One of the first few things a successful trader must decide on is his or her preferred trading style. It is one of the fundamentals since this will set the ground on how long are you going to hold on to each of your stocks as an investor.
Knowing your choices indeed matters. This article will focus on the basics of Scalping Trading.
Definition of Scalping
Scalping is a trading strategy that focuses on making a lot of profits on small price changes, generally soon after a trade has been entered and has become profitable. Traders who implement this strategy set 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.
It requires a trader to have a strict exit strategy because one large loss could eliminate the many small gains that the trader has worked to obtain.
Characteristics of Scalping
Scalping is a fast-paced activity for the most nimble traders. It requires precise 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.
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 use Level 2 and time of sales windows to move orders to the most liquid market makers and ECNs for quick executions.
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 produces heavy commissions due to the high number of transactions.
3 Types of Scalping
The first type of scalping refers to as “market making,” whereby a scalper tries to take advantage of the spread by simultaneously posting a bid and an offer for a specific stock. Obviously, this strategy can succeed only on mostly fixed stocks that trade big volumes without any real price changes.
The second type of scalping is purchasing a large number of shares that are sold for a gain on a very small price movement. A trader of this style will enter into positions for several thousand shares and wait for a small move, which is usually measured in cents.
The third type of scalping is the closest to the traditional methods of trading. A trader enters a number of shares on any setup or signal from his or her system and closes the position as soon as the first exit signal is generated near the 1:1 risk/reward ratio.
Scalping can be very profitable for traders who decide to use it as a primary strategy, or even those who use it to supplement other types of trading. Following the strict exit strategy is the key to making small profits compound into large gains.
See Also: Learn Swing Trading
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