Trading Styles: Scalping, the aggressive day trader
Approaches to trading differ, in this article we look at an aggressive form of day trading, scalping
What is scalping?
Scalping is considered a very short-term aggressive form of trading financial markets. Trades generally run from over a few moments to a few minutes. Much like day trading (a category within which scalping falls), this approach sees traders not holding their positions overnight.
Position / lot sizes
Position or lot sizes for trades are generally larger to maximize small movements in markets.
Scalpers are concerned with taking small but frequent profits out of the marketplace. The view here is that smaller moves are also more frequent than larger ones.
Time frames for traders using a ‘scalping’ approach are generally very short and can range from a tick chart up to a 5min chart. Larger times frames can be used for general analysis i.e., key trends and price levels, although execution triggers are most often considered on the aforementioned shorter time frames.
Because this style of trading sees frequent transactions being placed and smaller point or percentage movements being targeted, traders who are looking to scalp the market might prefer lower cost higher leveraged and very liquid markets.
Indices and forex trading pairs often fit this criteria with a number of brokers only charging small spreads. These markets are also associated with having higher leverage (the degree which profits, or losses are magnified) and higher liquidity.
Leveraged equity markets (i.e., CFDs / Futures etc.) are also candidates for scalping, provided that the shares selected are highly liquid. However, it should be considered that these products generally carry a higher associated cost, due to usually having an inherent market spread as well as commission charge.
Scalping market strategies
This trading style is concerned with short term bouts of volatility and movement. The idea is often to catch a piece of a short term bullish or bearish momentum in markets. In turn this approach can look at trading over news flow and economic events as well as capitalizing from bouts of short-term volatility.
Scalping news flow
For example, key economic events create short term market sentiment and direction. An economic calendar therefore becomes an important tool. A simple approach to scalping the markets could be diarizing the time and date of important data i.e., GDP, Employment, and inflation data. There is always a consensus expectation of outcomes for economic data points. When the actual data is released the general rule of thumb is that better than expected, it is positive for the market concerned, worse than expected is negative for the market concerned.
The above graph highlights a short term move lower on the SP500 following the release of US retail sales data which fell short of estimates. News data with the estimates can be plotted on the IG charts as above.
Scalping volatility movements
Volatility indicators such as average true range (ATR) and Bollinger Bands can assist this short-term trading format. A sharp rise in the ATR or widening of the Bollinger Bands can highlight a short-term directional momentum in markets and quick opportunity to gather a few points.
The below chart illustrates how when the distance between the upper and lower Bollinger band is narrow, volatility is relatively muted. Scalpers in the market might use a sharp widening of the distance of these bands and breakout (price move above upper or below lower Bollinger Band) to trigger a short-term trade.
Hit rate and risk to reward
Scalping requires traders to a have higher hit rate, meaning that the frequency with which you are right needs to be significantly higher than the frequency with which you are wrong. This is due to the fact that you are not riding out winning trades but rather banking only a few points when you are right.
A trader adopting this aggressive trading style might look to risk one or two points for a reward of one point. If your risk to reward (R:R) assumption is 2:1, a trader will need to be right two out of every three trades just to break even. Therefore, a hit rate of more than 67% may be required for profitability.
Other trading systems, such as trend following techniques might find the inverse R:R assumptions i.e. 1:2 or 1:3. This is because here the objective is to ride out winning trades and keep losses small. However, the hit rate is often considerably lower.
Scalping is considered a very short-term aggressive form of trading financial markets
Trades will run over a few second to minutes
Position sizes are often larger in an attempt to magnify smaller moves
Highly liquid markets with lower costs are generally considered more suitable to this trading style
News flow and volatility breakout are often used as tool for scalping markets
This trading style requires a higher hit rate as traders could be risking more on losses than achieving on gains
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