scalping strategies used by traders. It must be noted however, levels of success are difficult to quantify and occasionally definitions may vary.
- Moving Average Ribbon Entry Strategy
- Moving average strategy
- Multiple Chart Scalping
- Parabolic SAR indicator strategy
- Relative Strength/Weakness Exit Strategy
- RSI strategy
- Stochastic oscillator strategy
