29.11.2022

What is Scalping in Trading?

Author: Iskander Ziyanurov

Newbies, who are beginning to learn such a complex and interesting "craft" as stock trading, often have a lot of questions. Most begin to look online for advice, which instruments are worth trading, etc., or for ready-made strategies. Because of the poor theoretical background and zero experience, the person cannot judge the gist of truth from the incoming information, which leads to sad consequences. They come to the exchange market and start speculating, raising broker's commission income, or buying stocks of the companies they know nothing about. It is not uncommon for the very ambitious to rush into the derivatives market right away, and things can go very wrong. Instead of immediately searching for the "ideal trading style" or copying a dubious trading strategy, it is necessary first to determine what kind of trading is preferable for you and what that strategy is all about. One of the most popular styles of trading in the markets today is scalping.

In this article, we will answer the question of what scalping is and how it is applied. You will also learn about the advantages and disadvantages of this trading style and which indicators can be used to maximize your trading results.

What is Scalping?

So, what is scalping and why is it so popular? Scalping in trading is a strategy of high-frequency trading, which provides earnings from a multitude of transactions in a short period of time. A scalper is a trader who uses this strategy, making a large number of transactions within a day.

The scalping strategy is aimed at insignificant changes in the price movement of an asset during the day, and frequent entries with exits during the trading session, to increase profits.

Scalping is often classified as a subtype of day trading technique involving several trades with very short holding periods ranging from a few seconds to minutes. Because positions are held for such short periods, profits from any particular trade (or profit per trade) are small; as a result, scalpers make many trades — up to hundreds during an average trading day — to generate profits. Limited time in the market reduces the risks of huge losses.

Scalpers look for adequate liquidity to match the frequency of trading. Access to accurate data (e.g., a quote system) and the ability to execute trades quickly are necessary for these traders. High commissions reduce profits on frequent buys and sells because they increase the cost of executing trades, so direct brokerage access is usually preferred.

It's worth noting that scalping is best for those who can take the time to market, stay focused and act quickly. It is commonly said that impatient people make good scalpers, as they tend to exit a trade as soon as it becomes profitable. Scalping is for those who can handle stress, make quick decisions and act accordingly.

Scalping Types

Now that you know what scalping is in trading, it's time to elaborate on what types of scalping exist today.

1. Impulse Scalping

Impulse scalping implies the presence of a certain impulse, which sets the quotes on the exchange in motion. It can be economic or political news, a public statement, etc.

The impulse pushes the price; this movement attracts traders' attention, giving even more strength to the emerging trend. At a certain point, the movement loses strength, and the situation changes to a trend reversal. The trader's task is to buy the asset at the right moment for him and then sell it. The attenuation of the impulse can be caused by reaching a critical number of buyers and sellers.

The basic essence of impulse scalping is that an event or external force can give sufficient impulse to move the price. Changes in the market in any particular country can also create an impulse to exchange in another country. Therefore, this type of scalping requires analysis of the economic agenda and observing quotes on other markets (oil, dollar, etc.).

2. Scalping with the Order Book

The use of the order book is considered a classic method. In contrast to the method above, it does not need charts, indicators, and other tools. The trader uses only the order book. As a reminder, the market depth is a table available at any exchange where orders to buy and sell the selected asset are displayed.

Analyzing the number of orders in the order book, the scalper sees the predominance of supply or demand and the rate of change in the number of orders. More importantly, he predicts in which direction the price will change and when the best moment to enter the trade will occur.

3. Hybrid Scalping Method

As you have already guessed, this method combines impulse and order book scalping. Each trader chooses the best of the two methods and uses them in his own analysis. Thus, the scalper covers a larger information field for observation. However, there is a disadvantage: the analysis requires more time and resources.

Benefits and Drawbacks of Scalping Trading Style

Like any other trading style, scalping has its advantages on the one hand and disadvantages on the other hand. Let's take a closer look at all of them.

Benefits of Scalping

Scalping has very impressive advantages.

1. Potential Profit

This is the most important and influential reason many traders pay attention to scalping. Amazing profitability is possible due to big leverage and many transactions with a small profit. Unlike long-term trading, where you open one deal and "invest" everything, with scalping, you execute many deals, most of which are potentially profitable.

2. Flexibility

Scalping allows you to be flexible and mobile. You're not tied down and limited to one trade whose calculation could be wrong. You won't miss out on a good opportunity just because you already have a position open. The fact that scalping trades can last only a few seconds makes it possible to make the most of any situation that arises in the market.

3. Small Investment Volume

Trading is generally less capital-intensive than investing, so you can start trading in small amounts. However, keep in mind that the profit will also correspond to the amount of investment.

Scalping, in particular, is characterized by instant profit fixing. If you trade expertly, the result will be visible on the very first day. In addition, a significant total income is made up of small transactions.

Drawbacks of Scalping;

Every good trading style has its drawbacks, and scalping is no exception. Among them are the following:

1. High Risks

This refers to too much leverage combined with inadequate money management tactics. Excessive risk per trade can deprive you of your deposit in two or three unsuccessful entries, so finding the optimum balance is vital. Even in pursuing mythical returns of hundreds and thousands of percent, stepping over some rules of conservative trading, you can not do without good risk management.

2. Time

Scalping requires a long stay in front of the monitor with an open trading terminal, continuous monitoring of the situation, and many decisions made during the working day. In short, constant presence and involvement in all processes are necessary. On this basis, you should understand that scalping is worth doing only if you have enough time, patience, and desire.

3. Emotions

Trading using scalping methods can knock even experienced traders off-balance because the need to make a lot of decisions in a short time exhausts many emotional resources. This, in turn, can lead to incorrect, emotional actions, which often have disastrous results. Even a carefully calculated trading strategy with perfect entry and exit points can collapse under one emotional action.

Indicators Used in Scalping

Indicators are technical tools used in short-term stock trading, which help to quickly analyze the chart and make a decision.

Relative Strength Index (RSI);

The Relative Strength Index (RSI) is one of the most popular indicators used in trading. It is a classical oscillator that evaluates market conditions and, in combination with a number of filters, gives reliable reversal signals. Application in trading RSI is not limited to Forex — it is suitable for the stock market, commodities, and even for crypto.

Moving Average Convergence Divergence (MACD);

The MACD indicator is the so-called trend oscillator, which combines the properties of both a trend indicator and an oscillator. The MACD is calculated based on moving averages. The indicator aims to simplify a visual perception of signals produced by moving averages, reduce their lag, and eliminate some drawbacks of regular trend indicators. There are two ways to construct it, the linear MACD and the MACD histogram.

Moving average (MA);

Moving Average (MA) in technical analysis is an indicator based on the average price value over a selected time period. MA refers to the trend indicators, smoothing out volatility and helping to determine the price direction. The MA indicator is applied not only to price data but to any other data, including trading volume, values of other indicators, statistics, currencies, commodities, and other financial instruments.

Conclusion

Whatever instrument and strategy you choose, you should remember that scalping is a rather time-consuming and strenuous way of earning. Before introducing it into your practice, you need to soberly assess your capabilities, skills, and temperament. This style of trading is not suitable for everyone. However, if you have the right temperament, are willing to learn, practice strategies, and follow them clearly, you will achieve success.