What is scalping in trading? — a beginners guide for traders

As previously mentioned, scalping is a popular short-term trading style that falls into the day trading category. It involves traders looking to take advantage of small price movements in the market by opening and closing multiple positions, lasting anywhere from a few seconds to a few minutes.

Two of the most popular financial markets scalpers tend to focus on are stocks and forex because these two markets are known to have regular price fluctuations even on small timeframes, especially the forex market. After all, it’s open 24 hours a day, five days a week.

This trading style is mainly done through derivative products such as CFDs or spread betting, allowing them to open positions on rising and falling markets. With this, they could also trade on margin with leverage.

Trading with leverage allows traders to open a bigger position using only a small amount of investment capital.

Scalpers believe that minor price movements occur more frequently than larger price movements, which is why their overall goal is to try to make small but frequent profits, assuming that these small potential profits will add up at the end of a trading day.

These types of traders tend to close their positions as soon as the price moves above or below the breakeven, depending on the position they took, happy with taking a small percentage of profits after the spread has been covered.

Scalpers generally mainly focus on technical analysis because of their short-term market outlook.

However, some might keep an eye on fundamental analysis, such as specific news and economic events, from time to time because even though the majority of news and economic events might not have a major influence on price movements over the short term, there might be a few occasions where they could.

Some popular technical indicators scalpers could use are moving averages, Stochastic Oscillators, RSI (Relative Strength Index), and Parabolic SAR.

Two different techniques can be employed when scalping: manual or automated. Manual scalp trading involves traders opening and closing their positions manually, following their preferred strategy based on market conditions and using technical analysis to look for possible entry and exit points. 

This requires traders to be patient while waiting for their set-up, staying focused, and making fast decisions on opening and closing positions.

Through an automated process, traders could employ trading bots, which are programmed algorithms using artificial intelligence. It works by having the program look for specific trading opportunities and executing those positions based on the trader’s strategy.

As with any style of trading, there are always essential elements that traders might want to keep in mind, and scalping is no different. Below, you’ll find an in-depth overview of the essential elements involved.

Setting up a trading plan

The first element of scalping is setting up a trading plan. This plan could include what kind of strategy traders might want to use, be realistic about their trading goals, and how much money they are willing to lose with every trade because scalping does carry a certain level of risk.

It could also help traders develop a system for entering and exiting trades and determine which technical analysis factors they might want to incorporate with their strategy to assist with decision-making.

As mentioned, scalping requires discipline, focus, and the ability to make quick decisions when entering and exiting a position. Creating a trading plan could assist a trader in staying disciplined by following the specifications set out in their trading plan. 

Risk management

The potential profits traders seek to make through scalping are generally smaller than other trading styles, which is why most scalpers use higher leverage with all their positions. Trading with leverage could increase potential profits. However, it could also magnify potential losses. 

This is because the result of a trade using leverage is calculated based on the position’s entire value and not just the initial margin used to open the position.

One fundamental way to limit potential losses is by placing a strategic stop-loss order on every trade.

A stop-loss order is a predetermined level set up by the trader at a specific price point, depending on their risk-to-reward ratio. The way it works is when the price reaches this level; the position will close automatically, limiting any further potential losses.

Another form of risk management is the risk-to-reward ratio, which we just mentioned; this ratio is unique to each trader and states the amount a trader is willing to lose compared to how much they potentially want to make.

Many traders might stick to only risking 1-2% of their total account on a single trade.

Self-control

As previously mentioned, scalping is a fast-paced trading style involving opening and closing multiple positions to try and profit from the short-term price movements in the markets. 

Because of this, traders might need to practice a certain level of self-control in order to stay focused and emotionally grounded while following their chosen strategy.

Not being emotionally grounded could result in traders making possible poor trading decisions or wanting to overtrade or revenge trade, ultimately resulting in losses.

Market conditions

Scalpers generally look for volatile market conditions. When a market is volatile, it means price fluctuations happen more frequently, which is ideal for scalpers because they look to open and close multiple positions over a few seconds or a few minutes.

