Scalping is the definition of what traders try to achieve, buy at one price and then sell for a higher price. This is exactly what scalping entails but it is done over a short period trying to capture the smallest price increases. When scalping a trader may go in and out of a stock or currency pair several times a day. Whereas most trading allows the investor to hold their position for anything from a few days to multiple years. With scalping, you are hoping for the small profits on each trade to add up and when you could be making hundreds of trades a day, small profits can add up fast.

Costs

One of the main issues with this trading style is the cost of execution. Now costs can contain multiple parts beyond just the price you pay in commission. Firstly, when you are only making a small profit on each trade the commission that you are charged can be a big barrier. You may be able to place multiple trades and get a profit from it but the execution costs can soon eat up any profit you have accumulated. For this reason, most scalpers will go with a broker will the lowest possible commission charge.

Another cost is slippage, which is the delay in time it takes from the order to be placed on your platform until it is execution on the exchange or with your broker. Even small amounts of slippage can wipe out any profit made on the trade. Due to this, they will also look for brokers with the quickest execution times to negate this issue.

The last cost is an opportunity cost. As you are constantly looking for small profits much of your capital is kept out of trades and sitting on the sideline. When the money is sitting on the sideline there is an opportunity cost where it could be making money with another trading strategy.

Tools of the Trade

Scalping is not like other types of trading as you do need some extra access to be able to perform this correctly. The main tool you need is level 2 data. Level 2 data is the underlying order book in the market. So to take an example of the New York Stock Exchange, for each stock they will have a book of orders that show where other people in the market have put in their orders. You can see the price levels and volume which can help you to understand which way the market is moving. If you can see that there are lots of Bids in the market, then you may want to buy and hope that the price will increase for you to see at a profit. Even FX markets have orders books but many brokers do not provide access to this if they are using a platform such as MT4.

You can also use other indicators that can give you a view on short-term market moves to help you to predict the market movement such as linear regression channels but this will always give you a delayed response.

One thing to look out for when trying to use this method is change in the size of the spread. Back before decimalization stock would be quoted in in 16ths so each tick would be far larger than the 0.01 cent spreads you see in today highly liquid stocks. Due to this, many traders will only use this method if the spread is large enough to cover the costs of trading.

introduction to scalping