What is Scalp Trading and How Does Scalping Work?

What is scalping trading? Complete guide to scalp trading strategy, its pros and cons

As opposed to long-term investors, day traders manage to open and close deals within a few hours. Sounds fast? Well, there is an even more intensive strategy - it’s called ‘scalp trading’. In this guide, you will find out what it is, how it works, its difference from day trading and the most efficient strategies for beginners and seasoned traders.

What Is Scalping?

Scalping is a short-term trading method that involves possibility of making a profit from transactions that last only a few minutes. The traders who operate such positions are called scalpers. They are rightfully considered one of the most cold-blooded participants in financial markets.

Every day, the scalper makes hundreds of trading operations, which can last from just a few seconds to several minutes. From each position, the scalper’s income is minimal: pretty often, it can be a profit of 1 pip. However, overall earnings can be significant if a scalper performs a lot of transactions.

Scalping became possible and widespread when electronic exchanges and online trading appeared, and the Internet made it possible to almost instantly conclude transactions from anywhere in the world. Thanks to the Internet, the number of participants in intraday trading on the stock exchange is growing constantly, and scalping is also becoming increasingly popular among traders.

How Stock Scalping Works

The main way scalpers work is to monitor the so-called “order book”. The Order Book is a window that displays buy and sell orders from all market participants. The scalper captures the moment when either demand or supply prevails and instantly makes a deal. The main point of scalping is the choice of the moment for the transaction. In case of an unsuccessful trade, the scalper immediately closes it, as the situation on the market may change and the losses may be significant.

When it comes to stock scalping, traders assume that most assets will complete the first step of its movement. Sometimes, it works out and some scalping stocks keep advancing. This strategy is the opposite of increasing the size of successful trades. Scalpers bet on the number of trades. This strategy brings results when the number of winning trades grows and exceeds the number of sacrificed deals.

The major points of scalping are:

• Reduced exposure limits risk. Thanks to the high speed of transactions, there is a lower probability of facing an adverse event.
• Smaller market moves are simpler to achieve. For instance, a $0.01 move in stock price is more likely than a $1 move.
• Smaller moves are more frequent than larger ones. That makes scalping strategy applicable even to less volatile markets.

Scalping vs. Day Trading

These trading strategies have many features in common but they are not the same thing. Scalping is a form of day trading, but not vice versa. Here’s a rundown of their differences:

To perform many transactions, scalpers use bots and trading systems: they activate stock selling when the price reaches Take Profit or Stop Loss. Day trading is more thought-through: a trader usually has 5-10 deals per day. As a rule, no bots are used and certain actions are carried out on the basis of a thorough analysis of the situation.

Day traders also choose particular timeframes and need to identify the profit target correctly in order to close a position at the right moment. A day trader trades inside one news background. Tomorrow, there will be different events and the market may change. Here, the number one risk management rule is to never leave positions for the next day.

Spreads in Scalping vs. Normal Trading Strategy

During scalping sessions, traders earn by using changes in the asset’s bid-ask spread (the difference between the price at which the broker buys a security from a market participant and sells it). Scalpers are searching for narrower spreads.

Under normal market conditions, trading is regular and can generate earnings since the spread between the bid and ask keeps steady.

Scalping as a Primary Trading Style

Those who practice scalping only usually make several dozens or hundreds of deals per day. Most often, they use one-minute charts because the time frame is small and need to see setups in real time (as fast as possible).

In order to automate trading, you should use supporting systems like DAT (Direct Access Trading) and Level 2 - they trigger the closing and opening of deals. Automatic deal execution is critical for scalpers and they prefer direct-access brokers.

Scalping as a Supplementary Trading Style

Traders who operate longer time frames apply scalping as an additional strategy. It is applicable when the market is flat and prices are moving in a narrow range. So if there is no pronounced long-term trend, you can use scalping.

An interesting way of adding scalping to your strategy is the so-called ‘umbrella’ concept. It works the following way:

• A trader opens a long-term position.
• While the major trend is evolving, a trader identifies new setups in short terms (they coincide in direction with the market sentiment) and keeps scalping (entering and closing positions).