Apart from high volatility, scalpers also look at financial instruments that have a high trading volume and a high level of liquidity because they enter and exit positions much faster than other styles of trading; they are also looking to get in and out at the best possible price to try and secure any potential profits earned.

Below is a list of some of the advantages of scalping.

• Scalping is traded through derivative products such as CFDs or spread betting, allowing traders to open positions on rising and falling markets.
• Scalpers are exposed to less risk because they only keep a position open for a very short time.
• Scalpers don’t necessarily need to have a solid fundamental understanding of the financial asset they might be trading because this style mainly focuses on technical analysis set-ups and short-term holding periods.
• There is potential for higher profits because scalpers only try to target small profits from short-term price movements.
• In certain market conditions, scalpers have the opportunity to take advantage of many trading opportunities in a single session.
• No overnight fees are payable because scalpers open and close their positions in a few seconds or minutes, never leaving a position open overnight.
• Scalpers generally trade with a higher leverage ratio, which magnifies any potential profits because the trade results are calculated based on the total value of the position and not the margin amount used to open the position.

Below is a list of some of the disadvantages of scalping.

• Even though trading with leverage has the potential to magnify potential profits, it also magnifies any potential losses.
• Scalpers also tend to use bigger lot sizes, which could result in a significant loss of capital if a string of losses do occur.
• Due to the fast-paced nature of scalping can be time-consuming as it requires traders to look at the charts for potential trading opportunities constantly.
• Scalping is naturally a more challenging style to adopt because it requires a significant level of focus and patience and the ability to make quick decisions when an opportunity appears.
• Spread fees can quickly add up because scalpers open multiple trades during a trading session.

With scalping, there are various trading strategies; however, choosing a strategy might come down to a trader’s preference and trading goals. Combining two or three strategies to analyse the market better is also possible.

Below, we’ve given you an in-depth overview of four popular scalping strategies.

Stochastic Oscillator

The stochastic oscillator is a momentum indicator that indicates areas where the price of assets could be seen as overbought or oversold. This indicator compares the most recent closing price to the previous trading range over 14 days.

Apart from being a momentum indicator, it’s also a leading indicator, meaning momentum generally changes ahead of volume or price.

With this indicator, scalpers seek to capture possible moves in a ranging market, which is where the price tends to reverse after failing to break above or below the extreme highs or lows of the previous range.

Within this indicator, there are two moving lines: the first is the indicator line, generally presented as a solid white line, and the second is the signal line, generally presented as a solid red line.

These two lines move between a range of 0 to 100 with two horizontal, one set at the 80-level and one at the 20-level.

The way this indicator works is if the indicator line and the signal line are above the 80 level, the market could be seen as overbought. Conversely, the market could be seen as oversold if the indicator line and signal line are below the 20-level.

That’s not all, though; traders could also look for a possible market reversal at these levels when indicator and signal lines crossover.

Theoretically, when the indicator line crosses above the signal line at or below the 20-level mark, it could be a possible signal to open a buy (long) position, as seen in the example of the 5-minute chart below. 

Meanwhile, if the indicator line crosses below the signal line at or below the 80-level mark, it could be an indication to open a possible sell (short) position.

Parabolic SAR

The parabolic SAR, which stands for ‘stop and reversal’, is a trend indicator showing the market’s direction through a series of dots displayed above or below the candlesticks while providing possible entry and exit points. 

If the market is bullish, the dots will appear below the candlesticks, whereas if the market is bearish, the dots will appear above the candlesticks.

The way it works, as seen from the example below of EUR/USD on a 5-minute chart, is when the market changes direction, the dots will change position. 

So, a trader could open a long (buy) position when the first dot appears below the candlesticks, signalling a possible bullish trend reversal. Conversely, a trader could open a short (sell) position when the first dot appears above the candlesticks, signalling a possible bearish trend reversal.

