The scalping daytrader
Scalping is daytrading with very short time frames. Let's have a look at the different methods.
- Originally scalping refers to one thing market makers do. Buy at the bid when prices fall into a pocket and sell at the ask when they are overshooting. Small gains are made within minutes. This scalping pattern works best when the price moves in a range or hits a line of resistance or support. Alternatively in the stock market the index may hit say a support line and that may be the buy signal for a stock in expectancy for a market reversal. Deviating from market maker behavior would be to have a stop loss in case the price does not swing around.
- A more modern version of scalping is sort of swing trading for the many tiny oscillations that occur throughout the day. You buy at the ask and sell at the bid with a market order when the micro-trend ends. In this variant the stop loss is intrinsically built in.
- The more sophisticated scalper uses intraday charts to identify trends, bases, breakouts, pullbacks, swing breaks, crossing moving averages and so on. This equates to using technical analysis in the shortest possible time frame. In the Forex market 10 sec charts are common, while in the stock market the shortest ones are about 1 min, so that a whole day fits on one screen. More often than not this trading method involves paying the spread and accepting the slippage. To get on board you have to move quickly in and out, otherwise waiting for getting hit with your limit order distorts your original plan when to get in and where to stop, so much that you probably end up in deep confusion. The problem with this and the last trading strategy is twofold: high execution costs combined with the risk to fall prey to random patterns and movements.
- Finally the gut trader with his somewhat unsystematic trading approach is sometimes called scalper. Often these traders only have one real rule and that's about money management. Typically they are executing a tight stop loss, no matter what. Everything else comes from long experience of sensing what the market will do next in situations that these traders can't describe themselves sufficiently so that one for example could derive a trading system from it. Instead they have patterns and constellations subconsciously internalized that may produce short market moves. Because the situation that triggered their hunting instinct is gone within a short time frame or a small correction of the price they often have an idea of a price target for closing the trade. So they may go flat when the price still moves and thus their trading style is indeed true scalping.
More specialized scalping setups
- There are traders who wait patiently for the right situation like an overdone sell off that at least temporarily will produce a market where no one wants to sell anymore but more and more traders are waiting for a reversal and are prepared to jump in on the slightest sign of up-movement. Said patient traders may preempt the reverse avalanche by buying into the falling price, building up support and finally having entered the market at the best level. Of course this is a market maker technique, too.
- During the open prices often fluctuate wildly with wide spreads. Having limit orders on both sides in place will statistically produce a scalping gain in the old fashioned sense.
- Another statistical method is to enter the market only on a real intraday signal and to close the position again only when a real cyclical signal like a breakout etc. occurs. This means, there is no stop loss. If prices walk up or down in a random fashion no trade is conducted. At a first glance this may sound questionable, but so often the stop loss is just a fictive line that is crossed without any real meaning. With this system both sides of the trade have a real reason. Problematic on the other hand is the psychology. Will the trader when the price moves against him not be tempted to discover a signal where he otherwise would have seen nothing? Or worse, will he ignore any possible chance to close the trade unless it is in positive territory?
- One such signal could be simply a longer movement in one direction without breaking out of a range or producing such a strong trend that a signal for a cyclical market entry is given. In such a case just going against the movement on both sides is statistically equivalent to a grossly widened spread.
- A more automatized version uses Bollinger Bands as an envelope around the price chart that takes changing volatility into account. If the price moves out of its envelope it is considered overbought or oversold and a signal to enter the market anticyclically is given. It is probably wise to combine this automatic signal with the veto of the former method. A chart indication for a cyclical position voids the signal.
- The coarse grained scalping trade is opened at the open and closed at the close of the stock or futures market. Both sides of course with a limit order and the trade itself in the direction of a major trend. Statistical trading pure.