Since it’s applicable to many setups, scalping can serve as a risk management tool. Besides, any trade can serve as a scalp by fixing profit around the 1:1 risk/reward ratio. For example, if a trader opens a position at $10 with the stop loss at $9.90, the risk is $0.10. Then 1:1 risk/reward ratio will be $10.10.

Scalp trades can be performed on breakouts and in range-bound trading. Besides, many chart formations are applicable (triangles, cups and handles). Technical indicators can also be applied to short-term strategies.

Scalping Strategies

Before we get down to describing the most widespread strategies, we will dwell upon the peculiarities of scalping. Here’s how it usually works:

1. Preparation for work starts at 8 o’clock in the morning - you need to be present at the opening of trading. Check out the news that came out overnight and take into account the important events that have taken place in the US and the Asian region, and determine the impact of that on assets.
2. The beginning of scalping trading can bring quick profits. Therefore, it is recommended to start with 2-3 deals with strict risk control. The morning market is dependent on the news of yesterday - this is what you should use at the starting point. If there is an impulse jump (breaking through a key level, cutting stops, no price jump, larger lots), skip it, wait about an hour.
3. Before lunch, you need to take a key level with a subsequent trend, and close intraday positions before the break to reduce risks. Usually, after 2.00 PM, a new trading day is developing. This stage of position distribution becomes dangerous for the scalper because it usually has a protracted sideways movement and many punctures in different directions. This happens due to a surge in volumes and a redistribution of positions.
4. Before the release of important statistics, you should observe the participants and obtain from being too active. Freshly-published information will increase the volume of trades, and the scalper needs to decide on the moment and direction of the transaction.
5. While observing the trend, take into account all the circumstances and wait for the end of the main session. Scalping is an intellectual game based on facts, therefore it is interesting and promising.

There are many strategies for scalping, both simple and complex, based on a combination of fundamental and technical analysis techniques. Let’s take a look at some of the most popular options to understand this method better.

Scalping with two MAs

Scalping with two moving averages is one of the simplest strategies, but this version has been slightly improved to filter out a lot of false signals and improve trading efficiency. For analysis, two simple MAs are used: with a period of 10, the second - 20.

Transactions for this TS are opened not at the intersection of the moving averages, but, on the contrary, when they diverge:

• If the moving averages diverge in different directions and are directed downwards, sell trades are opened. The position is entered when the price rolls back and touches the further MA, and then turns down again and breaks the 10-period moving average.
• Buy deals are opened when the moving averages are directed upwards. The entry into the position occurs when the price rebounds from the lower moving average after the correction and the breakdown of the upper, 10-period one.
• Stop loss and take profit are set at the same distance from the open order (about 10-15 points). The positive dynamics of trading is achieved through the correct inputs.

M5 (five-minute) is the best timeframe for trading. As a rule, such transactions remain open for a maximum of an hour.

Scalping on the news

News scalping is one of the most popular, but also the riskiest strategies. It is often chosen by novice traders because they seem to be a “win-win” scenario, but in fact, stop-loss closing is a frequent outcome for such trading, and traders need to be prepared for losses.

To trade on the news, no tools are required, you just need to carefully monitor the events in the economic calendar.

Trading is carried out by pending orders:

• 1-2 minutes before the release of important news, two stop-type orders are placed for buying and selling at 5-10 pips from the current price (the distance depends on the volatility of the asset and the importance of the news).
• For these orders, stop loss is immediately set in the amount of the same 5-10 points, and take profit is twice as much.
• At the time of the news release, the price makes a sharp jump to one of the sides and, breaking through one of the orders, rushes further. In a favorable scenario, the deal is closed by take-profit, and the trader deletes the second order. However, the price can also quickly turn around, then the first order closes in the red, but the trader still has the opportunity to make a profit on the second transaction.

Both M1 and M5 and higher are suitable for tracking the price - after placing orders, the trader’s position becomes passive, and he can only observe. In rare cases, it is required to remove a failed order.

