There are several strategies that traders use for trading securities, such as scalp trading, day trading, and swing trading. Finding the best style that suits your personality and financial position is extremely critical to be successful. Here’s what you need to know about scalp trading and a few basic scalping trading strategies.
What is scalp trading?
Scalp trading is a short-term trading style that capitalizes on small price changes, usually right after a trade is executed and becomes profitable. It is a simple strategy in theory, but it is typically one of the most challenging trading styles to master because it requires intense discipline and trading focus. Additionally, scalp traders spend hours in front of a computer in order to pay continuous attention to market price fluctuations.
Some traders prefer scalp trading because it’s less risky and has a higher number of trading opportunities, ranging from tens to hundreds of bids in a trading day. Moreover, there is no overnight risk because the end of the trading day efficiently summarizes profits and losses.
The goal of scalping is to capture multiple small wins, such as 0.1% to 1% of your original investment, which can add up to big profits at the end of the day. These small gains can also help fight greediness and the tendency to take more risks.
Scalpers, or scalp traders, require high leverage, high trading volumes, and intense concentration. In general, scalpers have short trading session or time frames by entering and exiting the financial market within a few seconds, minutes, or at most a few hours.
How does scalping work?
The main goal and bottom line of a scalp trading strategy is to secure gains from small price changes. In successful scalping, profit is amplified by taking a more substantial position size.
There are three types of scalping methods.
1. Market Making
In market making, a scalper utilizes spreads by simultaneously entering a bid and an offer for a particular stock. In other words, the scalper plays the role of the market maker in hopes of making a small profit.
2. Purchase Many Shares and Sell for a Gain
Another type of scalping is when the trader purchases a large number of shares and sells them on a small price movement. For example, a scalper may purchase several thousand shares. He then waits for a small price move, which may be a difference of cents. Subsequently, the scalper then sells the shares for a gain.
To be able to purchase several thousand shares requires extremely liquid stock.
3. Risk Reward Ratio
The third scalping method is most similar to the traditional styles of trading. A scalper enters several shares on a calculated set-up. He closes the position when his trading strategy triggers the first exit signal based on the 1:1 risk/reward ratio.
A 1:1 risk/reward ratio is the comparison between the size of the profit potential and the stop loss. For instance, if a trader enters his position at $10.00 with an initial stop at $9.90, the risk is $0.10. As a result, with a 1:1 ratio, the profit is also $0.10. Therefore, the target price for a $0.10 profit is $10.10.
Scalping Trading Strategies
There are numerous successful scalping trading strategies to help you find profitable set-ups and scalping opportunities.
Scalp Trading Strategy 1: Moving Average Ribbon Strategy
A simple moving average (SMA) is a moving average derived by adding recent closing prices of an asset and then dividing that by the number of time periods in the calculation average. The SMA serves as a technical indicator to help traders determine if the asset price will continue or reverse a trend.
The Moving Average Ribbon Strategy utilizes a 5-8-13 ribbon on a 2-minute chart to determine strong trends. The scalper can buy or sell short on counter swings. The 5-8-13 ribbon will align, which indicates a higher or lower trend and keeps prices aligned with the 5 or 8-bar SMA.
When the asset pricing crosses the 13-bar SMA, it is a signal of waning momentum indicative of a range or reversal. During a range swing, the price may cross the ribbon frequently. The scalper observes and waits for realignment, which is a buy or sell short signal.
Scalp Trading Strategy 2: Relative Strength/Weakness Strategy
This strategy combines 5-3-3 Stochastic Oscillators, 13-bar, 3-standard deviation (SD) Bollinger Band, and ribbon signals on 2-minute charts.
The Stochastic Oscillator is a technical momentum indicator popular for generating overbought and oversold signals. It is not meant to be a standalone indicator. As a result, you need to combine it with Bollinger bands to validate the strength of the signal.
A Bollinger Band is another technical analysis tool defined by two standard deviations away from a security’s simple moving average.
Scalpers enter the market when the stochastic generates an overbought or oversold signal that is validated by the Bollinger Bands. The trader stays with the trade until the price touches the opposite Bollinger Band by breaking the middle moving average of the Bollinger band.
When the ribbons intersect, it is a signal that the trend will slow or reverse. Be sure to exit the trade if the price movement does not reach the opposite Bollinger band, but the Stochastics rolls over.
Scalp Trading Strategy 3: Volume Indicator and Price Action Analysis Strategy
Volume Indicator and Price Action Analysis Strategy is generally for major currency pairs in the forex market. It utilizes a Volume Indicator and proper price action pattern analysis.
The volume of a stock is the number of shares that are traded for a particular security. Any trading system platform should have a Volume Indicator.
This strategy uses an M5 or M15 time chart to analyze price movements. The goal is first to identify a strong uptrend or downtrend. When the volume slows down, you know that there are two possibilities: the trend will head for a reversal, or it is taking a break as buyers and sellers decide what to do before the trend continues upwards.
When the volume indicator levels off, pull-back or retracement is expected. After the initial pull-back, the scalper monitors the volume for a spike. This leveling off or pull-back a is a strong indicator that things are trending upwards and it may be time to buy.
A pip, or point in percentage, is a measure of change in a currency pair. It is generally represented as $0.0001 or 1/100th of 1% for U.S. dollar related currency pairs.
Your target price should be 10 to 20 pips with a 5 to 8 pip stop loss. Once you have gained 10 pips, adjust your stop loss to 5 pips to lock in small gains.
Scalp Trading Strategy 4: Bid-Ask Spread Strategy
A bid is the price that a buyer is willing to pay for a stock. The ask is the price a seller is willing to sell his or her shares for. The spread is the difference between the ask and the bid.
In general, the bid-ask spreads are steady and align with the natural flow of supply and demand. However, sometimes the spread is wider or narrower than usual because of short-term imbalances in supply and demand.
A scalper capitalizes on this short-term imbalance. If the spread is wider than usual, in other words, the ask is higher, and the bid is lower than average, the scalping trader will sell shares.
Conversely, if the spread is narrower than usual, in other words, the ask is lower, and the bid is higher than usual, the scalping trader will buy shares and wait for the market to shift before selling the assets for a small profit.
It is worth noting that this strategy is challenging to do successfully. Traders must compete with market makers as well as maintain a low trade cost structure to maintain a profit.
In addition to scalping stocks strategies, there are additional considerations to think about.
A Scalping Trader’s Personality
A strong scalping trader is fast, accurate, plans intensively, and executes decisions when appropriate. Additionally, they need a good broker that provides fast price feeds, due to the fast-moving nature of scalping.
Stick to Your Exit Strategy
Scalp traders also need to be extremely disciplined and stick to their stop losses. If you fail to set a limit, you may find yourself chasing losses rather than compounding small profits into significant gains.
Avoid allowing your emotions to get in the way of your exit strategy. Always practice proper risk management to limit your losses. Another profitable set-up will probably come along and help alleviate any losses incurred if you continue to use and execute your stop losses properly.
Be sure to exit all trades before a scheduled major announcement. Stocks are especially volatile right after an announcement and liquidity will likely dry up. Scalpers cannot risk the heavy losses, which will take significant time to recoup.
Instead, use the announcements as sources of information that may trigger price movements. Current news and knowledge of future events can help you gauge a security’s direction over the short-term.
Scalp trading is extremely fast-paced with carefully executed scalping trading strategies and chart analysis. For a fast-paced technical trading program, subscribe to Stealth Profits Trader to learn trading strategies like the pros. New York Times bestselling author and expert analyst for Fox Business and CNBC D.R. Barton, Jr. can teach you what you need to know about turning stock trends into fast gains.