Definition of scalping
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What is scalping?
Scalping is a trading method that involves placing a multitude of orders to take advantage of very small trading spreads, in the order of a few pips. Buy or sell orders can be up or down on the same product. A scalping trader does not take the trend into account. The duration of trades is usually a few seconds and does not exceed a few minutes. So scalping is an aggressive trading method.
It is now one of the most widely used trading methods in the financial markets, not by individuals, but by banks and hedge funds with high frequency trading. The practice of scalping is then pushed to its extreme with orders of just tens of milliseconds. This type of trading is fully automated and identification of trades is done by algorithms.
How to scalp?
Scalping is practised on all types of financial markets (equities, futures, indices, forex, commodities, etc.). Scalping is based on the use of several tools:
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The order book
: The order book lists the buy and sell orders not executed on a single product. Various information is available such as prices, quantities and number of orders. Reading the order book therefore gives indications of future changes in assets. For example, a scalper studies the volumes, the difference between the best limit and the next price, the spread, etc. Scalpers use this tool especially on stocks, indices and futures.-
Price charts on short units of time
: These charts range from 1 minute (the shortest unit of time available on trading platforms) to 5 minutes. Scalping is a little longer term, positions can be held for several minutes in some cases. This is particularly the case on Forex. Effectively, volumes are not available on this market. You can only get a volume indicator or order book from your broker but it is based solely on his clients (so it doesn't have much value).Essential requirements for scalping
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Low transaction costs
: To practice scalping in good conditions on the stock exchange, you must have very good trading conditions. Transaction fees should be as low as possible. Indeed, in scalping, fees eat away at your winnings and can even make your trades lose out. With a traditional broker (like your bank), it is impossible to practice scalping, the fees are too high. You must therefore turn to brokers offering CFDs (which replicate the price of the underlying asset) to scalp stocks, indices or commodities. On CFDs, there is no commission on the transaction, you just pay the spread. This is also the case on Forex. It is therefore logical to choose the broker offering the lowest spreads on the products you trade.-
Platform reactivity
: Scalping is based on the exploitation of small price spreads and your orders therefore need to be transmitted as quickly as possible to the market. It is therefore important to find a reactive trading platform with the lowest possible slippage risk (the price at which you click is not the price at which your order is placed). You could open demo accounts with various brokers to test their trading platform.-
High-performance computer equipment
: it is better to have a stable computer (which does not crash) and a high speed connection (without recurrent interruption) for your orders to be well transmitted. A bug in your hardware can cost dearly in scalping.Rules to follow when scalping
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Strict money management
: In scalping, risk management is the key to success. It is better to impose very strict rules on yourself and stick to them. It is very important to know how to take your losses at the risk of ruining several days’ efforts on a single trade. Scalping is a school of small profits. The goal is to take small earnings throughout the day to ultimately achieve a satisfactory overall performance (just like a swing trader).Always placing an automatic stop loss each time you take a position is strongly recommended. In a way, it is an emergency stop that protects you in the event of an unexpected increase in volatility. With scalping, no mistakes are allowed. All you need to do is forget about a trade and suffer a stroke of bad luck to jeopardize all your work.
It is important to constantly monitor your trade. In scalping, you should be aware that the majority of trades are manually cut, both on a winning trade and on a losing trade. So it is important to maximize your gains as much as possible and minimize your losses. Tell yourself that every point counts in scalping. It is in managing the details on all your trades that will make you a good or bad scalper.
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Low volatility
: It is often said that volatility is the scalper's friend. This is true but only for large banks and hedge funds with high frequency trading. For an individual, it's another story. Volatility increases and individual’s risk and the percentage of trades reaching their stop loss. That's what it all comes down to. It is important to reduce the amount of losses on losing scalping trades to a minimum. Every lost point counts.In volatile times, spreads will also increase. Transaction costs have a considerable impact on overall performance. Volatility also increases the risk of slippage and the movements are often too sudden to have time to react (as with an economic announcement).
