What Is Scalping Trading and How Does It Work?
Scalping trading is actually what most people imagine when they think of day trading. It’s a trading style that deals in rapid trade. And a scalper often makes hundreds of trades each day. Scalping sees traders holding securities for minutes at a time and capitalizing on small movements. It’s considered a lower-risk form of trading, which means big winners are difficult to come by. Instead, it’s all about incremental gains.
The idea behind scalping is to take profits quickly with as little exposure to time as a risk variable. Scalpers enter and exit their positions in a matter of minutes. This means there’s almost no chance of a run up or down. You’ll lose or gain pennies on the dollar instead of huge sums. With enough wins, scalpers can make significant profits over the course of a week.
Micro Trades Add Up to Big Gains
Price scalping is often subject to the 1-to-1 trading mindset. This means the trader is willing to accept equal gains and losses. If you purchase a security for $12.10 and set a price target of $12.20, you need to accept the $0.10 risk or reward. Trades that stick to the 1-to-1 ratio are generally considered a scalp because that range is very narrow.
Most scalpers aim to gain pennies on the dollar. And, because they’re trading so quickly, they’re willing to take small gains instead of risking any losses. You might profit only $5 or $10 per trade, but if you’re winning more than you lose, those gains add up. This is especially true when trading in volume. Scalping trading hundreds or thousands of shares at pennies can still add up to hundreds in profits per trade.
Scalping Strategies That Work
There are several strategies scalpers rely on when trading. Most of these play out in technical analysis via intraday charting. Here are some of the most common strategies:
- Large lot trading is the most common form of scalping trading for retail traders. It involves buying shares in bulk and selling at incremental gains. You might buy 1,000 shares of a stock at $0.50 and sell when the price hits $0.51 or $0.52, depending on your risk-reward tolerance.
- Market making involves placing a bid and an offer to capitalize on the spread of a specific security. It’s used on stocks that are trending flat. While it can yield quick profits, it’s difficult for retail traders to pull off. You’re up against actual market makers.
- Exit trading is a form of scalping that sees traders exit a position at the first sign of an exit in the pattern. This means disregarding previous price tolerances and getting out with any gains. It’s a strategy that hedges against any further market movement.
These strategies all have one thing in common: quickness. Traders can’t afford to spend more than a few minutes in each position or they reach price fluctuations that break the 1-to-1 ratio.
Scalping Trading vs. Day Trading
What’s the difference between scalping trading and day trading? Simply put, scalping is a form of day trading. Each scalp constitutes a round-trip trade, which puts traders at the mercy of FINRA’s pattern day trader rule. Expect to maintain a $25,000 minimum balance in your account to practice scalping.
The big difference between scalping trading and traditional day trading is time. Day traders may spend hours in a position to see a trend play out. Scalpers care about only the incremental movement within a pattern. Some day traders may practice scalping in certain pattern formations. Scalpers will always be in a position for much shorter than a traditional day trader.
Beware of the Pitfalls of Scalping
Scalping trading comes with several distinct risks. Traders need to get familiar with these risks to protect themselves against harsh losses that could wipe out daily gains.
First, is to beware of penny stocks. Many scalpers favor penny stocks because they’re under $10 per share and, thus, easy to buy in bulk. This, unfortunately, leaves them vulnerable to pump and dump schemes. Investors with open positions will tout the stock, causing the price to rise. When it does, they’ll sell at a profit and leave new owners sitting at a loss. Scalpers can make significant profits on pump and dump swings. But they can just as easily end up with huge losses when the pump is over.
The other mistake scalpers make is to ignore the 1-to-1 rule and try to play a breakout. The longer you spend in a scalp position, the more risk you assume. Scalpers chasing profits on a pattern can quickly see their gains erased with a correction or deviation from the pattern. Every scalper needs a clear exit strategy that they stick to.
Finally, it’s important to consider trend factors. Is the volume high for a stock? Is there recent news affecting the price of a security? Patterns aren’t the only variable to observe. Look beyond the chart to identify factors that affect volatility. Even if you’re scalping, small spikes or craters in the price are something to beware of.
The Bottom Line on Scalping Trading
Scalping trading is a strategy that takes a lot of attention to detail. While you’re mitigating time as a risk variable, you need to be disciplined in exiting a position. Most important, you need to be able to take a loss. Successful scalpers will win more trades than they lose, and their losses will be minimal.
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Keep in mind that scalping requires a background in technical analysis and access to real-time market information. When you’re dealing in minutes, it means you have seconds to observe and act. Scalping is for confident traders who understand the market second nature.