What is scalping in trading?
The stock market is known for fast-paced peaks and valleys. Many traders earn respectable incomes tapping into this volatility. Some even trade their way from rag to riches.
One common way to go about trading is known as scalping — a fast-paced trading strategy that involves making a large number of trades, each resulting in small profits. Here’s how it works:
What Is Scalping in Stock Trading?
Scalping in trading is a short-term trading strategy that’s centered around making several trades, each resulting in small profits. At the end of the day, the scalper adds up the small profits from a large number of trades, potentially resulting in impressive intraday returns.
Because of the short time frame involved in scalping, the strategy is a top choice among day traders.
These traders target high-liquidity stocks and other assets —those that can be bought and sold in the blink of an eye — because time is of the essence with this strategy. As soon as small price movements push the asset to the scalp trader’s profit goal, the trader sells the position and moves on to the next.
These traders aren’t chasing trends or hoping to determine a top or bottom in price movements. Instead, they use a series of technical indicators to find opportunities that are likely to move in the right direction quickly and exit the trade before any chance of a selloff.
How Stock Scalping Works
The process starts with the careful selection of stocks to scalp. To be a prime candidate for this type of trader, the stock must have:
- High Liquidity. A stock scalper wants to be sure there’s a buyer when it’s time to click the “Sell” button and exit a trade. Only stocks with high trading volume are considered for this strategy.
- High Volatility. Price action is key to any successful trade, and the scalp-trader wants things to happen quickly. These traders look for stocks with high levels of volatility, meaning they are known for fast-paced price fluctuations.
Once a stock or group of stocks is chosen, the trader performs technical analysis to determine the best entry points. The exit point for scalpers is always the first move into profits.
When looking for a solid entry, the trader uses real-time charts with a short time frame, using tick or one-minute charts to assess price moves. When scalpers see opportunities, they enter the trades, keeping their mouses on the “sell” button, ready to cash out at the first sign of profit.
Scalpers repeat the process throughout the trading session, accumulating small profits with each successful trade.
Scalp traders use a wide range of technical indicators to determine the best time to enter a trade. Some of the most common indicators include:
Simple Moving Average (SMA)
The simple moving average (SMA) shows the average price of an asset over time, smoothing out short-term volatility. It’s called a moving average because at the close of each time interval (trading session, hour, or minute), the oldest data in the trailing average is dropped and the newest data is added. Thus, the average moves gradually along with the movement in the stock.
Traders often use multiple moving averages set to different time frames and look for crossovers. When a short-term SMA crosses over a long-term SMA, it suggests that the stock is likely to move upward. Conversely, when the short-term SMA crosses below the long-term SMA, it suggests the stock is likely to move downward.
Moving Average Convergence Divergence (MACD)
The moving average convergence divergence (MACD) is an oscillator that measures the strength of price movements. On a MACD chart, the boundaries are set at extreme highs and extreme lows, and MACD and signal lines in the middle oscillate between the two.
Traders look for crossovers as a sign of changing momentum. When the MACD line crosses above the signal line, the signal is bullish. A MACD line that crosses below the signal line suggests declines might be ahead.
The Stochastic Oscillator
The stochastic oscillator is another tool to measure the momentum of a stock. Traders use this tool under the idea that momentum precedes price movement. Traders use the stochastic oscillator to get signals directly before movements happen in the market.
The scalp trading strategy is exciting but risky. It’s important that scalpers take steps to manage their risks. Here are a few ways you can do to reduce your risks while following this strategy:
- Use a Stop-Loss. Because each profitable trade only yields a small profit, it’s important to make sure one bad trade doesn’t wipe out your session’s earnings. A great way to do that is to set a stop-loss just below your purchase price on each trade. Although you may take on a small loss if the trade goes south, the loss won’t break the bank.
- Don’t Get Emotionally Involved. Upward movement is exciting, but it’s important to remember that you’re scalping. The point of the strategy is to accept smaller gains on each trade. It’s important not to get greedy and hold onto a winning trade long enough for it to reverse and become a loss. Check your emotions at the door before you start trading.
- Be Ready to Act. Always be ready to act. Changes happen quickly in the market, so you can’t take your eyes off the ball.
Primary Trading Style vs. Supplementary Trading Style
Scalping can be used as your primary trading style or to supplement other investing and trading strategies. It all depends on your preference. As a primary trading style, you’ll focus the majority of your trades on the small, fast-paced profits.
Scalping also works great as a supplementary trading style. When markets are choppy and long-term trading styles aren’t working well, scalp trading is a great way to exploit a volatile market for profits.
Should You Consider a Scalp Trading Strategy?
The scalping strategy is an exciting way to access profits in the stock market or other financial market. It’s fast-paced, it could lead to tremendous profits, and it’s a relatively simple strategy to deploy. But it’s not for everyone.
As with any other short-term trading strategy, scalp trading comes with a high level of risk. It’s best for a highly risk-tolerant investor who has plenty of time to recover should something go wrong. Retirees and others with a minimal risk tolerance should avoid this strategy.
The strategy also requires at least a moderate understanding of how the market works and strong technical analysis skills. Therefore, it’s best for beginners to choose a longer-term strategy and learn about the market before getting involved.
