Scalping (Day Trading Technique)

What is Scalping?

Scalping is a trading style wherein a trader/investor trades in extremely large positions of stocks looking to take profits based on small movements of share prices over a small period of time. It can occur over the entire trading period but is most dominant in the first and last hour of the trading session when the price of stocks are most volatile due to investors looking to close or enter into positions in the underlying stocks.

Let's look at the example of the same in action. Assuming that Jacob is expecting an up move in the stock of Tesla (NASDAQ: TSLA) based on the news that its revenues will exceed the expectations of investors. Around 9.35 am, the stocks start showing good momentum and Jacob buys 10,000 shares of Tesla at the price of $1,008.92 at 9.38 am. After a few upticks, he starts squaring off the bought position to book profits. By 9.40 am, he has sold all the shares of Tesla (10,000 shares) at an average price of $1,009.50. Here, the profit earned by Jacob is $0.58 ($1,009.50-$1,008.92) per share of Tesla, allowing him to earn a total of $5,800 ($0.58 * 10,000) profit.

In order to be a successful scalper, the majority of the trader's trades have to be profitable. Contrary to the " hold and sell" mindset, a scalper believes in making profits in quick succession as they place 10 to 100+ orders in a single day.

Scalping: How does it work?

This strategy consist of three parts:

  • A scalper usually uses a reference time frame of between fifteen to thirty minutes to analyze the trend and momentum of a particular stock to help identify potentially profitable trades.
  • Based on the fifteen-minute analysis, bulk positions in the identified stocks are taken up and held for a period between one to five minutes.
  • Compounded gains can be achieved when the number of winners is significantly more than the number of losers, leading to a gradual increase in profits over many trades.

A scalper can make money in different ways:

Profit target per trade

Most of the scalpers opt for this strategy where they set up a profit target for the individual trades. The size of the gains can be in the range of $0.10 to $0.25 in normal markets and between $0.25 to $0.35 in trending markets. The risk assumed while initiating such trades is generally not more than the level of reward. For example, Mr. X finds a favorable trade setup in AMC Entertainment (NASDAQ:AMC) and buys 1,000 shares at the price of $40.00 at 11.30 am. Irrespective of the volatility of a stock, Mr. X decides on a profit target of $0.15 with the assumed risk of $0.15. Around 11:31 am, AMC reaches its target of $0.15 at $40.15 and Mr. X offloads his position. If the buy position had otherwise gone wrong, he would have exited the trade at $39.85 and accepted the total loss of $150 (1,000 * $0.15).

Breakouts/Breakdowns on stocks

Most of the traders believe that price action is the king in the stock market. The movements exhibited by the price generate buy and sell signals and form the basis of technical analysis. During the course of these movements, the charts can form various patterns which subject to breakouts can give profitable trades. Some of the common chart patterns are head and shoulder pattern, falling and rising wedge, channel pattern as well as triangles. A breakout may also occur when the price of a stock breaks its previous all-time high or breakdowns below its previous all-time low. For example, the shares of Netflix, Inc (NASDAQ:NFLX) on September 02, 2021, broke their all-time high of $593.29 set on January 20, 2021. After a small retracement, the stock is continuously in the uptrend with the current price of $665.64 at the time of publication of this article generating a return of 12.19%.

News based trading

Buying and selling shares of listed companies based on certain events such as the declaration of dividends, earnings report, merger and acquisitions, Federal reserve rate announcement, job summary reports, or any other unexpected news. Such traders make investment decisions by taking advantage of positive or negative market sentiments. The market sentiment towards news remains strong for as long as the participants react to the news. Once the interest dissipates or turns out to be opposite of what was stated, the opportunity to make new positions in the market ends. For example, when former US President Donald Trump launched his own social media app called TRUTH Social, a part of The Trump Media and Technology group, and listed it on NASDAQ via a merger with a SPAC called Digital World Acquisition Corp (NASDAQ:DWAC). Because of interest generated based on news that it was looking to stand up against big tech social media companies such as Twitter and Facebook, DWAC on October 22, 2021, reached an all-time high of $175 from the previous day's closing price of $45.50.

