What is scalping?
Scalping is a trading strategy designed to profit from small price changes, with profits on these trades taken quickly and once a trade has become profitable. All forms of trading require discipline, but because the number of trades is so large, and the gains from each individual trade so small, a scalper must have a rigid adherence to their trading system, avoiding one large loss that could wipe out dozens of successful trades.
Scalpers will take many small profits, and not run any winners, in order to seize gains as and when they appear. The aim is for a successful trading strategy through the large number of winners, rather than a few successful trades with large winning sizes.
Scalping relies on the idea of lower exposure risk, since the actual time in the market on each trade is quite small, lessening the risk of an adverse event causing a big move. In addition, it takes the view that smaller moves are easier to get than larger ones, and that smaller moves are more frequent than larger ones.
Best scalping strategies
- Stochastic oscillator strategy
- Moving average strategy
- Parabolic SAR indicator strategy
- RSI strategy
Scalp trading using the stochastic oscillator
Scalping can be accomplished using a stochastic oscillator. The term stochastic relates to the point of the current price in relation to its range over a recent period of time. By comparing the price of a security to its recent range, a stochastic attempts to provide potential turning points.
Scalping with the use of such an oscillator aims to capture moves in trending market, ie: one that is moving up or down in a consistent fashion. Prices tend to close near the extremes of the recent range before a turning point occurs, such an example is seen below:
In the above chart, of Brent on a three minute timeframe, we can see that the price is moving higher, and the lows in the stochastics (marked with arrows) provide entry points for long trades, when the black %K line crosses above the dotted red %D line. The trade is exited when the stochastic reaches the top end of its range, above 80, or when the bearish crossover appears, when the %K line crosses below %D.
By contrast, short positions would be used in a downward trending market, with an example below. This time, instead of ‘buying the dips’, we are ‘selling the rallies’. So we will look for bearish crossovers in the direction of the trend, as highlighted below:
Scalp trading using the moving average
Another method is to use moving averages, usually with two relatively short-term ones and a much longer one to indicate the trend.
In the examples below, on a three minute EUR/USD chart, we are using five and 20-period moving averages (MA) for the short term, and a 200-period MA for the longer term. In the first chart the longer-term MA is rising, so we look for the five period MA to cross above the 20 period, and then take positions in the direction of the trend. These are marked with an arrow.
In the second example, the long-term MA is declining, so we look for short positions when the price crosses below the five-period MA, which has already crossed below the 20-period MA.
It is important to remember that these trades go with the trend, and that we are not looking to try and catch every move. As in all scalping, correct risk management is essential, with stops vital in order to avoid larger losses that quickly erase many small winners.
Scalp trading using the parabolic SAR indicator
The parabolic SAR is an indicator that highlights the direction in which a market is moving, and also attempts to provide entry and exit points. SAR stands for ‘stop and reversal’. The indicator is a series of dots placed above or below the price bars. A dot below the price is bullish, and one above is bearish.
A change in the position of the dots suggests that a change in trend is underway.
The chart below shows the DAX on a five minute chart; short trades can be taken when the price moves below the SAR dots, and longs when the price is above them. As can be seen, some trends are quite extended, and at other times a trader will face lots of losing trades.
Scalp trading using the RSI
Finally, traders can use the RSI to find entry points that go with the prevailing trend. In the first example, the price is moving steadily higher, with the three moving averages broadly pointing higher.
Dips in the trend are to be bought, so when the RSI drops to 30 and then moves above this line, a possible entry point is created.
By contrast, when the RSI moves to 70 and then begins to decline within a downtrend, a chance to ‘sell the rally’ is created, as we have seen in the example below.
What you need to know before scalping
Scalping requires a trader to have iron discipline, but it is also very demanding in terms of time. While longer-term time frames and smaller sizes allow traders to step away from their platforms, since possible entries are fewer and can be monitored from a distance, scalping demands a trader’s full attention.
Possible entry points can appear and disappear very quickly, and thus, a trader must remain tied to his platform. For individuals with day jobs and other activities, scalping is not necessarily an ideal strategy. Instead, longer-term trades with bigger profit targets are more suited.
Scalping is a difficult strategy to execute successfully. One of the primary reasons is that it requires many trades over the course of time. Research on this subject tends to show that more frequent traders merely lose money more quickly, and have a negative equity curve. Instead, most traders would find more success, and reduce their time commitments to trading, and even cut down on stress, by looking for long-term trades and avoid scalping strategies.
Scalping requires quick responses to market movements and an ability to forgo a trade if the exact moment is missed. ‘Chasing’ trades, along with a lack of stop loss discipline, are the key reasons that scalpers are often unsuccessful. The idea of only being in the market for a short period of time sounds attractive, but the chances of being stopped out on a sudden move that quickly reverses is high.
Trading is an activity that rewards patience and discipline. While those successful in scalping do demonstrate these qualities, they are a small number. Most traders are better off with a longer-term view, smaller position sizes and a less frenetic pace of activity.
As an experienced trading enthusiast with a deep understanding of various trading strategies, including scalping, I can attest to the importance of discipline, risk management, and a thorough grasp of market dynamics in implementing successful trading approaches. My expertise is rooted in practical experience, extensive research, and a keen understanding of the nuances involved in navigating financial markets.
Now, let's delve into the concepts used in the provided article about scalping:
1. Scalping Defined:
- Definition: Scalping is a trading strategy focused on profiting from small price changes. The goal is to capture quick profits, and traders often avoid letting winning trades run for too long. The strategy relies on making numerous small trades, with the expectation that the cumulative gains will outweigh potential losses.
2. Key Principles of Scalping:
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Discipline and Risk Management:
- Successful scalping demands strict adherence to a trading system.
- The risk of a substantial loss is emphasized due to the large number of trades executed.
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Lower Exposure Risk:
- Scalping relies on lower exposure risk, as the time spent in the market for each trade is minimal.
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Smaller Moves and Frequency:
- Smaller price moves are considered easier to capture and are more frequent than larger ones.
3. Best Scalping Strategies:
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Stochastic Oscillator Strategy:
- Utilizes the stochastic oscillator to identify potential turning points in a trending market.
- Entry and exit points are determined based on crossovers and extremes in the stochastic.
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Moving Average Strategy:
- Involves using short-term and long-term moving averages to identify trends.
- Trades are taken in the direction of the trend based on moving average crossovers.
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Parabolic SAR Indicator Strategy:
- Utilizes the parabolic SAR indicator to highlight market direction and determine entry and exit points.
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RSI Strategy:
- Uses the Relative Strength Index (RSI) to find entry points in line with the prevailing trend.
4. Considerations Before Scalping:
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Discipline and Time Commitment:
- Scalping requires iron discipline and full-time attention due to the rapid appearance and disappearance of entry points.
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Challenges and Suitability:
- Quick responses to market movements are essential, making it challenging for individuals with day jobs.
- Scalping is demanding and not necessarily suitable for everyone, as it requires constant attention.
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Risk of Overtrading:
- Research suggests that frequent traders may experience losses more quickly, and scalping can contribute to negative equity curves.
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Long-Term View Recommendation:
- Emphasizes the importance of patience and discipline in trading, suggesting that longer-term trades with smaller position sizes may be more suitable for most traders.
In conclusion, while scalping can be a profitable strategy for those with the right temperament and skills, it requires a high level of commitment and is not without its challenges. Traders should carefully assess their own risk tolerance, time availability, and skill set before adopting scalping as a trading approach.
