Scalping is a trading strategy that allows a trader to exploit small price changes to accumulate small profits from a high volume of trades. Although the scalper prioritizes his number of wins over the size of wins, he usually ends up making as much profit as the average successful trader without exposing himself to as many risks.
The earliest reference to scalping can be traced to the 19th century when some individuals would resell theater tickets at unauthorized prices for profit. The term eventually became more widely used as brokers sold unused portions of railway tickets to passengers. Long-distance railway tickets cost less per mile than short-distance tickets. So, a passenger whose destination was just 5 kilometers away could purchase a ticket for a 25-kilometer journey. When he alighted at his destination, he would sell the ticket to scalpers and recoup a significant part of the money he initially spent.
Scalping (Source: TopBrokers.com)
The scalper would then sell the ticket to new passengers trying to get on the train to the final destination at a price lower than the official price but high enough to make a profit. Since then, scalping has evolved as traders have figured new legal and effective ways to trade by using its core strategy––conduct multiple transactions on a single purchase.
How Scalping Works
A scalper buys a stock (or any other financial asset for that matter) on the assumption that there will be a predictable price movement in it within a short period, usually less than a few minutes. The scalper then exploits the small change in market price to trade the stock for a small profit.
S/he then proceeds to repeat the process for a high volume of trades to accumulate a large number of small profits without exposing himself or herself to significant risks. A scalper often relies on technical analysis rather than fundamental analysis to assess the past movements of securities, using charts and other tools. S/he predicts the security’s price movements before making quick entries and exits into trades.
In scalping, it is essential to develop a strict exit strategy. This allows the scalper to exit trades once the required profit has been made rather than waiting for a potential rise in value. It also makes sure that the scalper exits once a loss is incurred on a trade instead of waiting for a possible turnaround.
10 Questions to Ask Yourself Before You Adopt Scalping
- Do You Analyze Every Trade Move You Make? A scalper’s success depends on his/her ability to make a large volume of small trades per day. Therefore, s/he has limited time. If you have a habit of analyzing every trade, you might not meet the required target.
- Do You Like to Maximize Every Trade? A scalper who goes against the fast-profit strategy and waits for his/her profit on a particular trade to maximize will end up exposing himself/herself to significant risks that can nullify the small gains s/he made from other small trades.
- Do You Have Access to The Right Tools? Before adopting scalping as a trading style, make sure that you have the right tools to do the job. A scalper needs access to live feeds to monitor real-time changes in prices. S/he also needs a direct-access broker to speed up the execution of orders and trades.
- What is Your Exit Strategy? Before you start scalping, you need to prepare an exit strategy for your trades so that your risk would be greatly reduced.
- Can You Adhere Strictly to Your Exit Strategy? After developing an exit strategy, it is necessary to adhere strictly to it on every trade for maximum protection from losses.
- Do You Have the Required Energy for Scalping? To reap the full benefits of scalping, you need to have the energy to make a massive number of trades in a day.
- Can You Be Decisive When Making Decisions? The last thing you need as a scalper is to second-guess every decision you make. Your decisiveness in decision-making ensures that you make a profit without delay.
- Are You Highly Disciplined? Scalping requires discipline. No matter how promising a trade position looks, you should not deviate from the fast-profit trading strategy.
- Are You Willing to Pay a High Transaction Cost? Due to the high number of trades a scalper carries out, commission on each trade can also accumulate to a significant amount. Therefore, you need to factor in the commission while calculating your profits to decide if it is worth it.
- Do You Have the Time? Scalping is time-consuming. It requires a high level of concentration to monitor several small changes in numerous trades, most times even in split seconds, throughout the day.
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