Level II quotations

Level II quotation is the in-depth order book for NASDAQ stocks that shows the bid and ask prices by various market participants, the order size as well as the names of buyers and sellers, usually the market makers. These are the high volume traders that initiate buy and sell positions at their quoted price on exchanges thereby creating the supply and demand of stocks and providing the necessary liquidity to the markets. Some of the biggest market makers on NYSE are Goldman Sachs and Company (GSCO), Morgan Stanley (MSCO), and JP Morgan (JPHQ). For example, GSCO > 95.7 > 200,000 on the Level II quotations basically means that Goldman Sachs has purchased 200,000 shares at the price of $95.7 each in the market. It is a good sign when a large number of buyers agree to buy at the price quoted by the sellers, thereby increasing the price of the stock.

Level II quotations - Why are they important?

The four-letter ID on the level II quotes is responsible for the identification of the market makers who are responsible for the price action of specific stocks on the exchange. Day traders follow these market makers called Ax, to greatly increase their chances of successful trades. An Ax is not constant and may continuously change depending on the market conditions. Keeping a close eye on the number of shares bought/sold by market makers as well as how freely they allow the stock to rise or fall helps determine the most influential market maker in the stock. The bid-ask spread on Level II quotations also helps to determine the liquidity of the underlying stock. A stock with a narrow spread is more likely to be liquid allowing a trader to exit his position immediately if things go wrong.

Level II quotations - Advantages

The advantages of Level II quotes are:

  • Level II quotes show the market participants - retail or the institutional investors involved in buying and selling of stocks. It is always advisable to follow institutional investors as they have better access to price discovery, as well as analysis of stocks and hence, are the market makers.
  • When the trend is strong, a good bid-ask price can be set to enter and exit the market respectively to increase the odds of a successful trade.
  • The irregularities in the order sizes also display a red flag while trading certain stocks. For example, suppose that Morgan Stanley (MSCO) is selling 50 shares every 50 seconds. In spite of the stock reaching new highs, it can be a sign of the beginning of a distribution phase indicating to the trader to take a cautious approach while trading the stock.

Level II quotations - Disadvantages

The disadvantages of Level II quotations are:

  • Smart market makers offload their positions by placing small orders of 100-200 quantities of stock. If the trader ignores such subtle signs, there is a probability of losing a big chunk of capital by trading at the wrong time.
  • Many times, institutional investors place a large buy order to generate the attention of retailers in stocks and later replace it by placing a sell order instead to trap the retail investors.
  • Level II quotations can be really confusing for beginner retail traders.

Is Scalping illegal?

No, scalping is not illegal. Some institutional investors as well as retailers undertake scalping strategies while day trading. It also provides general liquidity to the stocks on the exchange. However, it can create unnecessary attention towards some stocks by increasing their volatility which may trap amateur traders in fundamentally weak stocks. As it involves trading in large quantities of stocks, some traders might opt for margin trading accounts giving them access to leverage of three or four times their account value. For example, if Joseph has $50,000 in his trading account, he can buy stocks worth $200,000 to use in his day trading strategies. He would earn a profit of $2,000 even if stock gained 1%. However, the potential losses are also amplified by the fact that if the stock drops by 3% it results in a loss of $6,000. Considering the potential for big losses, such day traders are subjected to a regulation called Pattern Day Trader(PDT) wherein they are required to hold a minimum of $25,000 in their trading accounts. If they fail to comply, they will receive margin calls prohibiting them from making any further trades till the minimum $25,000 balance is made. Instead, if Joseph held an open position of stock/options with more than 20% loss ($40,000), he would have received margin calls to maintain a minimum balance in the account. Only by depositing more than $15,000, will his restricted account return back to normal. Ignoring the margin calls for five trading days can result in a penalty of 90-days cash only account status.

What makes a good Scalper?

Scalping involves a high amount of risk due to the large volumes of shares required per trade. A good scalper exhibits the following characteristics:

  • Ability to cope with the unpredictable nature of the stock market. For example, a day trader may think that tech stocks such as Tesla Inc are highly overpriced while a long-term investor may believe that the high price justifies the long-term growth potential of the same stock. This creates a tug of war between the two sides resulting in the volatility of the stock. During such periods of high volatility, many trading strategies fail due to unpredictable markets. Hence, only a highly skilled scalper is able to cope with the volatile market conditions having a high level of discipline and trading plan. 
  • Is highly disciplined and follows a strict trading plan. A strict trading plan means properly entering and exiting from the trades. Most scalpers follow a risk-to-reward ratio of 1:1 so that even if losses occur it won't be more than the determined target price.
  • Makes quick decisions based on technical analysis and efficiently places the order for trade. Technical analysis forms the basis of price action trading which is considered the best tool for reading stock charts. Scalpers trade in small time frames such as 1-min or 3-mins where buying or profit-taking opportunities may dissipate immediately. Hence, it is advisable to only enter into positions where all the conditions are favorable.

