What Is Scalping In Trading? Strategies and Examples for Beginners
EG
Summary:
Scalping in trading involves making many small short-term trades throughout the day to take advantage of the volatility of the stock market. It can be a profitable strategy but requires too much risk and effort for most investors.
For many people, investing is a long-term strategy. They put money into diversified funds over the course of decades to save for retirement and other long-term goals. But for active traders, investing is about the short game. And few (if any) trading strategies focus more on the short game than scalping.
Scalpers often buy and sell stocks within minutes — or even seconds — to take advantage of the volatility of the stock market. It can lead to major profits, but it’s not the right strategy for everyone. Make sure you understand how this trading style works and its various risks before adopting this investment strategy for your portfolio.
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What is scalping?
Scalping is a type of day trading strategy that involves making short-term trades throughout the day to profit from small price movements in the stock market. This strategy is named after those who buy an item — often tickets to an event — with the goal of immediately reselling them for a higher price.
Scalpers often make hundreds of trades within one trading session, entering and exiting their positions in a matter of seconds or minutes. They generally try to take advantage of small price movements, meaning they could make only cents per share on a trade. However, because they make so many trades throughout the day, the profits (and the losses) can really add up. Scalpers might even buy and sell the same stock throughout the day to take advantage of its short-term volatility.
Most standard brokerage firms, such as Robinhood and E*Trade, can’t be used for scalping because they are not set up to make trades at the required speed.
Is scalping trading illegal?
No, scalping is not illegal. It is a perfectly legal trading strategy as long as you follow trading regulations. However, some brokerages choose not to support it because it requires placing a high volume of trades in a short period. Other brokerages allow scalping but have additional rules and restrictions for investors that use this strategey. That may cause some to believe that scalping trading is illegal.
Is scalping good for beginners?
If you’re brand new to investing, scalping is probably not the right strategy for you. It involves greater risk than long-term investing and considerably more effort and market knowledge.
How do scalping trading strategies work?
Scalpers generally try to limit their risk by exiting their positions quickly. Suppose a scalper buys 1,000 shares of stock at $5.50 per share and sells it when it reaches $5.60 per share, for a profit of $100. Another investor might have waited to see if the stock price increased even more, which would increase their profits. However, exiting their position quickly helps scalpers to ensure they lock in their gains quickly.
In that same scenario, suppose that instead of rising $0.10 per share, the stock fell $0.10 per share. A scalper is still likely to sell their shares and lock in their losses to avoid even greater losses. On the other hand, someone with a longer investing strategy likely would have waited to see if the stock price turned around.
Scalping strategies can be done manually but requires a considerable commitment of time and effort. Many investors use an automated trading system to execute their quick scalp trades.
Scalping-friendly brokerages
Scalping trading requires a direct-access broker for it to work. Direct-access brokers focus on providing the fastest possible trades and specialized software that allows users to optimize trading and place direct trades with exchanges.
Most mainstream brokers don’t support direct market access because their users are either casual day traders or passive investors who don’t need high-speed trades. TD Ameritrade is a great choice for scalping and day trading because it offers direct market access through its thinkorswim platform, which is free for investors with a TD Ameritrade account.
Scalping vs. day trading
You’re probably familiar with the concept of day trading, which is active trading throughout the day to profit off the natural volatility of stock markets. Rather than focusing on long-term growth, day traders seek to take advantage of the day-to-day price movement in the stock market.
In reality, day trading and scalping aren’t all that different. Both trading strategies involve investors attempting to use the volatility of the stock market to make a profit, entering and exiting positions within the same trading day.
However, the two strategies differ when it comes to their risk level, the size of the investment, the time period, and other factors.
- Time period. Day trading could involve holding a position on stock for several hours, or even an entire day. Scalping, on the other hand, involves holding positions for seconds or minutes.
- Investment size. A scalping trading strategy is generally done with much smaller amounts of money than day trading. While the profits are usually smaller, so are the losses. Scalpers make up for these small trades by making many trades — even hundreds — per day. Meanwhile, day traders are likely to make fewer trades per day, but for larger amounts of money and with the goal of larger profits.