If you think you’re ready to try this or any other strategy, consider using a trading simulator to test your skills in a digital environment using digital cash. Once you’ve perfected your strategy, you’re ready to throw your hard-earned money in the ring.
Pros & Cons of Stock Scalping
As with any other trading strategy, the scalping strategy comes with its own list of pros and cons that should be thoughtfully considered before diving in.
There are several benefits to scalping in the stock market. Some of the most significant include:
- No Need for Detailed Fundamental Analysis. Scalping happens quickly based solely on price movements, so there’s no need for detailed fundamental analysis or other daunting research about the assets you’re trading.
- High Profit Potential. Successful scalpers make quite a bit of money. If you have the technical analysis skills and a keen understanding of how the market works, you could become the next major success.
- You’re Never Bored. As a fast-paced strategy, scalping requires traders to constantly look for the next opportunity and keep an eye on open trades. Many traders find it an exciting way to keep themselves busy while making money in the market.
- Make Your Own Hours. If you become a full-time scalper, you’ll be able to make your own hours and break free of the 9-to-5 rat race.
Although there are plenty of reasons to be excited about getting started with this trading strategy, there are also a few significant drawbacks to scalping.
- Large Potential Losses. Traders bank on small price changes and small profits. That means one bad mistake that leads to a big loss could be enough to wipe out your entire trading day’s earnings — or more!
- High Failure Rate. According to Tradeciety, the vast majority of short-term traders lose money. Because scalping is a short-term strategy, there’s a relatively low chance of success, especially for a beginner.
- Demanding. Although some like trading strategies that keep you busy, others find this particular strategy overwhelmingly demanding. Traders must make several trades every day, analyzing and tracking price movements each step of the way.
- Pattern Day Trading. Scalping is a form of pattern day trading. The Securities & Exchange Commission (SEC) requires that pattern day traders maintain a minimum balance of $25,000 in their trading accounts at all times. That rule limits access to this strategy for traders with smaller investment portfolios.
How to Get Started With Scalp Trading
So, you’ve been active in the market for some time and you’re ready to try your hand at scalping. Here’s what you’ll need to do:
- Research Indicators. Do some research on technical indicators and choose some you believe will give you the best chances of successfully pinpointing strong entry points.
- Assess Your Skills. Using a trading simulator, assess your scalping skills by working in a real environment with virtual cash. If you generate losses, adjust your strategy and try again. If your strategy leads to consistent wins, you’re ready to trade with real dollars.
- Open & Fund a Brokerage Account. Compare multiple brokers to determine which you’d like to work with. Even if you already have a brokerage account, keep in mind you’re best served working with a commission-free broker for scalp trading because scalpers make several traders per session. Working with a broker that charges even a small commission per trade will cause the fees to mount quickly.
- Start Trading. That’s it. You’re ready to start trading. Now, it’s time to look for fast-moving asset to trade and watch for the technical indicators that signal a good entry point. Consider using a stock screener to pinpoint opportunities that fit your strategy or a given set of criteria.
Stock Scalping FAQs
It’s only natural to have questions when learning about a new strategy. Here are answers to common questions about scalp trading.
Is Scalp Trading Legal?
Yes, scalping is legal. However, SEC regulations require high-frequency traders such as scalpers to keep a minimum of $25,000 in your trading account at all times.
What Is Forex Scalping?
Can You Scalp Trade Cryptocurrency?
Yes, you can scalp-trade cryptocurrency like any other financial asset. Its high volatility naturally makes it an attractive asset to try to scalp. However, beware of the potentially high trading fees that can eat into your crypto profits.
What Are the Other Day Trading Strategies?
Scalping is just one form of trading that suits some participants better than others. Some other day trading strategies you might want to consider include:
- Momentum Trading. Momentum traders take advantage of upward momentum in the stock market. These traders look for the biggest moves during any given trading session and take action to exploit them for profit.
- Pullback Trading. Pullback traders look for stocks that have a strong and consistent trend upward. The trader watches the chart closely, looking for a pullback. When downward movement happens, the trader buys the stock, hoping to have purchased it at a discount and be able to take advantage of the recovery.
- Breakout Trading. Breakout traders look for stocks that are trading close to the technical level of resistance. When the stock breaks above resistance, it’s likely to make a strong move upward, creating opportunities for day traders.
- News Trading. Some traders pay close attention to the news and the stocks that make the biggest headlines. These stocks are likely to make wide movements in the market, creating opportunities for traders.
What’s Difference Between Scalp Trading & Swing Trading?
Scalpers are interested in making several moves in the market and making small profits on each move. This fast-paced, short-term strategy differs greatly from swing trading. Swing trades generally take place over the course of one to three days but can last for months. These traders take a slightly longer-term approach to exploiting the swings in financial asset values.
What Is Gamma Scalping?
Gamma scalping is a type of hedging strategy that’s generally used in forex markets. The strategy involves scalping in and out of an underlying asset in an attempt to offset the time decay component of relatively long-term forex option positions.
Scalping is an exciting strategy that many successful traders have used to become millionaires. However, it’s not for everyone. Only those with a decent understanding of the market and the risks associated with trading, coupled with strong technical analysis skills, should consider scalping.