Momo scalping strategy

In this case, two indicators are used: the EMA and the MACD oscillator. The period of the exponential moving average is 20, the MACD is plotted with standard settings.

Buy deals are opened under the following conditions:

• The MACD histogram crosses the zero line upwards.
• The price crosses the moving average in the same direction.
• The entry into the position is carried out after the price moves away from the moving one by 10 points.
• Sell trades are opened in the opposite directions.

It is recommended to trade on the M5 stock chart. Any liquid currency pairs, as well as CFDs and cryptocurrencies, are suitable for making transactions.

Tips for Novice Scalpers

In scalping, you really have to love what you do. It’s a challenging strategy because you need to wait for a signal from the market in order to know whether to take a short or long position. Scalpers use 15-, 5- and 1-minute charts. In order to make money using the scalping method, you need to wait for the right time to open a trade, then quickly open orders and close a floating position if necessary.

The tips below will help you maximize the efficiency of your trading strategies.

1. Focus on one or two currency pairs

By doing so, you will know how the market situation affects the currency pair. It also allows you to predict what is a good time to trade, enter and close your deals at the right moment.

2. Stick to one scalping strategy

All scalpers have their own scalping strategy. To get the best results in scalping, you need to master your particular tactics. There are many trading strategies, but you only need to choose one strategy and master your skills trade by trade, day by day.

3. Wait for the right moment to enter the market

Scalping is about timing. You need to wait for a suitable signal to trade. It depends on your trading strategy. Wait for the right time, the right situation, the right signal, and then make a decision to enter the market.

4. Trade small and feel no regret

The most important thing in scalping is money management. If you want to scalp, try to enter a deal with a sum that you can afford to lose in order to stay in the market longer.

5. Eliminate everything that distracts you

When you are scalping, you need to focus on the market and the chart situation, so make sure to close everything that distracts you: Skype alerts, chat rooms, email and so on. You need to stay attentive and be able to make quick decisions without all the buzz around.

6. Learn the basics of economics

To minimize losses, you need to know when is the right time to trade and when it is forbidden to open deals. Always check the Forex economic calendar, track events and make sure that there will not be any news that can have a big impact when you open the chart for trading.

7. Use scalping indicators

If you are a novice scalper and want to get into scalping, you should learn how to work with certain indicators (Moving Average, for example). Indicators will show you the right time to enter the market when you want to sell or buy. After analyzing price charts and finding day trends and certain patterns, you only need to wait for a signal before opening a buy or sell position.

8. Practice makes perfect

For successful scalping trading, you need a lot of practice. In the beginning, for one successful market entry, you might open 100 unsuccessful positions. It sounds painful but you cannot avoid losses when mastering this strategy.

Note that you will also learn to control your emotions if you want to continue scalping. Scalpers should never be distracted by their emotions because it leads to inevitable mistakes. Either you accept failures (which happen even with super-experienced stock scalpers), or you try another trading style.

Pros and Cons of Stock Scalping

The major reason why people use scalping is that these strategies can apply even to minimum price movements. Quick deals on the M1 and M5 timeframes allow you to earn even when trading against the trend, on corrections. However, such trading is a very complex process that requires knowledge and experience, so beginners are advised to choose something less stressful and more reliable.

In addition, scalping is more emotionally demanding on a trader than long-term trading. Not everyone will sustain five stop losses in a row within one trading day, while such a result is quite normal for scalping. A trader must remain calm and cool in any situation, and in no case deviate from the trading plan - this is the hardest thing to do when scalping.

There is always a threat of losing your funds. In order to reduce risks, it is recommended to strictly follow the rules of money management and always set a stop-loss. All decisions that a trader makes while working on Forex are his personal responsibility.

The Bottom Line

If you are planning to day trade, you should master scalping strategies. It can be profitable both as a primary or as a complementary strategy. However, it’s important to stick to a certain technique and stay disciplined if you want small profits to compound into substantial earnings. Adequate market evaluation and frequency of deals are crucial components of successful scalping.