Beginners guide to scalping

Scalping is a short-term trading style, where a trader looks to take small but frequent profits out of the market. Here we explain how it works.

What is scalping?

Scalping is generic term used to describe a very short-term trading style where a trader looks to ‘skim off the top’, i.e. take small but frequent profits out of the market. The theory is that small price movements are easier to predict than larger ones.

Traders scalping the market fall into the ‘day trader’ and ‘high frequency’ trading categories. This is because they generally prefer not to hold positions overnight, but rather open and close their trading positions intraday whilst looking to accumulate profits through frequent intraday trading activity.  

Leverage

The scalping trading style lends itself to trading derivatives such as CFDs (or spreads) as a general preference, in an attempt to magnify (leverage) profits over the shorter time frame. It should be noted that losses can be magnified (leveraged) equally in the CFD or margin trading environment.

Cost

Because of the frequency of trades that scalping involves, cost becomes an important consideration. While the intraday scalping technique is often applied to shares (CFDs), it is  forex and index trading that find prevalence due to the lower costs of trading these products. Spread costs for indices and forex are generally lower than those for share (CFD) trading, which may have commission charges associated as well. Cost is a trader’s first barrier towards making a profit, and because scalping is a high frequency trading technique, costs of trading are compounded.

Time

Scalping the market means adopting a ‘quick in, quick out’ approach. The active nature of this type of trading requires a person’s undivided attention. When a trader is looking for these fast moving opportunities, it is considered wise to allocate uninterrupted time, whether that is during the day, the night, or just over a few hours.

Risk versus reward

As the scalper is looking to take small frequent profits out of the market, to maintain profitability he or she needs to maintain a high hit rate, which means being right more frequently than being wrong. While having a high hit rate seems an obvious necessity for trading, it does not automatically equate to profitability. If profits are small but frequent, a loss that is not managed can become large and wipe out the benefit of multiple profitable trades. It’s therefore important for scalpers to understand risk management and to be strict about their exit strategy from each and every trade.

Managing a risk that’s not bigger than the expected reward is considered prudent in trading. If a trader can establish this risk metric and achieve a hit rate greater than 50% then he or she will be a profitable trader.

Find out more on how to manage risk.

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