Definition and Example of Scalping
Scalping is a trading style with the shortest trading cycle—even shorter than other forms of day trading. It got its name because traders who adopt the style—known as "scalpers"—quickly enter and exit the market to skim small profits off many trades throughout a trading day. Their goal is to make enough of these small trades to add up to the profit they could have made from one day trade with a higher profit.
- Alternate name: Scalp trading
To scalp trade, a trader enters a limit order to buy a specific number of stocks at a set price. The trade is automatically executed when the price falls to the limit order. The trader then watches for positive movements. If the stock's price moves up one minute later, the trader closes the trade. If they'd bought 2,000 shares, and the stock's price moved up $.04 from their purchase price, they would make $80.
How Does Scalping Work?
Scalpers believe that it's less risky to profit from small moves in stock prices than to take the risk on large price moves. It involves setting tight trading windows in terms of both price movement and time frame.
Scalping comes with the lost opportunity cost of larger gains, which requires trading discipline. Scalpers get out of trades once their profit target has been hit, rather than waiting to see whether they can profit more. They also exit trades when their target loss level has been hit, rather than waiting to see whether the trade turns around.
Legal scalp trading should not be confused with the illegal practice of stock scalping—influencing investors or otherwise manipulating prices with the intent to sell the stock secretly and profit from the manipulation.
Market Analysis for Scalping
Traders who adopt this trading style rely on technical analysis rather than fundamental analysis. Technical analysis is a way to assess a stock's past price movement. Traders use charts and indicators to find trading events and create entry and exit points.
Scalpers can observe a stock's price action with the day's trading prices open in real-time charts. Using indicators and known patterns, they try to predict how a price will move in the next few seconds or minutes. Then, they set up low and high trading points and use them to enter and exit trades.
In contrast, fundamental analysis involves using data from a company's financial statements to calculate ratios that help assess value based on investing goals. This allows traders to evaluate a company and manage risk for growing their wealth over time.
Fundamental analysis is more suitable for long-term investing, while technical analysis works better for short-term strategies like scalping.
Scalpers may trade on news or an event that alters a company’s value upon its release. In some cases, they might use short-term changes in fundamental ratios to scalp trades, but for the most part, they focus on technical indicators and charts.
Since these charts indicate past prices, they lose value if the time horizon increases. The time horizon is how long a position is held. The longer a scalper holds a position, the less value that position tends to have for them. That is why technical analysis and trading indicators work better for the short-term nature of scalping.
Types of Scalp Trading
Scalpers can be either discretionary or systematic traders. Discretionary scalpers quickly make each trading decision based on market conditions. It is up to the trader to decide the parameters of each trade (e.g., timing or profit targets).
Systematic scalpers rely little on their instincts. Instead, they use computer programs that automate scalping with artificial intelligence to conduct trades based on the criteria they set. When the program sees a trading opportunity, it acts without waiting for the trader to assess that position or trade.
Discretionary scalping introduces bias into the trading process that can pose a risk. Emotions may tempt a trader to make a bad trade or cause them to fail to act at the appropriate time. Systematic scalping takes human control away from trading decisions, making the trades unbiased.
Scalping vs. Day Trading
In theory, day trading and scalping are alike, but they aren't the same thing. Scalping is a form of day trading, but not all forms of day trading are scalping.
|Scalping vs. Day Trading|
|Is always a day trade.||May or may not use scalping tactics.|
|Positions are often held for a matter of seconds rather than hours.||Positions can be held as long as the markets are open on a given day.|
|Often automated using systematic trading systems.||May use either systematic or discretionary trading strategies.|
Day trading positions can be kept open as long as the markets are open. For example, a day trader could open a position right when markets open at 9:30 a.m. ET and close it right before markets close at 4:00 p.m. That would still be a day trade, even though the trader held it open for more than six hours. On the other hand, a scalper rarely has a position open for more than a few minutes—it's more common to see a scalper's trading time frame measured in seconds.
Trading within such small time frames means that scalpers might need to use computer programs that automate these trades. A day trader who uses longer-term strategies may be less likely to use automated trading programs.
- Scalping is a day trading strategy that involves making many small-profit trades rather than fewer large-profit trades.
- Scalping is one of the shortest-term trading strategies, and many positions last only seconds or minutes.
- Scalping requires discipline—once a set profit or loss has been reached, the scalper needs to exit the trade.
- Some scalpers use their discretion to place trades, while others utilize computer programs that automate their trading strategies.
Securities and Exchange Commission. "SEC Charges Social Media Stock Promoter with Penny Stock Fraud."