Scalping is a strategy that involves trying to profit from small changes in an assets’ price. The trader (or scalper) executing a scalp trade seeks to “take a little off the top” with each trade. Traders who employ the method generally have enough experience in this field to access efficient trading systems. This article will explain how scalping works. It will also take a closer look at how traders can use it for a wide range of assets.
What is Scalping in Trading?
Scalping is a trading strategy commonly used by traders who look to pursue small profits through marginal movements in the price of a stock. The trader exits the position when they achieve the target price without keeping the position intact for further gains. Scalpers generally have a strategy to exit an unfavorable trade at a moment’s notice. Such an exit plan is necessary to keep the profit intact in case their trades go against them. A scalping strategy works only if the number of trades with profit outnumbers the number of trades with losses.
This is a contradiction to traders who enter a position with a longer time frame in mind. That’s because the latter tend to maximize the profit on each individual trader rather than optimize the frequency of their successful trades. It is also necessary for a scalper to predict the movement in the correct direction, just like any other trader. However, the exact size of the price movement won’t matter quite as much. Scalpers also need access to appropriate trading infrastructure to make the strategy lucrative.
How Scalping Works
We can consider scalping a more dynamic form of intraday trading. The trader executes hundreds of trades in a single day. The risk scalpers take on any one trade is typically small, and they close their positions quickly regardless of the profit from it. Some of the common features of scalping include:
- Trading on small movements in price: Even when there may be a possibility of a large price swing, tend to consider it a safer bet to just close the trade while they’re ahead.
- Positions held for a short period of time: The target price for scalpers is typically close to its current price and achieved within a few minutes. Scalpers also need to ensure that they limit the downside risk by closing the position before the movement reverses.
- Liquidity is essential for scalpers: To execute a high number of trades within a short span of time, scalping needs liquid assets. For illiquid assets, the volatility and spread are generally higher, which does not match the risk appetite or trading strategy of a scalper.
- Access to a real-time trading platform with minimal latency: A scalper needs to execute their trades immediately to take advantage of the minor deviations in price. It is vital for their bottom line to not have a bit of lag potentially erase all their profit.
- High trading costs: Since the number of trades is high and the profit per trade is small, a scalper would need to cut down on trading costs, especially commissions, to improve their bottom line.
Spreads in Scalping
One of the ways scalping works is by exploiting the bid-ask spreads. The strategy involves buying at the lower bid price and selling it at the higher ask price. This is a relatively simple (but not easy) way to make a profit. These spreads are relatively stable and can generate a small profit that adds up for a scalper. However, it should be noted that price differences when using this strategy are tiny, and the spread could adjust to lower levels if this strategy is implemented by several traders. In such a case, the profits would not cover the commissions and other trading costs.
Scalping Trading Strategies
There are a few trading strategies that employ scalping with the help of technical indicators listed below:
- Exponential Moving Average (EMA): When the price is above the EMA, it would indicate a signal to short the stock, and if it is below, the signal is that of a buy. A trader relying on scalping would have an EMA that is of a shorter duration. In most cases, traders use multiple EMAs together to decide on a trade.
- Volume and price action: This involves studying the volume and price patterns. If the volume is high and the price is rising, it indicates a strong uptrend, and a scalper would go long on the stock. If volumes are low, it could be an indication of a reversal in trend.
- Bollinger Bands: Bollinger Bands are lines that give an indication of the volatility of the price. If the price is below the lower band, it is a signal to buy. Similarly, if the price is above the upper line, it is a signal to sell.
A scalper could deploy the same or different technical indicators to a standard technical trader while performing trades. What distinguishes the scalper is that the intervals set for these indicators are very small. This makes it a very dynamic approach to trading.
Is it Better as a Main or Complementary Strategy?
Many traders use scalping as their main trading strategy. However, it should be noted that it requires a lot of experience and efficient and responsive trading tools. Making scalping their primary strategy requires an extremely high rate of successful trades. That means the number of profitable trades needs to outnumber their losses. One also needs to understand that scalping is a stressful technique that requires a remarkably high level of attention during trading hours. An opportunity could vanish within a few seconds if the trader is not vigilant enough. Most people turn to scalping only after having significant experience in trading.
For most traders, it is advisable to take scalping as a complementary strategy. Understanding the markets before scalping ensures that the trader is aware of the risks. Many non-scalpers tend to hold their positions for a long time. While this could generate higher profits, the potential losses tend to be higher if the trader isn’t using stop-loss orders in a way compatible with the strategy. Making it an alternative strategy also ensures that one does not have to keenly observe the markets for a long period of time. The trader can select a specific period to indulge in scalping and pocket the gains, thereby keeping stress levels in check.
Scalping as a Complementary Strategy
Scalping has been popularly used as an add-on strategy by many traders to boost their profitability. While trading short-term works best when volatility is higher, scalping can be used when the price of a stock is trading range-bound.
For example, consider a trader having shares of ‘Company A’ with a long-term view. If the price toggles between $10 and $11, then the trader can go long at $10 and sell it at $10+ or go short at $11 and square it off at $11-. While his original portfolio remains intact, scalping enables the trader to book incremental profits. One advantage that such a strategy carries is that the trader is already aware of the behavior of the stock and would know when to enter and exit. By deploying it as a complementary strategy, the trader does not have to execute a high number of trades, and the tolerance for misses is also higher.
