DEFINITION of 'Scalping'
Scalping is a trading strategy that attempts to make many profits on small price changes. Traders who implement this strategy place anywhere from 10 to a couple hundred trades in a single day in the belief that small moves in stock price are easier to catch than large ones; traders who implement this strategy are known as scalpers. Many small profits can easily compound into large gains if a strict exit strategy is used to prevent large losses.
BREAKING DOWN 'Scalping'
Scalping utilizes larger position sizes for smaller price gains in the smallest period of holding time. It is performed intraday. The main goal is to buy, or sell, a number of shares at the bid, or ask, price and then quickly sell them a few cents higher, or lower, for a profit. The holding times can vary from seconds to minutes, and in some cases up to several hours. The position is closed before the end of the total market trading session, which can extend to 8 p.m. EST.
Scalping is a fast-paced activity for the most nimble traders. It requires precision timing and execution. Scalpers use day trading buying power of four to one margin to maximize profits with the most shares in the shortest amount of holding time. This requires focusing on the smaller timeframe interval charts such as the one-minute and five-minute candlestick charts. Momentum indicators such as stochastic, moving average convergence divergence (MACD) and relative strength index (RSI) are commonly used. Price chart indicators such as moving averages, Bollinger bands and pivot points are used as reference points for price support and resistance levels. Scalping requires account equity to be greater than the minimum $25,000 to avoid the pattern day trader (PDT) rule violation. Margin is required to execute short-sale trades.
Scalpers buy low and sell high, buy high and sell higher, or short high and cover low, or short low and cover lower. They tend to utilize Level 2 and time of sales windows to route orders to the most liquid market makers and ECNs for quick executions. The point-and-click style execution through the Level 2 window or preprogrammed hotkeys are the quickest methods for the speediest order fills. Scalping is purely based on technical analysis and short-term price fluctuations. Due to the extensive use of leverage, scalping is considered a high-risk style of trading.
Some of the common mistakes that scalpers make are poor execution, poor strategy, not taking stop-losses, overleveraging, late entries, late exits and overtrading. Scalping generates heavy commissions due to the high number of transactions. A per-share commission pricing structure is beneficial to scalpers, especially for those who tend to scale smaller pieces in and out of positions.