Last Updated on Nov 15, 2021 by Ayushi Mishra
Traders are always looking for active trading strategies. While not many are risk-averse, a few strategies that balance return and risk remain available. Literal to its meaning, scalping refers to the virtual scalping of stock prices to benefit from small price movements.
Let us delve into this in detail.
This article covers
- What is scalping?
- Who should do scalping trading?
- Strategies that can be deployed for scalping trading
- Common indicators used by scalpers
Table of Contents
What is scalping?
Scalping trading is a type of trading in which you book profits from small changes in the stock price, often trading the same stock many times throughout the day. Repeated trades is of course not a compulsion. Scalping trading is to capitalise on small price movements by buying and selling almost instantly in hopes of quick profit. Typically, scalping is executed through huge volumes for it to be worth the effort and cost of investment. An exit strategy is paramount in this kind of trading as one wrong trade can wipe off all the small profits made.
Scalping is also known as ultra short-term trading. It is less risky than day-trading as the scalpers generally execute orders instantly (and only enter open positions during a bull run in their chosen stock), which reduces the risk of market fluctuations.
It majorly functions on the bid-ask spread that a security offers. The trader mindset here is to make a large number of minute profits rather than waiting for the right opportunity to accumulate long-term gains.
Given the underlying principle that markets are inherently volatile, it gives scalpers enough opportunities to exploit the prices.
Who should do scalping trading?
Scalping trading is not everyone’s cup of tea. People who have an in-depth understanding of the technical tools, markets, and strategy are generally involved in scalping trading.
Scalpers usually follow one-minute chart patterns to execute the trade as it is carried out frequently. It needs a diligent watch on the formation of the patterns and hence requires traders to have ample time and quick reflexes apart from a large risk appetite. A great deal of self-discipline and timing is required for scalping trading.
Strategies that can be deployed for scalping trading
The most famous scalping strategy is the ‘market moving’ strategy, in which traders post bids and offer to capitalise profits on the stock. This strategy will work only when the stock has a lower beta and doesn’t fluctuate with market movement, and also, the trading is happening in huge volumes. This strategy requires some level of mastery over the subject as one has to be aware of both the bid and offer price of the stocks to effectively execute it to make profits.
The second scalping strategy involves buying and selling a large number of shares to profit from small swings in the market. This is done several times in a day as shares are bought and sold repeatedly. A scalper here could be trading thousands of units. But, the stock should be highly liquid to execute this strategy.
Another strategy is to use a 1:1 risk-reward ratio. When traders initiate a trade along these lines, then as soon as their risk-reward signal of 1:1 is generated, they would immediately exit the trade. For example, if you buy a stock at Rs. 10 with a target of Rs. 11 and set stop loss at Rs. 9, then your risk-reward would be 1:1 as you are risking out Re. 1 to earn Re. 1. A scalper in this example would exit the trade at Rs. 11.
Price action scalper uses indicators like line, bar charts, candlesticks, etc., which is another strategy used by traders who want to make quick money from forex. Price action can help you view supply and demand like no other tool. And, forex being the most liquid market globally, the potential to scalp and generate profits is abysmal.
Common indicators used by scalpers
Scalpers don’t just rely on market analysis for buying and selling. They should adapt to modern technical indicators in order to book multiple profits during a trading session. The commonly used scalping indicators are:
Price action: In price action, instead of using regular indicators, traders make use of bars, candlesticks and other charting tools to identify quick trade opportunities.
Moving averages: It is a technique that uses 20-day/50-day/200-day MA trend lines for generating resistance and support lines of the stock. The 20-day MA is the most popular one used for scalping and even for short-term trading.
Relative Strength Index: RSI helps understand trendlines and price momentum, and assess whether the stock is overbought or underbought. If the index shows movement towards 70 levels, the traders can predict that the price will move positively here on, and if it moves to 30 levels, it can be indicating bear resistance. Accordingly, the scalper can choose to enter and exit a trade.
While using these indicators, you have to be glued to the seat as the entry and exit points are very narrow, and you may miss out if you are distracted. You have to be quick to respond to the market when the opportunity arises.
Lastly, scalping trading should not be confused with swing trading. While scalpers trade the most literal price changes in a day, swing traders generally lookout for price variations that are more significant and hold over a period of a few days.
Conclusion
Scalping is a trading strategy that traders deploy to earn small profits from market fluctuations, often through large-volume trades many times during the market session. Though not as risky as day trading, one should thoroughly understand the markets and stock they chose to scalp. Large volumes also pose a high risk to capital should the strategy fail. Reach out to your financial advisor before initiating any positions or trade.
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