It might be essential to remember that some potential signals could be false due to multiple factors that could influence the market trend, such as irregular data sources or timing lags.

Scalp with moving averages

Moving averages are generally one of the most popular indicators used by scalpers. It works by taking the closing price data of an asset over a certain period of time and presenting it in the form of a line across the charts.

For example, the 20-day moving average takes the closing price of the last 20 days, adds those prices up, and divides it by 20 to get an average price range. The data will then be assembled to form a single line across the charts to give traders a better indication of the overall trend movement.

Moving averages are, in essence, lagging indicators, which means they only assist traders in confirming the trend and won’t assist in identifying it.

Theoretically, if the moving averages are above the price, the market is in a downtrend. Whereas if the moving averages are below the price, the market is in an uptrend.

The most common strategy for moving averages is the crossover strategy between two or three moving averages. The first one is the ‘golden cross’; if we look at the example below when the 20 MA and the 50 MA crosses above the 100 MA, it could signal a possible change in direction towards the upside.

The second one is the ‘death cross’ where the 20 MA and the 50 MA crosses below the 100 MA, which signals a possible trend reversal to the downside.

Relative strength index (RSI)

The Relative Strength Index (RSI) is also classified as an oscillator, another momentum indicator that traders could use to identify overbought and oversold areas.

Within the indicator, there is a solid line moving between a range spanning from 0 to 100 with two horizontal lines, one at the 70 level and another at the 30 level. 

The way this indicator works, in theory, is if the moving line is above the 70 level, it’s considered overbought, which could be viewed as a possible sell opportunity. If the moving line is below the 30 level, it’s considered oversold, which could be viewed as a potential buy opportunity.

Scalping and day trading are the same because both styles involve traders opening multiple trades during a trading day, never leaving a position open overnight. Both trading styles also involve trying to profit from short-term price movements in the market.

However, there are a few differences between these two trading styles.

Scalpers also don’t leave a position open for longer than a few seconds or minutes, whereas day traders tend to leave their positions open for a few minutes to a few hours. Scalpers also tend to use bigger lot sizes when opening a position compared to day traders because their positions are kept open for such a short period.

Even though scalpers and day traders open multiple positions during a trading day, the number of positions between these two styles differs. Scalpers tend to open hundreds of positions, whereas day traders open significantly less, as they keep their positions open for much longer.

Both of these trading styles rely solely on technical analysis. However, both will monitor crucial fundamental analysis factors, such as specific news or economic events, that could influence short-term price movements.

Scalping and swing trading are completely different; where scalping requires opening and closing multiple positions within a few seconds or minutes, swing trading involves opening fewer positions and only closing those positions after a few days or weeks.

Swing trading is riskier than scalping because these traders keep their positions open longer, including overnight, where overnight price fluctuations could change due to various fundamental aspects such as sudden economic, news, or political events.

Trading costs for swing trading tend to be less than with scalping because scalping involves opening multiple positions, which could add up to hundreds of positions in a single trading day. Meanwhile, swing traders open significantly less, sometimes only a few positions spanning a few days or weeks.

As previously mentioned, scalpers need to make quick decisions. In contrast, swing traders need to be more patient in waiting for their set-up to form before opening a position, which also means scalpers need to spend more time in front of the charts than swing traders.

As previously mentioned, scalping is a highly time-consuming trading style, requiring traders to monitor their charts constantly; this is why scalping might not be for those individuals looking to trade the markets only part-time.

Scalping could be challenging to put into action because of its fast-paced nature, requiring traders to make fast decisions on trading opportunities and, if an opportunity is missed, having the discipline and patience to let it go and wait for the next set-up, not getting emotional and ‘chase’ after the next opportunity.

Being in the market for such a short period of time could be appealing. However, a certain level of risk is involved because traders look to profit from the quick price movements, which could just as quickly move against them.

This is one key reason why risk management in scalping might be essential; as previously mentioned, having a predetermined stop-loss in place for those quick price movements that could possibly move against their prediction could prevent any substantial losses to their account.