When you first dip your toes into the stock market, you may be confused by the trading lingo and unsure about what certain terms actually mean. If you are intrigued by the idea of scalping stocks but aren’t sure how to get started, this comprehensive guide provides everything you need to know about implementing this effective trading strategy.
What Is Scalping Stocks?
Scalping stocks refers to the tactic of trading stocks to optimize the profit from small changes in price. Scalping hinges on the idea that while most stocks complete an initial movement, many subsequently fail to advance. Thus, traders who use this strategy take advantage of this first increase, then exit quickly with the goal of collecting as many small profits as possible. In effect, scalping is the opposite of the common wisdom to profit by holding onto your investments and giving them time to grow. The goal is to keep profits above losses while completing as many successful trades as possible.
Learn the Basic Premises of Stock Scalping Strategy
Scalping is appropriate as a primary stock trading strategy or can be used to supplement another main strategy. First, it’s important to understand the three main concepts underlying this technique:
- Keep trades short to decrease your market exposure and thus lessen your chance to lose money on an unsuccessful deal.
- Small profits are more common than large profits and easier to obtain.
- Even when the market is relatively flat, a savvy trader can use scalping investing to take advantage of small moves.
In addition, you should look for trades with a wide spread so you can profit from the difference between the bid and the ask. The ask is the price at which a broker will sell a security and the bid is the price at which he or she bought it from the broker.
Scalping is a great way to profit even in a slow or stagnant market. Remember that even a move of 1% will earn you income as long as you sell quickly. This strategy limits your susceptibility to market fluctuations, so it works well for risk-averse traders. Although small profits can add up when you become a volume scalper, you need to be constantly monitoring your stocks while trading and making quick decisions to act each and every minute. Have a fast, reliable internet connection at the ready and prepare for a day of checking your screen for minute changes in your target stocks.
Determine Primary vs. Supplemental Strategy
Above, we noted that the scalping strategy can serve as either your primary or supplemental stock technique. However, the way you use this strategy will differ depending on which technique you prefer. Primary scalpers make multiple trades every day, typically in the hundreds, using one-minute charts to access prices in as close to real-time as possible. Level 2 quotes and direct access trading systems provide the necessary support to profit from scalping, since direct access to your broker gives you the power to execute your trade orders instantly.
When adding scalping as a supplemental strategy within your normal trading approach, you can extend the time frame to gain insight and trends when markets are narrow or choppy. For example, many supplemental scalpers use the umbrella concept to maximize profit. With this tactic, you set up a trade with a longer time frame and then use the short timeframe analysis of scalping to look for smaller profitable setups that follow the same direction as the main trade.
Select a Trading System
Scalping can be used to manage your risk and protect your profit within any trading system. To transform any trade into a scalp, simply cash out for a profit when your risk/reward ratio is as close to 1:1 as possible. For example, when your trade position is $50 and your stop price is $49.50, the risk is 50 cents and the reward must thus also be 50 cents. Cash out at $50.50 to successfully execute a scalp trade. The beauty of the scalp strategy is its versatility, since you can use it to profit with range-bound trading, breakouts, long side, short sides, classic chart formations like handles and cups, and countless other technical indicators. However, you must maintain a solid stop point to avoid a significant loss that could quickly wipe out your small gains from scalping many transactions.
Explore Scalping Scenarios
Novice scalping traders can get started using one of three common scenarios. The first, described above, follows a traditional trading scenario but takes advantage of a 1:1 risk-reward ratio to maximize the change for small profits.
Another technique involves buying a hefty amount of shares and selling them for profit after a small price bump. This strategy works best with several thousand shares of very liquid stock. Make your move after the price changes by just a few cents.
An advanced tactic, called market making, involves posting a bid and offer for a stock at the same time. For best results, use this technique with a stock that offers significant volume but minimal price changes. This is the most difficult form of scalping in which to succeed because of hefty competition and the difficulty of making a profit when stock movement is miniscule.
Make Trading Decisions
Because you need to act quickly and often on instinct as a scalper, having a few general rules of thumb in mind provides an easy schematic to follow. Here are three ways you can decide whether it’s time to act on a target investment:
- Stay abreast of stock news and make a shortlist of hot target stocks that interest you and have the potential to move in the coming hours and days. Monitor this list religiously so you can strike when the iron is hot.
- Take advantage of level 2 quotes, which show new intraday lows and highs for your target stocks. Execute buy and sell orders ASAP when stocks hit these points to optimize your profit margin.
- Abide by a goal profit margin for each trade, which changes depending on the price of the specific stock. For scalping to work, try a target profit of 0.10 to 0.25 cents, which works well if you also deal in volume and have a high ratio of wins to losses.
Hone Your Skills
Although scalping is most appropriate for seasoned traders, anyone can succeed with this strategy by learning the right techniques and practicing consistently. Those who succeed must constantly keep track of stock positions and make rapid decisions and frequent sales. Seasoned pros offer this sage advice for new scalpers:
- Know the foundations of technical analysis. Without these tenets, you won’t be able to succeed as a scalper.
- Learn to execute your orders effectively to avoid taking a loss. With such a limited profit margin, you need exceptional accuracy supported by level 2 quotations and direct access trading.
- Expect scalping to be costly at first, since you’ll be making hundreds of trades during each session. Don’t forget about fees and commissions that could take a significant bite out of your profit. A reputable online broker that offers competitive commissions and direct market access (and is amenable to scalping) will be your trusty partner in any scalping endeavor.
- Understand how the market works before you start scalping. Having some experience will make it easier to pick out patterns in momentum and trends that will help you profit with this strategy.
- Stick to the buy side of trading until you feel confident and have earned some profit. Once you gain your sea legs, try some short side trades. The most successful scalpers use a blend of both buy and short sides.
- Have liquid capital with which to trade. The higher the volume of your trades within a limited time frame, the more liquidity you’ll need in your investment funds.
- Close your scalping positions within a single day. If trades take longer, you’re not unlocking the true benefits of these small, short-term opportunities.
- Aim for a win rate of around 80%. A higher lose rate will severely hamper your scalping profit.
If you want to learn more about successful scalping strategies, learn from the expert team of traders at Raging Bull. Get in touch today to schedule your webinar session with advice from market gurus who have been quoted everywhere from U.S. News and World Report to Forbes. Enter your email to receive a free e-book with our best trading strategies.