Scalping is a trading strategy focused on capitalizing on minor price fluctuations in a stock’s price. Traders utilizing this approach execute anywhere from 10 to hundreds of trades in a single day, believing that smaller price changes are easier to catch than larger ones. These traders are known as scalpers. When combined with a strict exit strategy, numerous small profits can grow into substantial gains, preventing significant losses.
Key Takeaways
- Scalping is a trading strategy aimed at profiting from small price changes in a stock.
- It relies heavily on technical analysis, such as candlestick charts and MACD, for execution.
- Numerous small gains can accumulate into large profits if a disciplined exit strategy is consistently employed to mitigate losses and capture gains.
Understanding Scalping
Scalping leverages larger position sizes for smaller price gains, held for the shortest duration within an intraday time frame. The primary goal is to buy or sell shares at the bid or ask price and quickly sell them at a slightly higher or lower price for profit.
Holding times can range from seconds to minutes, and occasionally several hours, but the position is always closed before the end of the trading session. Scalping demands discipline, sticking to a stringent trading regimen, and making decisions with certainty. However, scalpers must adapt quickly to changing market conditions to avoid excessive losses.
Scalping Characteristics
Scalping is a fast-paced activity suited for nimble traders. It requires precise timing and execution, utilizing day trading buying power (four to one margin) to maximize profits with most shares in the shortest holding period.
This strategy focuses on smaller time frame interval charts, such as one-minute and five-minute candlestick charts. Indicators like stochastic, Moving Average Convergence Divergence (MACD), and Relative Strength Index (RSI) are commonly used. Additionally, price chart indicators like moving averages, Bollinger bands, and pivot points serve as reference points for price support and resistance levels.
To avoid the Pattern Day Trader (PDT) rule violation, account equity must be greater than the minimum $25,000. Margin is required for executing short-sale trades.
Scalping Strategies
Scalpers buy low and sell high, buy high and sell higher, short high and cover low, or short low and cover lower. They often utilize Level 2 and time of sales windows to route orders to the most liquid market makers and ECNs for quick executions.
The point-and-click style execution through the Level 2 window or pre-programmed hotkeys provides the speediest order fills. Scalping relies purely on technical analysis and short-term price fluctuations. Due to extensive leverage use, scalping is a high-risk trading style.
Common scalping mistakes include poor execution, poor strategy, not using stop-losses, over-leveraging, late entries, late exits, and overtrading. The high number of transactions generates substantial commissions. A per-share commission pricing structure is advantageous for scalpers, especially for those scaling smaller pieces in and out of positions.
Example of Scalping
Suppose a trader employs scalping to profit from price movements of ABC stock trading at $10. The trader buys and sells a substantial amount of ABC shares, say 50,000, capitalizing on small price increments of $0.05. This strategy results in small profits that accumulate throughout the day due to bulk transactions.
Is Scalp Trading Illegal?
No, scalp trading is completely legal. The practice of executing large transactions for small price movements is permissible under financial regulations. However, it is a risky strategy requiring expertise and discipline.
Why Is Scalping Risky?
Scalping involves numerous transactions for minimal profits. This high volume of trades requires significant time, attention, and monitoring. The extensive execution of large transactions for small profits increases financial risk.
Why Do Brokers Not Like Scalping?
Brokers may dislike scalping because it strains their systems due to constant buying and selling. Managing the risk associated with high-frequency trades in large volumes also complicates the broker’s operations.
The Bottom Line
Scalping is a specialized form of intraday trading that demands flexibility and discipline to profit from small price moves on large orders. Prospective scalpers should be experienced traders or practice thoroughly before committing real money.
Related Terms: Intraday Trading, Technical Analysis, Pattern Day Trader, Level 2, MACD, RSI, Bollinger Bands.
References
- FINRA. “Day Trading”.