Takes small and regular profits. Due to the unpredictable nature of the stock market, volatility can immediately turn the tide in the opposite direction for scalpers. Small and regular profits ensure a steady buildup of profits that compound over time.

What to avoid while Scalping?

A single bad trade in this strategy can wipe out the entire capital of the scalper. Some of the best practices while scalp trading is:

  • Avoid holding losing positions. Since a scalper buys a large number of stocks, investors' accounts can look deep red due to any unfavorable news. A good scalper always gets out from such positions at the first hint of trouble. 
  • Late entries and exits are signs of indiscipline while trading. FOMO is a new term in trading which is an acronym for Fear Of Missing Out on trading opportunities. Different emotions exhibited by traders such as greed, fear, and excitement can further fuel FOMO causing them to be overconfident and have overly high expectations from their trade setups. An overconfident trader initiating trades with a late entry will almost always end up losing their money.
  • Avoid trading in illiquid stocks with poor supply and demand for securities. Some securities are restricted to positional or long-term investments while others may not be dominant in terms of market participation of market makers. Devoid of market makers, such securities might not have good volume for this kind of trading and can result in illiquid positions.
  • Avoid overtrading as it can generate huge costs in terms of fees paid as commission to brokers. As it involves many trades in quick succession, it can generate a huge amount of taxes and brokerage payable by the trader. There should always be a limit to the number of trades that can be taken considering the day's profit and loss.

How much money does a Scalper make?

The amount of money a scalper makes can depend on a number of factors such as the number of trades, account size, and the payable brokerage. The higher the number of winning trades, the greater is the compounding of the profit. For example, if John undertakes five trades and earns 0.1% each with the capital of $20,000, he would earn a compounded profit of $100.20. This might not look like making much difference, but in the long run, compounding leads to huge profits. Small profits combined with high trade turnover can increase the capital base exponentially. The account size is another factor that affects the money made by scalper. A trader with huge capital will always make more money as compared to a trader with less capital. However, they will also bear more losses than their latter counterpart. A margin trading account can further increase the capital available to the scalper and make money but it must comply with the regulations set by the Financial Industry Regulatory Authority (FINRA). Finally, the third factor that helps scalpers make money is reducing the payable brokerage fees on trades. The less the brokerage paid by the trader, the greater is the earning potential for them. It is obvious that a large number of trades can result in more brokerage amounts payable, which means that only a high win rate can help cover brokerages and taxes. A strategy that involves trading in large quantities also helps to reduce the relative brokerage paid.

Opening Capital($)Profit @10%($)Closing Capital($)

As per comparably, the salaries of Scalpers in the US range from $23,830 to $58,720, and the average Scalper in the US makes $39,176.

Is Scalping good for beginners?

Scalpers require intensive knowledge about trading in the market as well as access to extensive computer setups to constantly monitor movements in the price of stocks. This requires a huge investment upfront for purchasing the best setups and tools that improve the precision while trading. As a single big loss can affect a trader emotionally and psychologically, it may not be the best trading strategy for amateurs who have not experienced the emotional pain related to making losses. A good trader begins their journey by working first on higher time frames and slowly reducing their time frames to one minute or even seconds while building experience. If a trader reaches this level, they can buy positions or short sell stocks to book profits on downwards price movements. Another consideration for amateur traders is the position size. Most US-listed equity options have an option contract size of 100 shares. Buying or selling multiple lots can potentially increase the risk of losses due to the amount of leverage involved. Hence, it is always better to build up confidence in small position sizes and then try this strategy with large positions.

Scalper Vs Day Trader

ScalperDay Trader
They work with shorter time frames of usually between 1 - 5 minutes.Day traders may buy positions based on 1 - 2 hours time frame analysis.
Their account size is large with margins up to four times the account size.Generally don't use margin accounts, hence no leverage.
More than a dozen trades, up to 100+ may take place in quick succession.Day trading involves a limited number of trades with a holding period that can extend to the entire day before the market closes.
A scalper may take up a trade based on intuition and years of experience of where the market might go.Day Traders initiate positions solely based on the momentum and trend of the stocks and indices.

The video below gives a detailed explanation about being a good scalper:


Excel Modeling Course

Everything You Need To Master Excel Modeling

To Help You Thrive in the Most Prestigious Jobs on Wall Street.

Learn More

Free Resources

To continue learning and advancing your career, check out these additional helpful WSO resources: