Scalping is a style of business that specializes in profiting from small price changes. This usually happens after a trade is executed and it becomes profitable.
Scalping requires a trader to have a strict exit strategy because a large loss could wipe out the many small gains that the trader worked to make. Therefore, it is necessary to have the right tools, such as a live stream, a shortcut broker, and the resistance to perform many trades, for this strategy to be successful.
Read on to learn more about this strategy, the different types of scalping, and tips on how to use this style of trading.
How scalping works
Scalping is based on the assumption that most actions will complete the first stage of a move. But where it goes from there is uncertain. After that initial stage, some actions stop moving forward while others continue.
A reseller intends to make as much small profit as possible. This is the opposite of the “let your profit run” mentality, which attempts to optimize positive trading results by increasing the size of winning trades. Scalping achieves results by increasing the number of winners and sacrificing the size of the winnings.
It is not uncommon for a trader with a longer period of time to achieve positive results by earning only half, or even less, of his trades; it’s just that the gains are much larger than the losses. A successful reseller, however, will have a much higher ratio of winning trades to losing trades, while keeping profits roughly equal to or slightly greater than losses.
The main premises of scalping are:
- Reduced Exposure Limits Risk – Brief exposure to the market decreases the likelihood of encountering an adverse event.
- Smaller movements are easier to obtain: a greater imbalance between supply and demand is needed to guarantee larger price changes. For example, it is easier for a stock to make a move of $ 0.01 than it is to make a move of $ 1.
- Smaller moves are more frequent than larger ones – even during relatively quiet markets, there are many small moves that a reseller can exploit.
Scalping spreads vs. normal trading strategy
When resellers trade, they want to profit from changes in the bid-ask spread of a security. That is the difference between the price that a broker will buy a security from a reseller (the bid price) and the price that the broker will sell it (the selling price) to the reseller. Therefore, the reseller looks for a narrower extension.
But under normal circumstances, the trade is quite consistent and can allow for stable profits. This is because the spread between supply and demand is also stable (supply and demand for securities is balanced).
Scalping as the main trading style
A pure scalper will make a series of exchanges each day, perhaps by the hundreds. A scalper will primarily use tick or minute charts as the time frame is small and they need to see the settings as they take shape as close to real-time as possible. Support systems like Direct Access Trading (DAT) and Level 2 quotes are essential for this type of trading. Automatic and instant order execution is crucial for a reseller, which is why a direct access broker is a preferred method.
Scalping as a complementary style
Longer-term traders can use scalping as a complementary approach. The most obvious way is to use it when the market is choppy or locked in a tight range. When there are no trends in a longer time frame, going to a shorter time frame can reveal visible and exploitable trends, which can lead the trader to the scalp.
Another way to add scalping to longer-term trades is through the so-called umbrella concept. This approach allows the merchant to improve their cost base and maximize their profits. Umbrella exchanges are carried out as follows:
- A trader initiates a position for a longer time frame trade.
- While the main trade is developing, a trader identifies new setups in a shorter time frame in the direction of the main trade, entering and exiting them according to the principles of scalping.
Based on particular settings, any trading system can be used for the purpose of scalping. In this sense, scalping can be seen as a kind of risk management method. Basically any trade can turn into a scalp making profits close to the risk / reward ratio of 1: 1. This means that the size of the profit made is equal to the size of a stop dictated by the settings. If, for example, a trader enters his position for a scalp trade at $ 20 with an initial stop at $ 19.90, the risk is 10 cents. This means that a 1: 1 risk / reward ratio will be reached at $ 20.10.
Scalp operations can be performed on both the long and short sides. They can be performed on breakouts or limited range trades. Many traditional graphic formations, such as cups and handles or triangles, can be used for the scalp. The same can be said for technical indicators if a trader bases his decisions on them.
Types of scalping
The first type of scalping is called “market-making,” whereby a scalper attempts to capitalize on the spread by simultaneously posting an offer and an offer for a specific share. Obviously, this strategy can only be successful on mostly immobile stocks that trade high volumes without any real price change.
This type of scalping is immensely difficult to perform successfully because a trader must compete with market makers for shares in both offers and offers. Also, the profit is so small that any stock movement against the trader’s position justifies a loss that exceeds his original profit target.
The other two styles are based on a more traditional approach and require a moving stock where prices change rapidly. These two styles also require a solid strategy and method for reading movement.
The second type of scalping is done by buying a large number of shares that are sold for a profit on a very small price movement. A trader of this style will enter positions for several thousand shares and wait for a small move, which is usually measured in pennies. This approach requires highly liquid stocks (to allow 3,000-10,000 stocks in and out easily).
The third type of scalping is considered to be closer to traditional trading methods. A trader enters a specific number of shares in any configuration or signal in his system and closes the position as soon as the first exit signal is generated near the 1: 1 risk/reward ratio.