Scalping Trading Strategy: What is and How to Use it

As a trader, you are exposed to hundreds of strategies. Certainly, you cannot use all of them. If you attempt doing this, chances are that you will lose your entire investment within a very short duration.

The secret is to have one or two strategies and then mastering them. In this article, we will look at what scalping is, why people use it, and some of the strategies you should use.

What is scalping?

Scalping is a day trading strategy that involves buying and selling of financial assets within a few seconds or minutes. This is one of the most common trend strategies in Day Trading; just analyze several assets, find the one you think will go up and buy it and vice versa.

It is different to the ordinary day trading, where traders can hold their assets for hours. Also, it is different than swing trading, which involves buying and holding assets for a few days. Further, scalping is different from position trading that involves buying and holding assets for weeks or months.

Unlike other types of traders, scalpers are not interested in knowing the fundamental details of the assets they are trading. For example, in case of stocks, they are not interested in the firm’s revenue or growth.

Similarly, in forex, they are not interested in the macro issues like interest rates and inflation. They are only interested in the current price action

Why scalp?

Scalping is a simple strategy where a trader opens a trade and then watches it. He will then close the trade once it goes positive. This can be seconds after opening the trade.

There are many reasons why one can decide to scalp:

1) It is a very simple strategy that anyone with limited experience as a trader can undertake.

2) A scalper one can trade for a very short period of time on a daily basis. In fact, many scalpers trade for less than 30 minutes per day.

3) As a scalper one does not need to understand a lot about the macro environment. Remember that one can make money in whatever way a trade goes.

4) It is possible to foresee the market short term than it is on a long-term basis. For instance, one can tell how the dollar is going to trade on a daily basis. No one can accurately predict how the dollar will behave in a longer duration.

Finding the asset

The first thing you need to do as a scalper is to identify an asset. This asset could either be:

  • currencies
  • equities
  • commodities
  • indexes

You should avoid identifying very many assets. You should avoid being a jack of all trades but a master of none. As a scalper, the more you try very many things, the harder it will be for you to make a good return on investment.

For instance, you can decide to focus on Brent oil. In this, you will only trade Brent oil while ignoring other asset classes (just in case, here are some tips on how to trade crude oil). If your area is equities, you can select one or two companies and specialize on them.

Mode of analysis

As a scalper, you will definitely need a mode of analysis to define your entry and exit positions. The best strategy to follow here is to identify the trend (upwards or downwards) and then move with it.

For instance, if Brent oil is moving upwards, you could either buy the trend or wait for the reversal. To do this, there are a number of strategies you can use.

Identifying the trend

In scalping, the most important detail is the trend. If a trend is bullish, the scalpers will place buy positions and if the trend is going south, they will open a short position. For this reason, these traders don’t waste their time doing deep macro analysis.

Rather, they spend most of their time identifying the trend.

After identifying the trend, they will have a close look at the support and resistance points. They will therefore place a buy position at the support, and close the trade at the resistance point. At the resistance point, they will place a sell position.

On paper, this might seem as a very easy thing to do. In reality, identifying a trend is the most challenging thing that a trader can battle with.

» Related: The best Trend indicators

trend

Support and Resistance Point

Scalp with technical indicators

You can use technical indicators such as moving averages, Stochastics, and the Relative Strength Index (RSI). You can use each indicator separately or combine two or three.

Ideally, you need to have a technical analysis method that you have back-tested for a long time. If you have this, your process of making money will be a walk in the park.

Timing

After identifying the trend, the next most important thing is to decide on the entry position. Based on your risk appetite, you can trade on any market time. For instance, you can trade effectively during the Asian markets, the European markets or the American market. This will be based on the asset class you are trading.

Another strategy to time the entry position is on the data. Economic data which is released on a daily basis is one of the key drivers of price movements.

In scalping, a trader will enter a trade minutes before crucial data is released. For instance, minutes before the non-farm pay rolls data is released, a trader will use the past data to predict whether the new number will beat the analyst estimates.

If it will, then he will sell EUR/USD on the hopes that the dollar will continue to rise. Then, if his prediction is correct, he will make an exit a second after the data has been released. However, this is usually very risky especially when the market goes against his thesis.

Economic data for scalping

Finally, you should be cognizant of periods when there is economic data. The economic calendar is therefore a very valuable tool to use. Remember that there are traders who have achieved a lot of success in trading news.

Just assess and test yourself to find out what works for you.

Once you create and test your strategy, you will be good to go. To succeed, you will need to be a very disciplined person by following the rules you set. For instance, if you purpose to make 200 pips a week, you should learn to stay away from the market once you hit your target.

Approach to Scalping strategy in stocks

As mentioned above, you can conduct scalping in all types of assets, including bonds, stocks, commodities, and currencies. In this part, let us look at a simple approach you can use to scalp stocks.

Gainers and Laggards

First, you need to use tools that help you identify the premarket gainers and laggards. The idea is that you want to focus on those stocks as soon as the market opens. So, find these stocks and learn why they are moving.

Level 2 Data

Second, use level 2 data to identify the order flow in the market. This data is provided by some of the leading brokers. At DTTW, all our traders have access to this order flow data. Using this data, together with time and sales, you can understand the how to position your trades.

Technical analysis & price action strategies

Third, use technical analysis (as stated above) and price action strategies. For example, some traders focus on indicators like VWAP to predict whether to buy or short a stock. Others use price action strategies to identify these opportunities.

Protect yourself

Finally, trade and always remember to have a stop loss and take profit per trade. If you break the rules you set yourself, you will have a very difficult end.

Risk management

While scalping can make one a lot of money, the fact is that it exposes traders at great risks. For this reason, scalpers must exercise a lot of caution when making trades.

There are a number of techniques that this can be achieved. One, the trader needs not risk more than 2% of his portfolio in a trade. This can be achieved by setting the right lot size and having proper stop losses. A stop loss is an important tool that can help you mitigate the outflow.

Second, a trader can come up with a strategy of trading a single currency pair. In this, experience has shown that the more pairs a trader trades, the more he exposes himself to risk. By focusing on only one currency pair, the trader will have in-depth knowledge about it. He will also be at a good position to understand the positions to place.

Useful external resources for you scalping strategy

  • Beginners guide to scalping - Ig.com

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