Scalping in practice
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Scalping strategies
: Scalping is generally practised in the areas of supports and resistances. Effectively, it is often possible to capture small correction movements at these levels. The supports/resistances can be pivotal points, boundaries of chart patterns, etc. These are the moments when investors hesitate and when it is possible to make multiple round trips.You can also scalp all after a key level break. There is often movement acceleration and even if the movement does not continue, it is possible to capture a few points.
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When to cut a losing position
: When you take a position, it means you have a clear bullish or bearish signal. Your bullish or bearish scenario must therefore be completed quickly once your trade has passed. If you see that the price does the opposite, do not wait until your stop loss is reached to cut your position. The stop loss is simply there to protect you in case something unexpected happens. It is not there to cut your losses on all your losing trades. Scalping has nothing to do with swing trading on small units of time. These are two totally different methods.-
When to cut your winning position
: With scalping, it is not wise to be too greedy. Your objective is not to take a trend movement but simply to capture a tiny part of this movement (in the order of a few points). If the price moves in the right direction, cut at the first sign that the movement is flagging. You can also cut as soon as your price objective has been reached.-
What leverage to use
: It is quite possible to practice scalping without leverage but to have profitable gains in terms of money, it is better to have a large account. If this is not the case, you need to use leverage. This does not mean that it should be abused. Remember that the greater the leverage, the greater the risk. It's up to you to determine the maximum leverage you can use based on the number of trades you make. For example, you can risk 0.1% of your capital on each trade. It's up to you to calculate the size of position to take.-
What must be the percentage of winning trades
: In scalping, the percentage of winning trades must be high, much more than in swing trading (where one winning trade can be enough to cover the loss on 2 or 3 losing trades). With scalping, this is not the case and it is the percentage of winning trades that makes the difference. If you are unable to have a positive win/lose ratio, stop scalping.Advantages of scalping
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The trade’s result is known very quickly
: In scalping, the duration of holding the trade does not exceed a few minutes and is very often only a few seconds.-
Reduced stress
: You don't have time to be stressed over the outcome of the trade as is the case in swing trading. In addition, at the end of your day’s trading, all your positions are cut and there is no stress.-
Regular earnings
: If you are a good scalper, your trading account will rise constantly. You will not see a downward spike as is the case for a swing trader after a series of losing trades.-
No emotions
: Emotions are the trader's enemy and are often the cause of traders' loss in the financial markets. With scalping, there is much less requirement to manage emotions due to the short duration of the trade and the speed with which it is possible to catch a losing trade.-
Important trading opportunities
: Whether the asset you are trading is in a trend or in a range, it has no impact on your trading and the number of your trades. Scalping is practised in all market conditions.-
Simple trading strategies
: With scalping, there is no need to spend days, weeks or months finding the right strategy as is the case for a swing trader. A single indicator could be enough to open a position.Disadvantages of scalping
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Time-consuming
: You have to carry out dozens of transactions a day to make substantial gains (if you have moderate leverage, which is recommended). Looking for opportunities all the time takes a lot of time. Also, you cannot take a break if you are in a position.-
Mentally wearing
: Scalping requires high concentration to avoid mistakes that could be fatal. Repeating this effort of concentration throughout the week is mentally draining.-
Low gain per trade
: A winning scalping trade brings in almost nothing. It is the accumulation of all your trades that generates performance or not.-
High commissions
: It takes a high number of trades and you pay the spread every time. The spread has a costly impact on every trade and on your overall performance.-
Experience required
: Scalping is generally reserved for experienced traders. It requires some experience to quickly identify trading opportunities.Conclusion
Scalping is a unique trading method in the financial markets. It offers many advantages, but the disadvantages associated with this practice must be accepted. With experience, gains can be significant, often superior to swing traders' strategies. But, scalping is a difficult technique to master even if it seems simple at first sight.
