Scalping definition

Scalping is a particular trading strategy; the traders themselves are known as scalpers. Its defining characteristic is making many, quick, in-and-out trades, even more frequently than day traders. As only a small profit is expected from each trade, scalpers simply have to trade often. Scalpers can also increase the size of their positions in order to amplify the results. Since they often trade on margin, though, this does not require extra capital but does increase their risk.

Who should be a scalper?

You can think of scalpers as the financial markets’ equivalent of being a professional fighter (many scalpers seem to!). Like a boxer or UFC contender, scalpers need to possess lightning-fast reflexes, unusual resilience, and the ability to make quick decisions under intense pressure. If they strike at the right time, they profit, but a single wrong move can be very costly.

Scalpers, again like boxers, need to be disciplined but also willing to improvise. Much of their time at work is spent patiently waiting for the most promising and reliable opportunities. Of course, other, competing scalpers will also be keeping a hawk-like gaze on the markets. When a chance for a quick profit emerges, each must act very quickly or watch it get subsumed by other buyers and sellers. A moment’s hesitation in entering a market order can mean an entry or exit price that makes the entire trade unworkable.

The challenge is made worse by the fact that price signals are often ambiguous or difficult to recognise. Scalpers therefore have to adjust to even the slightest indications of changes in momentum, both when seeing a potential opportunity or, if the market turns against their position, so they can immediately go on the defensive.

Scalping as a strategy

A company’s quarterly performance or prospects for the coming year have very little influence on its stock’s daily trading action. For this reason, scalpers are purely technical traders, focused only on the intraday action and unconcerned with fundamentals or long-term trends. In this sense, they differ even from other day traders who trade frequently but who aim to capture more of the day’s action and typically enter positions for several hours. A scalper might hold onto a trade for mere minutes or even seconds.

Scalpers typically focus their attention on the one-minute or five-minute bar or candlestick charts, looking for technical indications that the market may surge in one direction or the other within the next few minutes of trading. They then place an order with a minimum of delay; once they have made just a few points of profit in the trade, they sell out.

In contrast to most investors, scalpers are unconcerned with whether or not the market will continue moving in the same direction. Trend prediction or following would be a meaningless exercise for them; you could even say that they specialise in analysing the noise rather than the signal. When planning these very short-term trades, indicators such as the 20 EMA or Stochastic 5,3,3 are often relied on. (The EMA acronym stands for Exponential Moving Average, which can be a good alternative to a straight SMA or Simple Moving Average.)

An example of scalping

Here is an example of a scalping trade from the forex market: a trader sees a bullish candlestick pattern develop on the five-minute chart for EUR/USD, indicating a potential market reversal. They buy the currency pair, placing a stop-loss just below the low end of the candlestick. If the market advances five pips in their favour, they will quickly close out the trade, satisfied with a mere five-pip profit. If the market turns the wrong way and goes 5 pips against them, the trade is closed automatically, this time for a small loss.

(source: Strafx.com)

Let’s take another illustrative example. Since investors in the stock market often take profits at a major price level corresponding to a round number, a scalper may sell short at that price the first time that the share price rises to such a price level. In this case, they’re looking to make a quick but modest profit when the market retreats slightly. The necessary conditions for this trade setup to work may exist for only minutes or even seconds, but that is long enough for a scalper.

Requirements for success

The main requirement to work as a scalper, at least for more than a few weeks, is a high tolerance for stress and a firm belief in one’s own decision-making ability. Scalping is a potentially lucrative but also very risky enterprise, and everyone has bad days. 

Unlike traders who take positions based on a favourable risk/reward ratio – where their potential profit is significantly larger than their potential loss – scalpers may frequently enter trades where they risk more than they are hoping to make on a trade. While business education is not disparaged in a scalper, a mathematics-related degree is preferred. Since much of their work is based on mathematical abstractions rather than business concepts, they have to be able to leave their intuition and gut feelings at the door, playing the market based purely on the probabilities they are able to estimate.

Some of the other risks inherent in scalping are bad trade execution, overtrading, and employing too much leverage. Even an internet outage that lasts no more than a few minutes could cause them to take a significant loss. Anyone thinking of trying scalping for themselves will have to configure their trading platform’s dashboard with care, ensuring that their spread and margin levels are set to match their target assets and the best tools for this strategy are available and enabled.

Conclusion

Scalping is a commonly used trading strategy that offers the potential to reap substantial profits each trading day. However, it is an inherently risky endeavour and can only be successfully used by the most skillful, well-trained and disciplined traders.