Have you ever heard of scalping? Some newcomers may wonder what this barbarian-sounding term has to do with the world of finance. In fact, it is a popular trading technique favoured today by many.
If you are interested in entering and exiting trades in a short time frame, then this article is for you. We are here to guide you through the notion of scalp trading.
What is scalping?
Scalp trading, also known as scalping, is a popular trading strategy characterised by relatively short time periods between the opening and closing of a trade.
Scalping is the shortest-term style of day trading that specialises in profiting from small changes in the price of assets. Its name derives from the way its goals are achieved – by skimming many small profits off a vast number of trades throughout the day.
The philosophy behind this technique is that small wins can easily morph into large gains. Scalping focuses on larger position sizes for smaller profits in the shortest period of holding time: from a few seconds to minutes. Rarely, it can last up to several hours. The main goal is to open a position at the ask or bid price and then quickly close the position a few points higher or lower for a profit. All positions are closed at the end of the trading day.
Traders who implement this strategy are referred to as scalpers. They believe that it's easier to profit from small moves in prices rather than from large ones. Scalpers can place up to a few hundred trades in a single day, seeking small profits.
You have to take into consideration that scalping trading requires some level of professionalism, as it is known as one of the most challenging trading styles to master. It requires razor-sharp focus and unbelievable discipline due to the fast-paced nature of scalp trading, where decisions should be taken within a few seconds. Therefore, a thought-out exit strategy should be developed by the trader in order to prevent potential large losses.
Scalp trading strategies and techniques
In fact, a scalper has a variety of ways to make money. Scalping can be used as a primary technique or a nice addition to your overall trading strategy.
A successful scalper is trying to work out price patterns, support and resistance, and technical indicator signals. To stay on top of scalping trading, you can focus on the various time frame interval charts, such as the one-minute and five-minute candlestick charts.
Scalping traders also commonly use momentum indicators, such as the stochastic oscillator, relative strength index (RSI) and moving average convergence divergence (MACD) oscillator. Price chart indicators, such as moving averages and Bollinger bands, can be employed too. You can also utilise some other technical analysis indicators as you please.
The most well-known scalping technique is simply using the market's time and sales to decide where and when to make trades. Another frequently used method is to have a defined profit target amount per trade that should be relative to the price of the asset – this can range between 0.1% to 0.25%. You can also track stocks breaking out to new daily highs or lows and employ Level II (the order book) to capture as much profit as possible. Lastly, some traders will follow the news and trade present or upcoming events that can cause increased volatility in some particular asset.
One of the most convenient ways to execute scalp trading, however, is through trading a contract for difference (CFD). CFDs allow you to leverage your money, providing you with the opportunity to take much larger positions with a smaller amount of initial capital. Leverage gives you an opportunity to magnify returns (as well as losses).
CFDs also give you an opportunity to trade an asset without ever taking ownership of it by simply speculating on its price direction. It provides greater liquidity and easier execution. Additionally, when you are scalping with CFDs, you don’t have to pay financing interest, as you don’t hold any positions overnight.
So, to be or not to be a scalper? It all really depends on your personal trading interests and goals. If you prefer quick trades and are eager to learn some new techniques, then, perhaps, scalping is for you. Certainly, this strategy can be quite challenging. If you’re a novice, it might be a good idea to practice with a demo account until you are ready to dive into the real game.
What you need to know about scalping
Just like any other technique used in trading, scalping has several characteristics that should be considered before you decide to add it to your overall strategy.
Firstly, what makes scalping so attractive to traders? One of the ponderable pros of a scalping strategy is that it gives a trader lower exposure to risk due to the relatively smaller position size – something we could all benefit from in today’s unpredictable markets.
Scalping offers a greater number of trading opportunities as smaller price moves are easier to enter. Plus, smaller moves happen more frequently than larger ones: even in relatively calm markets, there are still many small movements from which a scalper can benefit.
Additionally, you can place up to a hundred or more trades per day.
The main disadvantage of a scalping strategy is that not everyone is ready for such fast and demanding trading. It is profitable for some traders, but also brings its own share of risks. When scalping, precise timing and prompt execution are essential. If something in the market goes wrong, and you don't respond quickly, there is a high chance you can sustain some large losses. Think of scalping trading as a sprint, so you have to capitalise quickly on available opportunities.
How scalp trading works
A scalp trade is better described as an assumption that most securities will complete the first stage of a movement in a short span of time. When trading, scalpers want to profit from the changes in an asset's bid-ask spread. So, it is fair to say that scalping takes advantage of market volatility.
The scalp trader buys an asset when the spread between the bid and the ask is narrower than usual, with the ask lower and the bid higher than it normally is. Conversely, the scalper sells when the spread between the bid and the ask is wider than usual, with the ask higher and the bid lower than it should be.
Many traders rely on scalping during slow market days. As each trade carries some transaction cost, scalping can facilitate more costs than profits. However, if executed correctly, it can be a nice way to make some steady profits.