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There are several techniques and methods investors and traders employ to find success in the stock markets. For example, a trader has a good and old long-term investing approach, where they buy and hold fundamentally sound companies for at least more than a year. Besides long-term investing, traders have other strategies like intraday trading, swing trading, and momentum investing. It is suitable for traders to find the approach that suits them the best. However, at the same time, they can always try out new strategies.
This blog will discuss one of the more advanced trading strategies called scalping. Let’s understand the concept of scalping, its types, and the difference between day trading and scalping.
Understanding Scalping
Scalping is a trading approach in which traders aim to earn from the smallest fluctuations in the price of financial securities like stocks and derivatives.
The rationale behind this approach is that liquid financial securities witness small price moves frequently. In other words, it is easier to capitalise on smaller price movements since they are more frequent compared to larger ones. One can use the Share India trading app and open a daily stock chart to observe the small price movements. The huge volume of the trade makes up for the small price fluctuations in the scalping technique.
One may find scalping and intraday trading the same, as there are plenty of similarities between the two that will be outlined in the later section.
The two primary characteristics of scalping are: small price movements and large traded volumes. Due to high volumes traded, a fluctuation of less than a per cent of the value can generate significant profits. However, at the same time, a minor price movement in the undesired direction can lead to major losses.
Scalper Trader and Their Role
An individual who implements the scalping strategy to trade in the financial markets is called a scalper. A scalper must maintain strict discipline because even the smallest movement can make or break a trade. At the same time, scalpers must be quick decision-makers to jump in and out of trades quickly. Lastly, scalpers are constantly monitoring the markets to find scalping opportunities. A scalper must be skilled enough to identify a movement or a pattern that other investors and traders may fail to see. Successful scalpers may make a dozen trades or even more on a single trading day. Furthermore, they may rely on trading algorithms to help them improve the efficiency of their trades.
Working of Scalping
Scalpers capitalise on small price movements and trade in high volumes. When it comes to the holding period, scalpers may hold their open positions for a few seconds or a few minutes. When it comes to financial securities, scalpers look for the most liquid securities as they look forward to instantly jumping in and out of the trade. If the security is not liquid enough, instant entries and exits won’t be possible, and that may force the scalper to hold their positions for longer than they intend to.
Therefore, since high liquidity is a crucial requirement for scalping, scalpers will generally trade liquid futures contracts like the Nifty futures and options. Besides that, scalpers also scalp highly liquid stocks in the cash or derivatives market. If they intend on scalping in the cash market, they may use leverage to get hold of more purchasing power. With the help of the following illustration, let us now understand scaping.
Suppose shares of a liquid company, XYZ, are priced at ₹2,000. A scalper keeping an eye on the price finds a scalping opportunity and enters the trade at ₹2,000, buying 1,000 shares, expecting the price to give a quick run up. In less than a minute, the scalper exits the trade as soon as the price touches ₹2,003. This way, a scalper makes ₹3,000 in less than a minute (excluding taxes and brokerage).
Types of Scalping Strategies
Moving forward, let’s look at some popular scalping strategies below. However, it’s important to note that these are just a few examples of scalping strategies, and there are many other approaches one can implement as a scalper.
- Breakout Scalping:
Breakout trading is one of the most widely practised scalping strategies. The breakout strategy is not only exclusive to scalping, but it is also modified and used by other types of traders. If one is familiar with the strategy, one can simply implement it by referring to a chart suitable for scalping. In this strategy, one basically identifies a price range and waits for it to break above or below the range, as the breakout can lead to a sharp movement.
- News-based scalping:
This scalping strategy involves buying or selling on the back of market-moving news or events. A scalper may sit tight and wait for a company to release its earnings report, expecting high volatility after the release, giving rise to a scalping opportunity. This strategy can be extremely risky if one doesn’t have a risk contingency plan in mind.
- Arbitrage scalping:
The arbitrage scalping strategy involves finding opportunities in price discrepancies between different markets or exchanges. Here, the scalper may buy the security on one exchange and then sell it on another exchange where the price is higher, with the difference being their profit.
Day Trading vs. Scalping
Let’s address the elephant in the room—how scalping differs from intraday trading. Technically speaking, scalping is also a form of day trading since scalpers also don’t carry their positions to the next trading day. That said, scalpers hold their positions for seconds or just a few minutes. On the other hand, day traders may hold their positions for hours before booking profits. Scalpers are always looking for instant results. Secondly, scalpers trade much higher volumes than day traders.
Conclusion
After learning about scalping and understanding its intricacies, one may consider becoming a scalper. However, before making a decision, it is important to assess various factors such as financial goals, risk tolerance, and skill level. It is also crucial to have a significant capital size in order to profit from the small price moves that scalping relies on. Mastering scalping requires a high level of discipline and dedication, making it a challenging technique for beginners to grasp. As such, it may be advisable for beginners to focus on growing their capital before attempting to engage in scalping.