What is Scalp Trading?
Scalping is a trading style specializing in profiting off small price changes and making a fast profit off reselling. In day trading, scalping is a strategy to prioritize making high volumes off small profits.
Scalping requires a trader to have a strict exit strategy because one large loss could eliminate the many small gains the trader worked to obtain. Thus, this strategy must have the right tools—such as a live feed, a direct-access broker, and the stamina to place many trades—to succeed.
Rather than going for equity shares or currency pairs with less than optimal liquidity, a scalper will choose highly liquid financial instruments that allow them to enter and exit easily and generate decent profits.
Apart from the returns, what attracts traders to scalping is the relatively low risk that the trading style carries. How badly can a stock or currency fall in a few minutes?
The answer is not much, at least not always. Check out the image below for the minute-by-minute changes in stocks and currency futures.
This principle limits the downside that a scalper may experience per trade. But one bad scalp trade has the potential to wipe out other wins.
That’s why scalp trading is perceived to be a low-risk form of trading, but, at the same time, it requires a nuanced approach to managing risk.
How Does Scalp Trading Work?
Scalping is based on the assumption that most stocks will complete the first stage of a movement. But where it goes from there is uncertain. After that initial stage, some stocks cease to advance while others continue advancing.
A discounter intends to take as many small profits as possible. This is the opposite of the “let your profits run” mindset, which attempts to optimize positive trading results by increasing the size of winning trades. This strategy achieves results by increasing the number of winners and sacrificing the size of the wins.
It’s not uncommon for a trader with a longer time frame to achieve positive results by winning only half, or even less, of their trades–it’s just that the wins are much bigger than the losses. A successful stock scalper, however, will have a much higher ratio of winning trades versus losing ones while keeping profits roughly equal or slightly bigger than losses.
The main premises of scalping are:
- Lessened exposure limits risk: A brief exposure to the market diminishes the probability of an adverse event.
- Smaller moves are easier to obtain: A bigger supply and demand imbalance warrants bigger price changes. For example, it is easier for a stock to make a $0.01 move than a $1 move.
- Smaller moves are more frequent than larger ones: Even during relatively quiet markets, there are many small movements a scalper can exploit.
Scalping can be adopted as a primary or supplementary style of trading.
While other trading styles, like position trading, depending on fundamental and technical analysis to identify trades, scalp traders primarily focus on technical trading techniques.
Technical analysis involves studying the asset’s historical price movements and following current trends; scalp traders use various tools and charts to achieve it. Equipped with historical prices, scalpers observe patterns and predict future price movements as they plan a deal.
Scalp traders use trading charts and timeframes that are the shortest of all trading styles. A day trader might use a five-minute trading chart to make five deals daily. But a scalp trader will use timeframes as short as five seconds to make 10 to 100 trades during the day. To achieve this high speed of trading, scalp traders use several trading techniques, including the market’s ‘time and sales’ – a record of buying, selling, and canceled transactions.
Day Trading vs Scalping
In nature, day trading is the closest to scalp trading. Like scalpers, day traders also make several trades during the day. But still, there are several differences between the two.
| Day Trading | Scalp Trading |
| A day trader may use a timeframe that lasts 1 to 2 hours | A scalp trader uses the shortest timeframe to trade between 5 seconds and a minute. |
| A day trader has an average account size | Since a scalp trader takes a higher risk in the market and has a larger account size. |
| Day traders also trade in quick successions but at an average speed. | Scalpers aim for immediate results. They trade in the market at ultra-speed. Before other traders see an opportunity, a scalper will open and close his deal. |
| A day trader will follow the trend. They base their trading decisions on technical analysis. | The strength of a scalp trader is experience. They understand where the market trend is heading and wait for closing trades to get profit into their account. |
Pros and Cons of Stock Scalping
Pros of Stock Scalping
- Can be very profitable if executed precisely and with a strict exit strategy
- Many opportunities to leverage small changes in the price of a stock
- Do not have to follow fundamentals.
- The very little market risk involved
- Non-directional strategy: can be used if the market is going up or down.
- It can easily be automated within the trading system that is being used.
Cons of Stock Scalping
- High transaction costs for participants
- Requires greater leverage to make a profit
- It can be a time-consuming strategy that requires high levels of concentration
- Need to make dozens or hundreds of trades per day to see a profit
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