Scalping can also be used in umbrella trades for traders with a long-term view. In this scenario, the trader buys a stock and sells it as the price increases. Later, they repurchase it again at a lower price.
Another advantage of using it as a secondary strategy is that the scalper does not need to invest heavily in trading platforms for superior execution of trades.
How to Become a Scalper
To become a successful scalper, it’s essential to understand the market and the underlying asset you plan to trade. Most scalpers rely on technical analysis before entering a trade. That’s why knowledge of technical analysis tools is also vital. The strategy relies on the trader’s ability to accurately predict price movements. That’s why a scalper should backtest their performance using a simulator first. This helps determine how successful the scalper is in executing their strategy. Many online platforms offer courses in scalping strategies that can be used during the learning phase. Understanding the cost structure of trading platforms is also essential to determine how this strategy can break even. As mentioned earlier, experience is crucial to scalping. Anyone looking to make a decent profit should be willing to absorb the risk and stress that comes with it.
Using It for Different Assets
Most of what we’ve discussed so far was mainly based on stocks. However, scalping has seen popular use across a wide range of asset classes. These include derivatives like futures or holdings like foreign exchange (forex) and stocks. Scalping has also been used by some in the volatile cryptocurrency market. The best thing to do for each trader is to apply it to the particular asset they specialize in if they have one.
For example, if a trader specializes in foreign exchange, he could have a specific set of currency pairs for scalping. Sticking to one asset ensures that the trader obtains a high level of specialization, improving their accuracy and success rate. Within each asset, the level of risk is also significantly different. Scalping in the cryptocurrency market can involve a much greater risk given how volatile the movements in price are. This can lead to a major loss within a few minutes of trade. The same could apply to a currency pair that is relatively illiquid or is sensitive to economic factors.
Scalping Futures
Using scalping for futures trading is a high-risk and high-return strategy. One needs a reasonable level of expertise before entering such trades. Futures on foreign exchange or stocks can be purchased to close out the position after garnering small profits. By putting an initial margin, a trader can gain exposure to a higher volume of assets, thereby maximizing their capital efficiency. The futures market is generally liquid, allowing for low margin traders, which lets a scalper exit their position quickly.
Scalping Forex
Using foreign exchange as an asset for scalping is common among traders. They generally use technical indicators to determine the correct time to enter and exit a trade. Many currency pairs are very liquid and offer plenty of opportunities to implement trades quickly. Scalpers can also take advantage of the bid-ask spread to profit. It’s worth noting that the movement in forex markets can be limited. Traders could have to take on a considerable position to generate even a small profit. Many scalpers also venture into currency pairs that are illiquid in nature or ones that have a larger bid-ask spread.
Scalping Stocks
Using technical indicators to enter the market is one of the most used scalping strategies using technical indicators to enter the market. One advantage of scalping in stock trading is that the risk is lower than for futures. However, there’s no leverage to multiply your profits either. Scalpers have an opportunity to choose from a wide range of stocks exhibiting different levels of volatility. They can go for strategies involving bid-ask spread or price action. Unlike the forex market, price movements can be unpredictable depending on the idiosyncrasies of the stock. Setting a target tick value for closing out a trade may not work out in a scalping strategy for equities if stock movements are unfavorable and exhibit any trend towards circuit breakers.
Irrespective of the type of asset involved, establishing a stop-loss is critical for a scalping strategy to work. One loss could erode the cumulative profits obtained from multiple trades.
Final Thoughts
Scalping can be an effective way to succeed in trading. However, it also comes at great risk and requires considerable experience and effort. It can be an alternate source of income for people well-versed in trading. The scope of scalping is tremendous and can be used in different asset classes depending on the experience of a trader. With improvements in trading systems, one could only see scalping gain popularity in the future. It also allows for market efficiency by eliminating any arbitrage possible through bid-ask spreads.
F.A.Q
The time frame for scalping in forex can be short and range from one minute to fifteen minutes. Traders generally deploy technical indicators of shorter duration to make the indicator more responsive. Most traders, however, prefer the range between 1 minute and 5 minutes for scalping in the forex market. Cutting down on the duration ensures that the trader is not exposed to higher volatility in these markets. Generally, scalping using short-duration timeframes works well for liquid currency pairs like EUR/USD and GBP/USD.
The size of the ticks can vary depending on the size of the contract involving derivatives, forex, or equity. In futures scalping, the notional amount is generally high, and the tick size can be as small as 1 tick. Similar strategies can be employed for equity and forex, but the amount of asset purchased needs to be high. Traders could opt for a higher tick value if the underlying amount invested is lower. Scalpers in these cases can opt for a movement of up to 5 ticks, but the time taken for execution of these trades can be longer.
Every trader has their preference of assets to scalp. The most basic approach would be to track the developments in these markets and follow relevant news affecting the stock’s price or forex. After this, a trader can gauge the nature of movement and take a necessary position after looking at the various indicators at his disposal. The scalper should already have a defined strategy to scalp and would need to assess whether the asset would behave in a way that would make the scalping trade profitable. For traders whose primary strategy is scalping, it could be a more strenuous effect to determine which asset to scalp numerous times in a day.
