What is scalping?
Scalping is a style of trading that aims to profit from small price changes in financial markets. Instead of buying and holding positions over a long period of time, scalpers make fast profits off a high volume of shorter trades, often lasting just seconds or minutes.
The theory behind the style is that smaller price moves are more frequent, and therefore easier to capture, than larger ones. By quickly entering and exiting larger positions, the smaller gains add up to the same level of profit from a normal day trade. By entering trades at a larger volume, even a profit of pennies would add up – but so does the risk associated with the position.
Scalping requires a strict trading strategy, which sets out exactly when to enter and exit positions and how much capital will be put up on each position.
An exit strategy is particularly important in scalping because allowing just one trade to run losses could eliminate a large portion of any capital gained. Scalp traders will make use of take-profit and stop-loss orders to automate these entry and exit targets.
What is a scalper trader?
A scalper trader is the name for an individual who uses the scalping trading style. Technically, scalpers are also day traders because they never hold positions open overnight, but there are a few traits that set them apart.
Scalper traders are often extremely disciplined individuals, due to the need to be strict about how long they keep positions open. They have the complete opposite opinion of ‘let your profits run’ and will instead cut trades at very specific profit targets, and even more strict levels of loss. Scalpers would never wait to see whether a losing trade will turn into a winning one.
A scalper trader will also need to be able to dedicate a lot of time to monitoring financial markets, given that a pure scalper would be entering dozens, if not hundreds, of trades each day. For this reason, it’s very rarely a style of trading adopted by beginners or part-time traders.
Scalper traders can manually make decisions about when and what to trade, but they do usually overlap with the class of trader that prefers to automate their trading strategy. Due to the amount of work a successful scalping strategy takes, it can be more cost and time effective to use a computer program. This guarantees speed when it comes to entering and exiting positions and reduces the risk of trading based on emotions and biases.
While investors hold stocks for years, and even position traders hold them for months, scalpers would have a position on a stock for just minutes or seconds.
A stock scalper might buy a large volume of stocks, wait for a tick upwards – or short a stock and wait for a small tick downward – and unload the trade as soon as it hits a profit.
For example, you put an entry limit order to buy 1000 shares of Company A when it hits $500 per share, a known level of support. Company A’s shares do fall to $500 and your trade is executed. You start to monitor the market and are ready to close your trade should the market move in your favour or against you.
The market rises to £501 and your trade is closed, regardless of whether the price looks like it will continue to rise. From this small position, the potential profit would be £1000.
However, if the market turned quickly losses could’ve stacked up. That’s why risk management is equally important, and most scalpers use stop-losses.
Liquidity is also vital when scalping shares, as without it, moving a large number of shares at once would be difficult. This creates a number of issues when scalping, the most obvious being you might be forced to hold your position for longer than you want. It could also result in a larger spread.
Every single cost incurred on a scalp trade is important as they can stack up due to the number of trades being entered every day.
Scalp trading forex
Forex scalping involves trading currency pairs over very short timeframes, in high numbers. A lot of forex scalpers will focus on high volatility events around economic data and breaking news, where large market moves are almost guaranteed.
A standard lot in forex is the equivalent of 100,000 units of the base currency, but thanks to leverage, scalpers can continue to take larger positions and skim off the top of smaller market movements. The average value of a pip is approximately $10, so holding a trade for a one-pip move ten times a day would equal $100.
Normally, forex scalpers will have a set amount of pips in mind and close their position once the currency pair has moved by that amount in either direction.
For example, a scalper might only open a trade on GBP/USD that’s only running for 30 seconds, aiming to cover a one or two-pip movement in the currency pair. Taking the average, this might only earn them a $10-$20 profit, but it would be repeated a number of times throughout the day.Learn about trading forex with FOREX.com.
Is scalping trading profitable?
A scalping trading strategy can be profitable, provided you have a higher ratio of winning trades versus losing ones.
This may sound obvious, but in other trading styles, a single losing trade might not blow all your hard work. Traders with longer timeframes, such as day traders or position traders, might win less than half of their trades and still come out with a profit. Whereas scalpers could see all their hard work gone in the blink of an eye.
Scalping trading strategies
Broadly speaking, there are three main strategies that scalpers employ:
- High-volume trading - Scalpers will often buy in large quantities to make the most of a small move, sometimes just a couple of points. As mentioned previously, this approach requires enough liquidity for the full position to be opened and closed effectively and with a tight spread
Breakout trading - Most scalping trading strategies will involve looking for breakouts, positioning your entry to a trade at the start of a breakout and riding the market move until the first exit signal is given off. This strategy is probably the most approachable, given it’s used across trading styles
- Trading the spread - Also known as market making, this is a strategy where scalpers attempt to profit on the spread itself by simultaneously buying and selling an asset. It relies on a market being relatively stable but still popular enough to experience deep liquidity. This is the most difficult strategy as the trader will be going up against much larger institutions and market makers
While most traditional scalping techniques are based on going long, a realm of opportunities can be opened up by going short too – especially when it comes to market-making strategies that involve buying and selling.
You can go long and short using derivative products, such as CFDs, options and futures.
How to scalp trade
The first step to starting to scalp trade is finding a provider that offers you the features and tools you’ll need to execute your strategy effectively. At a minimum, this should include:
- Fast, reliable execution – you need to ensure your broker has a best execution practice to ensure you’re getting the best prices, even in volatile markets
- Competitive costs and charges – profits can be eaten up by high costs of trading and commission fees. You’ll need to make sure your provider offers a competitive rate
- Advanced charting – your chosen platform should offer multiple timeframes on charts. If you’re opening and closing trades in seconds or minutes, then a 10 minute or greater tick isn’t overly useful
- Technical analysis indicators and drawing tools – most scalpers will focus more on price action and identifying known chart patterns over fundamental analysis
- Up-to-date news and analysis – remaining aware of news and ‘hot’ trades each day will help inform where opportunities are and what is likely to trigger sudden price changes
- Appropriate risk management tools – stops and limits are a core part of a scalper’s toolbox, being able to attach them before and during your trade can be the difference between a winning and losing trade
Before you consider taking your scalping strategy to live markets, it’s worth practising first in a risk-free demo account. You’ll be able to use virtual cash, eliminating any risk to your own capital, and start off with smaller position sizes to ensure you’re on the right track before opening a full trading account.