What is scalping? Beginner’s Guide to Trading Strategies
Scalping is a popular short-term trading style that involves taking small but frequent profits. Find out what scalping is and how you can start scalping the financial markets, including forex and stocks.
What is scalping?
Scalping is a style of trading that aims to profit from small price changes in the financial markets. Instead of buying and holding positions over a long period of time, scalpers make quick profits on a high volume of shorter trades, often lasting only seconds or minutes.
The theory behind the style is that smaller price movements are more frequent, and therefore easier to capture, than larger ones. By entering and exiting larger positions quickly, the smaller gains add up to the same profit level as a normal day trade. By entering trades at a larger volume, you would also add a profit of a few cents, but also the risk associated with the position.
Scalping requires a rigorous trading strategy, which defines exactly when to enter and exit positions and how much capital will be invested on each position.
An exit strategy is especially important in scalping because allowing a single trade to take losses could take away much of the capital earned. Scalp traders will use take profit and stop loss orders to automate these entry and exit targets.
What is a scalping trader?
A trader scalper is the name of a person who uses the scalper trading style. Technically, scalpers are also day traders because they never hold open positions overnight, but there are some traits that set them apart.
Scalping traders are often extremely disciplined individuals, due to the need to be strict about how long they hold positions open. They have the completely opposite view of “let your profits run” and will instead limit trades to very specific profit targets and even stricter loss levels. Scalpers would never wait to see if a losing trade turned into a winning trade.
A trader scalper will also need to be able to spend a lot of time monitoring the financial markets, as a pure scalper would enter dozens or even hundreds of trades every day. For this reason, it is very rarely a trading style adopted by beginners or part-time traders.
Scalping traders can manually make decisions about when and what to trade, but they generally overlap with the class of traders who prefer to automate their trading strategy. Due to the amount of work required for a successful scalping strategy, it can be more profitable and faster to use a computer program. This ensures that positions are entered and closed quickly and reduces the risk of trading on the basis of emotions and prejudices.
While investors hold stocks for years and even position traders hold stocks for months, scalpers would hold a position in a stock for minutes or seconds.
A stock trader can buy a large volume of stock, wait for a tick – or sell a stock and wait for a small tick – and dump the trade as soon as it reaches a profit.
For example, you enter a limit entry order to purchase 1000 shares of Company A when it reaches $ 500 per share, a known support level. Company A’s stock drops to $ 500 and your trade is executed. You start watching the market and are ready to close your trade if the market moves in your favor or against you.
The market rises to $ 501 and your trade is closed regardless of whether the price appears to continue to rise or not. From this small position, the potential profit would be $ 1000.
However, if the market changed rapidly, the losses could have accumulated. This is why risk management is equally important and most scalpers use stop losses.
Liquidity is also essential for stock scalping, as without it it would be difficult to move a large number of stocks at the same time. This creates a number of problems when scalping, the most obvious being that you may be forced to hold your position longer than you wish. It could also lead to further spread.
Any costs incurred on a scalping operation are significant as they can add up due to the number of trades entered each day.
Currency scalping in forex
Forex scalping involves trading currency pairs over very short periods of time, in large numbers. Many forex scalpers will focus on high volatility events related to economic data and breaking news, where big market moves are almost guaranteed.
A standard lot in forex is equal to 100,000 units of the base currency, but thanks to leverage, scalpers can continue to take larger positions and avoid minor market movements. The average value of a pip is around $ 10, so holding a trade for a move of one pip ten times a day would equate to $ 100.
Normally, forex scalpers will have a certain number of pips in mind and will close their position once the currency pair has moved that amount in both directions.
For example, a scalper can only open a trade on GBP / USD which lasts only 30 seconds, with the aim of hedging a one or two pip move in the currency pair. Taking the average, this could only earn them a profit of $ 10- $ 20, but it would repeat itself many times throughout the day.
Is scalping profitable?
A scalping trading strategy can be profitable, as long as you have a higher ratio of winning trades to losing trades.
It may seem obvious, but in other trading styles, a losing trade may not take away all your hard work. Traders with longer lead times, such as day traders or position traders, can earn less than half of their trades and still make a profit. While scalpers could see all their hard work disappear in the blink of an eye.
Broadly speaking, there are three main strategies that scalpers use:
- High volume trading – Scalpers often buy in large quantities to get the most out of a small move, sometimes just a few points. As mentioned above, this approach requires sufficient liquidity to open and close the entire position efficiently and with a tight spread.
- Breakout trading – Most scalping trading strategies will involve looking for a breakout, placing the entry into a trade at the start of a breakout and following the market movement until the first exit signal is issued. This strategy is probably the most accessible, as it is used in all trading styles.
- Negotiate the spread – Also known as market making, this is a strategy where scalpers attempt to profit from the spread itself by simultaneously buying and selling an asset. It is based on a relatively stable but still popular enough market to experience significant liquidity. This is the most difficult strategy as the trader will face much larger institutions and market makers.
While most traditional scalping techniques are based on going “long”, an area of opportunity can also be opened up by going “short”, especially when it comes to market making strategies involving the buying and selling.
You can go long and short using derivatives, such as CFDs, options and futures.
How to scramble a market
The first step to start scalping a market is to find a broker which gives you the features and tools you will need to execute your strategy effectively. At a minimum, this should include:
- Fast and reliable execution – you need to make sure your broker has best execution practice to make sure you get the best prices, even in volatile markets.
- Competitive costs and commissions – Profits can be swallowed by the high costs of trading fees and commissions. You will need to make sure your provider offers a competitive rate.
- Advanced graphics – the trading platform you have chosen should offer more time frames on the charts. If you open and close trades in seconds or minutes, a tick of 10 minutes or more isn’t very useful.
- Technical analysis indicators and chart analysis tools – Most scalpers will focus more on price action and identifying known chart patterns rather than chartist analysis.
- Updated news and analysis – Staying up to date on “hot” news and trades every day will help you know where the opportunities are and what could trigger sudden price changes.
- Adequate risk management tools – Stop and limit orders are at the heart of a scalper’s toolkit, being able to attach them before and during your trade can make the difference between a winning and a losing trade.
Before considering applying your scalping strategy to real markets, it is worth practicing on a risk-free demo account first. You will be able to use virtual money, eliminating any risk to your capital, and start with smaller positions to ensure you are on the right track before opening a real trading account.
By Rebecca Cattlin, FOREX.com »Official site
Disclaimer: The information and opinions contained in this report are provided for general information purposes only and do not constitute an offer or solicitation to buy or sell any forex or CFD exchange contracts. Although the information contained herein has been obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, and assumes no responsibility for any direct, indirect or consequential damages that may arise from the fact that someone relies on such information.