- Use of trading tools. Since scalping involves making trades within seconds or minutes, investors using these trading strategies often use automated systematic trading systems. And while some day traders may use systematic trading systems, many take a more hands-on approach.
- Risk. Day traders typically hold stocks for a longer time period using larger investments, which results in greater risks overall. While they could earn more profits, the losses could also be devastating. As with any investment in securities, scalping also involves risk, but it relies rely on smaller investments and quicker trades. This may not get you the profits of a day trader, but as a scalper, you typically carry less risk.
Is scalping better than day trading?
A scalping strategy isn’t necessarily better or worse than day trading. They are two different trading strategies that require two different time commitments, have two different levels of risk, and offer two different potential types of wins.
What kind of market analysis is best for scalping?
Market analysis is the process that investors use to analyze different stocks and decide which to invest in. There are two primary types of market analysis: fundamental and technical analysis.
- Fundamental. In fundamental analysis, an investor looks at various characteristics of a company to determine if it’s a good investment. Those characteristics include earnings, expenses, assets, liabilities, and more.
- Technical. Technical analysis looks less at a company’s financial statements and more at its statistical trends and past performance.
While fundamental analysis seeks to determine whether a stock is fairly priced based on its financial strength, technical analysis just assumes it is.
Traders who use a scalping trading strategy as an investment style generally rely on technical analysis, not fundamental analysis. Because scalping involves such small, short-term trades, it would be far too time-consuming for an investor to estimate the intrinsic value of a company and read all of its financial statements. The many technical indicators and analysis tools available make it far easier to focus on that information to place trades.
What are the pros and cons of scalping?
Scalping as a trading strategy has some definite pros and cons. If you’re considering using this strategy for your investment portfolio, it’s important to understand the potential outcomes.
Tips for beginning scalpers
Scalping is a more advanced trading strategy than is appropriate for most long-term investors. However, it can be an effective way to make a profit if you have the time and knowledge required.
If you’re just getting started with scalping, here are a few tips to keep in mind.
Focus on commission-free trading
Scalping involves making hundreds of trades throughout the day for very small profits. If you’re paying a commission on every trade, you’re likely eliminating all of your profits. Luckily, most popular brokerage firms now offer commission-free trading. However, most of the popular zero-commission brokerages do not make trades fast enough for scalping. In some cases they will even put a limit on the frequency you can trade within a day. Thankfully, some brokerages, such as TD Ameritrade, offer free trades and direct access to investors.
Use advanced charting tools
DIY market analysis isn’t the way to go if you’re scalping. It requires too much time and effort, and having the right tools is necessary if you’re going to be making many trades throughout the day. Remember that not all brokers are set up to support scalping.
Understand the time commitment
Unlike investing with index funds, scalping isn’t a set-it-and-forget-it strategy. It requires a significant time commitment, as well as plenty of knowledge about the stock market and its various quirks.
Focus on small wins
It can be tempting to increase your investment amounts or hold an asset for a longer period to try to boost your profits. But that’s not how scalping works, and by doing so, you risk even larger losses. Scalping is all about small wins.
Diversify your portfolio
Plenty of people adopt riskier and more speculative trading strategies like scalping but do so alongside a more diversified, long-term strategy. That way, even if you lose money in your scalping efforts, you’ve still positioned yourself well for the future.
Key Takeaways
- Scalping is a type of day trading that involves making hundreds of traders throughout the day to take advantage of short-term price movement in the market.
- Rather than holding their positions for long periods of time as many investors do, scalpers exit their positions with minutes, or even seconds.
- Scalpers aim to make small profits on each trade, often just cents per share. But because of the volume of trades they make, their profits (and losses) can add up.
- Scalping can be a profitable strategy, but requires higher risk and strategy than most investing, and therefore isn’t appropriate for most investors.
EG
Erin Gobler is a Wisconsin-based personal finance writer with experience writing about mortgages, investing, taxes, personal loans, and insurance. Her work has been published in major outlets, such as SuperMoney, Fox Business, and Time.com.
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