A Brief Guide to Scalping for Day Traders
Stock prices constantly change throughout the day. Some rarely stay the same for even a second! Just take a look at the intra-day charts of some of the most active stocks like Apple (NASDAQ:AAPL). What if you could take advantage of these split-second changes in the stock price? If you’re up to the challenge (and have the stamina to do dozens to hundreds of trades a day), then scalping might be the day-trading strategy for you.
Scalping involves moving in and out of a position as quickly as possible. This usually means selling your shares the moment it becomes profitable. For example, you may place a buy order for 100 shares of stock ABC at $20.00 per share. When the stock goes up to $20.10, you can unload your 100 shares for a profit of 10 cents per share. This would give you a gross profit of $10 excluding commissions. You can even sell your shares at lower prices; anywhere from $20.01 to $20.09, as long as you gain after fees are deducted. Unlike other common day trading strategies, you’re not looking to let your profits run. Exit your position the moment it becomes profitable, then sit back, take a deep breathe, and plunge right back into the action! Okay, so you won’t be making much per trade. But these small profits can add up for a huge payday once the market closes.
Advantages and Disadvantages of Scalping
If you’re new to day trading, scalping can be a good start to get a feel for the market. You’re not aiming for big bucks in one trade, but you’re looking to execute lots of smaller traders and having your winning trades add up. You can stop anytime once you reach your target profit or maximum allowed loss for the day. This helps build discipline, the best sidekick a trader has. Even if you have another strategy planned out, you can add scalping to supplement your main strategy. For example, you can go long on a stock with half your capital and use the other half to scalp along the way. Should the trend go against you, you would at least have made money scalping. Scalping works for every kind of setup out there. Waiting for a bull flag breakout? Scalp it while the flag is still forming then ride (or continue to scalp) after the breakout.
A big disadvantage is that any loss can quickly eat away your profits. Let’s go back to the example above, where you are scalping shares of ABC for a gross profit of $10 per trade. You successfully scalp ABC twice, bringing your total to $20. But on the third time, the stock tanked by 20 cents after you bought it. When you sell your shares, you’ll find that you are back at break-even! This is why scalping is not for the faint-of-heart. It can be rewarding if done correctly, but you need to be very careful in timing your entries. You can lose all your gains in one big sell-off.
Scalping can be very tiring as well. Not everyone has the energy to do hundreds of trades a day. It also requires you to make decisions on a fly. There’s no time for you to question if you should enter a trade. If you’re the type who needs to think carefully over every decision you make, scalping may not be the strategy for you.
Ideal Risk-to-Reward Ratio
As with any strategy, scalping is not perfect. Even if you profit in 60% of your trades, that means you are losing money in dozens of your trades. As mentioned earlier, a big loss can cut quickly cut your profits. That’s why you need to plan ahead when you should sell your shares should the trade turn against you. A 1:1 risk/reward ratio is one of the most used for scalping. This simply means that your maximum loss per trade is equal to your target profit. So if you plan to gain 10 cents a share for each trade, 10 cents should be your cut loss point. Set a stop at 10 cents below your buy price, and you’ll be fine.
What you need for Scalping
There are some things you need to take into consideration before you begin scalping stocks. The first and most important is that your brokerage firm should allow scalping. Some firms require that you hold your position for a certain portion of time. Take a look at your broker’s fees. You’ll be charged for every transaction you make. Hundreds of trades means you’ll be charged a fee hundreds of times. High fees which will eat into your gains, making it impossible to profit by scalping.
You also need to check if your stock is good enough for scalping. Not all stocks are suited for this strategy. You need to be looking for stocks that constantly trade with high volumes. Blue chips are generally good candidates for scalping. Volatility is important too. You don’t want to trade a stock that has volume but only moves a few ticks a day! Always check the news for clues. Mid-cap companies can trade with volume rivaling a blue chip’s if there is news affecting the stock. Macro economic news may affect some stocks. Commodity-related stocks may trade with high volume if their respective commodity breaks key support or resistance levels.
One last thing; before you head into the market with this new strategy, please try it out first with a demo account. See if you have what it takes to be a scalper before you use real money. If this works for you, then you may be on your way to making money! If not, it’s fine. There are many other strategies out there for day traders. You can ride a stock’s momentum or trade based on support and resistance.