The trading landscape is constantly changing and probably one of the most affected groups is day traders who actively participate in the markets each day. In a relatively short period of time we have seen spreads shrink, volatility increase, fully electronic markets, fee structure changes and the demise of the specialists and market makers traditional roles on the stock exchanges. It is likely day traders who have been involved in the markets for some time adapted their strategies to current conditions or where forced out of the market. New traders coming into the market face a choice of becoming a scalper or choosing another method of trading. This article will look at some of the benefits and down falls of scalping.
What is Scalping?
Scalping is the process of capturing small price moves in the markets, normally repeatable each day. A scalper may make several to several thousand trades each day. Scalping techniques are executed by individual traders, entire trading firms and also by algorithmic black box systems. With the amount of movement that occurs in the markets each day there are ample opportunities to grab small profits, but stops and losses must be kept extremely tight. Since profits are small stops must also be kept small so that a loss does not erase the profitable trades.
Oh the Joys of Scalping
There are benefits to scalping, but scalping often requires a certain personality type. While anyone can learn to scalp, the people who will enjoy scalping are the ones who generally don’t mind stress, can focus on the task at hand and often spend hours of intense concentration during their selected trading time. The traits amoung scalpers will of course vary, but since many trades are often made every single day, the trader needs to be disciplined and emotionally strong. Making many trades in a day can be wearing and many traders burn out before finding their groove.
The burn out issue can be avoided by knowing what scalping will entail both technically and psychologically. Once we know what to expect we can prepare and develop our strategies for profiting, remaining disciplined and focused. Let’s first look at the advantage of scalping:
-No overnight positions, which means much uncertainty is removed.
-Positions are not (and should not) be taken prior to major news announcement or economic events. This means scalpers do not gamble on direction.
-Losses are kept small and gains run until there is a trigger for exit. · Many trades can capitalize on small gains over and over which take advantage of “inefficiencies” on short timeframes (and these do exist).
-The trader can find almost endless trades (not all are worth trading though) as the markets are constantly moving.
-No real need for researching (although it doesn’t hurt) as the trades can be made on very short-term pops or drops.
-Scalping strategies can be created for almost any market – fast moving, slow moving, trending or range bound.
So there are some definite advantages to scalping…and there are probably many others, but now we need to look at the downside.
Oh the Horror
Scalping is definitely not for everyone. Some will take to it immediately (enjoying it, but profits will still take time to materialize) while others will feel there is no way they could ever trade like this. Let’s look at some of the potential downsides to scalping (remember both the advantage and disadvantages are subjective, and not all people will view the following as negatives).
-Scalping often involves waiting and watching a stock or other instrument, waiting for the right opportunity – patience.
-Fees can be high if the trader often removes liquidity (in the stock market fees can be reduced by adding liquidity, ie. Bidding on the bid side instead of buying at the offer).
-While traders capitalize on quick moves, unexpected quick moves in the opposite direction can be painful.
-Intra-day swings can be volatile and may seem chaotic…although this is also possible on longer time frames.
-To scalp effectively the trader needs access to high end trade execution software (trading platform), very low fees, and have a high speed internet connection and computer to keep up with quotes.
-Scalpers often take larger positions than they might for a longer term trade because the stops and profits are smaller, therefore to maximize capital use larger trades are taken. This can mean that if the trader loses their internet connection or their computer crashes they could be in for a very high stress time.
-Since trades are entered and exited generally very quickly, it is often impossible to set stop orders. Mental or soft stops are used.
The Verdict… In Today’s Market
The day trading boom of the late 90’s has come and gone and only the best day traders have survived through to the writing of this article. Those traders, and the new ones coming in, must be nimble and adaptable. But the real question is: Should someone scalp in today’s volatile markets?
Increased volatility has hurt many traders, but it also has created advantages. It has really become an issue of “the more the market changes, the more it stays the same.” Things still go too high, and then fall too far and there is always room for the scalper to jump in and take advantage of these opportunities intra-day. There are also the stocks which barely move at all, and a scalper can step in adding liquidity and trading the small range.
While some may argue that algorithms, black boxes and automated trades eliminate the arbitrage opportunities in the stock market, this really could not be further from the truth. If anything the abundance of computer orders allows for short term traders to capitalize on computer orders coming into the market. Just as humans push things too far, often algorithms do too, and then everyone turns and switches direction. Nothing has changed; it is just how we view the market that has changed. But the market does not care how it is viewed. As long as the market is there, scalpers can capitalize on its movements if they have the right personality for it.
Cory Mitchell, CMT
If you would like to know more, are interested in learning how to start trading or need help with trading methods visit me at http://vantagepointtrading.com.
