Scalping – All You Need to Know

The idea behind using a scalping trading strategy is to capture small movements as the price that people are willing to pay for a security changes relative to the price they are willing to sell a security.  When a security is volatile and moves rapidly, the opportunity to scalp that security increases, generating a potentially profitable market environment.  The risk may be small as the reward may be small, and the strategy entails taking small amounts out of the market dozens of times a day every day.

The key element to trading a scalping strategy is to use the bid offer spread and capture the bid relative to the mid and the offer relative to the mid.  The bid price of a security is the price where buyers are willing to purchase a security.  The offer price is the price where sellers are willing to short or sell a security.  The mid-price is a theoretical price in between the bid and offer price.

When market conditions become volatile, the bid-offer spread increases as a result of a supply and demand imbalance.  This may be from new information or changes to liquidity.  During volatile conditions, traders other than dealers can assume a dealer role, buying on the bid and selling at the mid-price as the market chops around looking for balance.

Timing and Costs

A scalper needs to trade quickly and often.  There is very little room to take your time once an opportunity presents itself.  Day traders often use scalping as a strategy when markets are not in an observable trend.  When financial markets fail to offer a clear direction, scalping strategies can subsidies a trader with income during difficult times.

The Psychology of Scalping

Scalping is an activity that invokes extreme emotions such as fear and greed.  Novice scalpers are subject to changing their strategy if the market moves quickly in their favor, attempting to generate additional income by riding the market further than their initial take profit level.  The reverse is also true where fear of a loss sets in a novice scalpers let the market move against them hoping it will quickly turn around.  Overcoming these issues and maintaining a consistent and disciplined approach to scalping is the key to success.

Risk versus Reward

The risk reward profile of a scalping trading strategy is usually 1 to 1.  This means for every dollar risked, a scalper will attempt to gain $1.  A scalping strategy is geared toward catching small moves where the security that is traded moves in the favor of the scalper quickly.  The strategy generally avoids situation where a security is held for an extended period waiting for a move substantial change in the direction of a security.  Novice traders who change the profile on the fly are bound to lose income.

For example, a trade that is expected to generate 25 cents should risk 25 cents.  If the price of a security moves against the scalper by 30 cents, the trade should be terminated.  Risking 30 cents to make 25 cents is a losing proposition of the long term and may erode the value of a scalping strategy.

The key to a successful scalping strategy is to find a good impetus to enter a trade, have sound risk management and maintain a psychology that will avoid situation where the strategy will generate significant losses.