What Every Novice Trader Must Know About Scalping
The market works in cycles and every few years, a sustained rally will create such a frenzy that members of the public jump into the stock market hoping to be day traders. With the advent of modern day laptops, desktop computers and the internet, the barriers to entry have been lowered to such a level as to attract a large portion of the general public. If you are a novice trader just getting into the markets to try your hand at scalping, this article is for you.
Profit Target and Objective
The profit target for scalping is usually very low in the range of 5 to 10 cents on stocks and 2 to 10 ticks on futures. The whole idea is to spot momentum and participate in the rally or selloff briefly in order to gain profits. The keyword here is momentum and a wise trader will find a day trading strategy that is able to identify momentum early. It is like playing musical chairs, who is left holding the stock when the momentum stops.
Efficient Execution of Orders
Simply put, a day trader has to be a master in order execution. An experienced futures or ETF trader will instinctly feel when to hit the bid and give up the spread, and when to patiently stay at the offer to short the market. Giving up the spread will immediately put the trader at a disadvantage and will eat into the profit potential of the trade. For efficient order execution, it is imperative that a scalper have direct ECN and exchange access to the markets and for stock traders, access to Level 2 data.
Frequency of Trades and Commission Risks
The day trader has to make numerous trades a day in order to meet the daily profit target. This profit target has to be such that it is worth the trader's time to risk capital to trade the markets. For example, if a trader's daily target is $500, an S&P e-mini trader with a 4 tick profit target (i.e. $50) has to make more than 10 trades (including commissions) to make &500. It is therefore important to choose an online broker with competitive commission rates and direct access to the markets like Interactive Brokers and MB Trading. Other brokers like TD Ameritrade and Scottrade are not suitable for stock scalpers but are geared more toward swing and core trading.
Trading Software
A scalper needs cutting edge trading software with real-time tick data and real time news like NinjaTrader or eSignal. As most traders will use some form of technical analysis to provide entry and exit signals, the trading software needs to be stable and robust and equipped with the required technical indicators. Also read Best TA Charting Software for more information.
Computer Setup and Network Connection
Speed is essential in scalping and every millisecond means a difference between being filled on your order or not. For internet access, get as low latency as possible to your online broker. For a computer, it has to be fast and stable in order not to be down during critical periods like. Read Computer for Online Trading for more information.
Competition
The markets are generally very efficient due to the presence of market makers, specialists and other professional traders. It is a crowded market, each participant with the goal of making a profit. A novice trader will be wise to know who is the competition and to always be inquisitive into who is taking the opposing side of your trade. Through time, the scalper will develop a gut feel on when to enter and exit the markets based on real time market intelligence like how easy or difficult it is to buy a stock at the bid or sell at the ask. Difficulty in getting a fill normally indicates that most likely the trade is in the same direction as the prevailing momentum.
Shorting Stocks is Difficult
For traders who scalp stocks, the implementation of the uptick rule has made it very difficult to trade from the short side. When the downward momentum begins, upticks are scarce and only the most experienced and technologically well-equipped traders will be able to get their orders filled. Most often than not, if the trend is firmly down for a particular stock, there would most likely be no more inventory to short. This however does not apply to futures, ETFs and Forex.
Small Risk Myth
This myth is perpetuated because of the tight stop loss orders that day traders normally use in order to limit losses. The tighter the stops, the chances of being taken out by whipsawing markets is very high. Numerous small losses add up to big losses in time so it is vital that a scalper has a viable strategy that gives positive expectancy, before trading with real money.