The price of a commodity futures contract or Micro E-Mini futures at the beginning of a trading session may not differ much from the price as the session closes. However, throughout the day these contracts repeatedly exhibit small price changes up and down. A day trading strategy that takes advantage of repeated incremental price movements throughout the trading day is called scalping. An attentive day trader can enter, manage, and exit multiple trades and take a small profit with each one. Profiting from micro price movements via scalping requires a live feed and a direct access broker. It also requires discipline, a strict exit strategy, and the stamina to be trading continually throughout the trading day.
Understanding Scalping Basics
Folks who are swing traders or short term investors are always trying to predict when futures, currencies, or stocks are going to move impressively up or down. This can be a profitable undertaking. However, these folks are missing out on normal price fluctuations that occur regularly throughout any given trading session. A day trader who uses scalping is not necessarily interested in where a market is headed. They profit from the normal ups and downs that occur minute by minute. When scalping, a day trader spots an opportunity, enters a trade, sets their stop-loss and take-profit targets, and exits as soon as they obtain a profit. This approach generally appeals to day traders who are not interested in trying to outguess the market over time. It appeals to day traders who are willing to do the minute by minute work needed to generate small but steady profits.
Volatility: The Scalper’s Playground
No matter what types of assets one trades and no matter what markets they trade in, profit comes when the market goes up or down. While long-term traders look for big price movements, a scalper looks for a volatile market that does not need to be heading up or down. Technical indicators for very short time frames are ideal for scalping. These include a relative strength/weakness exit strategy, multiple chart scalping, and a moving average ribbon entry strategy. A day trader who engages in scalping is less interested in market fundamentals and more interested in short term variations in market sentiment.
Key Terms in Scalping: Bid, Ask, and Spread
While many investors simply buy and sell at market prices, scalpers only use limit orders to buy and sell. They seek to profit when the bid price for a futures contract, currency pair, or stock differs significantly from the asking price. This difference is called the spread. It is during periods of volatility that some traders will be willing to pay a bit more for an equity or may be willing to sell for less. The job of the day trader who is scalping is to spot those opportunities, enter and manage the trade, and then exit once a reasonable profit is available. As a rule, successful scalpers look to profit repeatedly from small spreads rather than waiting to cash in on a much larger one. The point of scalping is to repeatedly generate small profits and not wait to hit a homerun.
Technical Analysis for Scalping
While a day trader who is scalping commodity futures may keep an eye on market fundamentals, the bread and butter of this work comes from technical analysis of very short term price movements. Traders use the same technical indicators that they may use for longer term trades but will set them for two minute intervals. This approach works best when trading is range-bound or trending strongly up or down. It may be less effective when market movement is totally chaotic. Commonly used tools are the moving average ribbon entry strategy, the relative strength/weakness exit strategy, and the use of multiple charts set for periods such as two minutes, thirty minutes and an hour. No matter which approaches you use, scalping opportunities can come and go quickly. Thus the success scalper is one who reacts quickly to market conditions and exits quickly with their profits before the market turns on them.
Risk Management Strategies in Scalping
Day traders who are scalping do not have time to dwell on the pros and cons of trade entry, management, or exit. The nature of a market such as commodity futures is that scalping opportunities come and go quickly. Scalpers are wise to remember that less time in the market means less risk. Smart traders routinely set their stop-loss and take profit targets with every single trade. They work with small and manageable position sizes. As with virtually all day trading, discipline and consistency are essential for continuing success.