Day trading scalping strategies may not be the most widely used strategies, but they are certainly one of the most talked-about. If you’ve heard about strategies where traders placed dozens or more trades, they were probably scalpers. This style is quick, risky, and potentially very lucrative.
One of the most popular and successful scalpers is Linda Raschke, whose hedge fund was ranked 17th for the best five-year performance by Barclays Hedge in 2002. According to her chapter in Jack Schwager’s book, The New Market Wizards, she receives a return after 2-3 hours of trading, and her profit ratio is 70%.
Scalping is by no means easy. But this article will try to explain this strategy in an accessible, beginner-friendly way.
What is a scalping trading strategy?
A scalping strategy involves taking advantage of small price changes and making multiple transactions within one trading session. Scalpers enter and exit positions in a matter of minutes, sometimes even seconds.
The main premises of scalping are:
- There is no time for fundamental factors to influence the price.
- Smaller moves occur more frequently than large price changes.
- Small returns are easier to obtain.
Scalping strategy setup
The core rules for trading a scalping strategy are:
- Compile a watch list of highly liquid assets to trade each day.
- Take a profit near the 1:1 risk/reward ratio.
- Don’t be too conservative with the amount you’re trading with.
- Buy at breakouts and sell as soon as the predetermined profitability is reached.
- Sell quickly if there is no move up;=.
- Incorporate technical indicators, such as RSI, Stochastic, and moving averages.
- Close all positions within the day’s trading session.
Here is an example of a scalp trade in the stock market. You set a limit order to buy 10,000 shares of company X for $1.98, which is close to the support level at the time of making the trade. When the stock price drops to $1.98, the move triggers the order and signals the trader.
In this example, you’ll be trading on a 1-minute timeframe. So, a minute later, the price bounces up to $2.00. This moves your equity in the stock from $19,800 to $20,000. You close the position at a $200 gain (assuming there is no commission). Even if you strongly believe the price will continue increasing, this particular trade must be closed. Then, you’ll move on to the next trade.
How Stock Scalping Works
Stock scalping works by gaining profit through day trading. You buy the asset at a lower price and sell it at a higher price during the same day, making smaller deals. This earns you a small profit from the price difference.
With the reduced exposure, the risks are limited. Therefore, you find yourself less likely to encounter an unlucky situation. Small moves are very common and occur regularly, which is why scalpers frequently work on this principle. Since the prices are smaller, it also makes them easy to catch.
Stock scalping uses timeframes that are considered the shortest in day trading. They can be set to below five seconds, allowing scalpers to make hundreds of trades every day.
Tips for Novice Scalpers
If you are interested in scalping, you have to be passionate about what you are doing. You must invest enough time into the market, even as a beginner, so that you may come up with the best strategy.
The reason behind this is that you’ll have to wait for specific market conditions to appear. Then, you will receive a signal that tells you whether to go long or short. As a novice, you might want to work on smaller timescales. This can be a 1-minute, 5-minute, or 15-minute timeframe, depending on your trading preferences.
To gain returns from stock scalping, you must learn how to quickly close your open positions and how to execute your orders. You have to keep an eye on the right moment – stick scalping is all about understanding when to make your move.
It’s common to trade the same security multiple times a day. So, you can capitalize on the continuing uptrend described in the example.
How is scalping different from other trading strategies?
Some traders find scalping counterintuitive. Why would you sell when the asset’s price movement shows no sign of a reversal? Wouldn’t it be better to let your advantageous positions stay open for longer? Scalpers’ answers to these questions are vastly different from trend or swing traders’.
If you’re a stock trader, you’re probably used to buying shares when they’re at a low price point and selling when their market value increases. Normally, it takes months and years before you reach your predetermined profit target. Conversely, day traders that they sell their winners very quickly.
Because a single winning trade is not worth much, scalpers compensate with the number of transactions. Tiny returns plus huge volumes are meant to build up into a decent income — that’s the idea.
How to maximize potential wins
The best scalping trading strategy should involve lightning-fast trade execution, reliable software, and a brokerage account with a favorable fee structure. Here are a few other things that will help you make the most out of scalping:
- Register with zero-commission brokers or look for heavy volume discounts. A flat commission on each trade can reduce your profits to practically nothing. If possible, only trade through brokers that don’t charge commissions or offer generous discounts when your trading volume exceeds a certain threshold.
- Trade with direct market access. DMA is a system where you can trade directly with another trader, market maker, or specialist without using a third party. This allows you to save time and closely monitor where and when the trade will be executed. Without a DMA, you lose the advantage of spotting bid/ask differences or small price movements in time.
- Use advanced charting tools. A traditional candlestick chart with no indicators is useless for scalpers. Even timeframes as low as 5-minute don’t provide enough data. You’ll need close to real-time price updates and a reliable combination of technical analysis tools to catch the movements you need.
- Improve your concentration and quick thinking. Spending hours catching small ticks in price takes a lot from you. Patience and attention to detail are other personal qualities you’ll need to work on.
Disadvantages of scalping
Not everyone will enjoy scalping because you need to get into a specific mindset to enjoy and succeed in it. Also, you should be willing to accept the exposure to risk and the fact that it’s very hard to succeed in scalping.
Before trading this strategy, consider the drawbacks:
- Higher transaction costs: When commissions are charged per trade, dozens of trades a day can quickly eat away your returns. If you don’t have a good profit ratio or aren’t trading with a zero-commission broker, you may even end up with nothing by the end.
- Can be tedious: There is constantly a lot of action, but it turns into a repetitive, almost routine task over time. You have to be glued to the monitor, looking at data, charts, and signals. Be prepared to make the same trades again and again.
- Risky and stressful: Scalping can be emotionally straining unless you turn yourself into a kind of a trading bot and become almost indifferent to any trading results. You’ll probably be missing out on favorable movements a lot because the strategy instructs you to close early.
Scalping strategies have been around for decades, and many traders have implemented them successfully, even during flat markets. The path of taking small but frequent wins definitely suits some traders.
But the downside is that while on paper, frequent wins sound like a good thing, real markets don’t always behave as you expect them to. If you aren’t experienced enough or you can’t handle a fast-paced trading style, you won’t be one of the success stories like Linda Raschke.
In any case, if you have the opportunity to practice scalp trading in a market simulator (or a demo trading account), it’s worth a try. If you’re hoping to get rich overnight, scalping is not for you. In fact, if immediate riches is your trading goal, no strategy is worth trying at all.
Disclaimer: No strategy can guarantee 100% correct outcome of the trade.