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Scalping Stocks: What You Need to Know

Scalping stocks with MA cross

Scalping stocks has become more popular over the years as cutting-edge technology becomes cheaply available. Electronic trading has meant that accessing markets is fast and prices reliable, which are two aspects that traders scalping stocks absolutely need.

Let’s have a detailed look at how to scalp stocks, the strategies, and things you need to look out for. 

Scalping Stocks Explained

Scalping stocks uses a short time frame and a small profit target or stop loss to enter and exit a trade. The small price targets dictate that the trade will remain open for short periods of time, sometimes just a few minutes. 

The idea behind scalping stocks is that the trader is exposed to less risk on each trade. However, this factor also means that you need to trade many times a day to make a consistent profit. Day traders and swing traders keep their positions open for larger profit targets, and consequently their positions remain open over a longer time frame.

For example, let’s say you identify stock AA as a valid security to trade using a scalping strategy. You open a position for 1,000 shares, your profit target is $0.25, and your stop loss is $0.25. Both targets will produce a profit or loss of $250. 

This profit or loss should be measured as a percentage of the equity needed to put on the trade. The idea is to take small movements in price as profit targets or losses. The price of the stock in the above example should be anywhere between $30 and $50, for you to have a reasonable risk-reward ratio.

If you are looking to make a substantial income from scalping stocks, you would need to repeat the above example various times throughout the day.

Identifying Stocks 

This is possibly the trickiest part when it comes to scalping stocks. So, I know my strategy, and I have a clear idea of how to execute it. But which stocks should I trade? The choice in my opinion is based on three factors: price liquidity, volatility, and price level.

You need to trade shares that have a high level of liquidity when you are scalping stocks. Liquidity provides easy and fast entry and exit of your trades. This aspect is vital to the successful execution of scalping stocks.

So, preferably a stock should have millions of shares traded every day, this will almost guarantee that slippage is minimal. Especially if you are trading retail amounts, your trade should get filled at the price on the screen or very close.

Volatility is the average size of price moves in a day. If the stock you are looking at has a very low intraday volatility, you will have to trade larger sizes of that stock to achieve a minimum profit target. And the margin requirements may squeeze you out of the trade.

The price of the shares is also an important factor, as it will determine what your minimum margin must be. If the share’s price is $100, your profit target should be between $0.25 and $0.50. to make $125 to $250 on 500 shares. This means that you would need to buy or sell $50,000 of stocks.

Commissions & Leverage

Some brokerage houses offer a flat fee per trade, while this is advantageous for traders looking to trade large enough amounts less often, it does not bear so well on scalpers. You will probably get a better deal at discount brokerages that offer minimal services and have low fees. As you will trade multiple times a day, commissions can take a heavy toll on your bottom line.

Leverage is also important as it will allow you to trade in larger amounts for less money on your account. The leverage ratio for US accounts is 4:1 on margin accounts, meaning you can trade up to $100,000 with the minimum $25,000 requirement. 

Margin requirements, or leverage rates, in Canada depend on the security and the broker. Some brokers offer 4:1 or higher with small minimum balances, especially if you are trading CFDs. While larger institutions trading physical stocks will only go as high as 3:1, such as the case of TD Bank.

Always consider carefully how much leverage you are going to use, as it magnifies your profits, but it also magnifies your losses.

Is Scalping Stocks Legal?

Scalping stocks is legal in Canada and the US, however, there are some rules to abide by. For Canadian residents, there is no obligation to maintain a $25,000 minimum of equity on your margin account. This rule applies to US traders under the day trading pattern rule. 

However, if you are trading US stocks on an American exchange, those stocks are cleared in the US. The broker you trade through will be required to adhere to the US rules for pattern trading. And they will designate your account as a day trading account. So, in this case, you will have to maintain a balance of at least $25,000.

The day trading pattern is triggered when you trade at least four times within 5 business days. A trade is recognized as buying and selling the same security within the same day. Also, your day trades must represent at least six percent of the total number of trades on your account over the same 5-day period. 

For a Canadian resident who wants to avoid the US 5-day pattern rule, you can choose a broker that does not trade on US exchanges. Clearly, for a retail trader looking to start scalping stocks, a minimum balance of $25,000 may constitute a drawback. 

Scalping Stocks Strategies

Scalping stocks strategies are based on technical analysis only, given their short time frame. Fundamental analysis is used only for long-term views on a company’s future profitability. As stop losses are always very close to the entry price, any headline news that may be negative to the position will automatically reduce the possible losses.

If you are going to trade stocks by scalping, you must necessarily master the basics of technical analysis. The subject is very broad and wide to cover it all. So, we are going to have a look at some of the most popular scalping strategies used by retail traders. Ultimately, you should do enough research to establish which technical tools suit you best.

Just to be clear, technical indicators and chart patterns work, but not all the time. Most traders use a mix of technical indicators and chart patterns to design their scalping strategy. Using more than one technical tool helps improve the percentage of winning trades for your strategy.

Here are four technical tools for you to consider. Some may have a better performance in specific markets. For example, when markets are trending rather than moving sideways. Also, remember that you must wait for the pattern to complete or for the indicator to give a signal to get the best chances. 

Moving Average Crossover

This strategy uses two moving averages (MAs), a slow MA and a fast MA. The slow MA is considered the baseline, while the fast MA is considered the signal line. When the fast MA crosses above the slow MA from below it is considered a buy signal. When the fast MA crosses below the slow MA from above it is considered a sell signal.

Scalping stocks with MA cross
Source: TradingView

The above chart shows the slow and fast MAs with their crossover points marked with a blue cross. For example, I chose an 8-candle period for the fast MA and a 13-candle period for the slow MA. You will notice that if you only apply the entry points many of the trades result in a loss.

To improve your win ratio, apply short enough profit targets that will result in a closed trade before the next pivot point in price movement. Also, each stock, and type of market may require that you tweak the fast and slow periods for better results.

MACD

This is the Moving Average Convergence Divergence strategy.  This indicator is made up of a signal line, the yellow line in the bottom window, and the MACD line. The signal line is the 9-EMA of the MACD. The MACD is the 12-EMA minus the 26-EMA. The bars in the bottom window represent the difference between the two lines.

APPL scalping stocks
Source: TradingView

A sell signal is produced when the MACD line crosses below the signal line, the higher above the zero line the stronger the signal. A further indication of downward momentum is given when the signal line crosses below the zero line. Trend exhaustion may occur when the signal and MACD lines are very far apart. This difference is also noticeable in the red and green bars that depart from the zero line.

Double Top or Bottom

This two-candle pattern occurs with a certain amount of frequency and has a good success rate. The win rate is improved greatly when they are used in conjunction with support and resistance levels. Adding these levels to your chart patterns will greatly improve results among all patterns you use.

The double bottom occurs after a long downward run in price action, possibly with a steep incline. When the last candle’s open price is the same as the previous candle and the close of the last candle is at least as high as 75% of the previous candle, but preferably the same as the previous open.

Scalping stocks with double bottom & top

A double top happens after a long advance in price upwards, preferably with a steep incline. The last candle’s open should be the same as the previous candle and the close at least 75% of the previous candle, but preferably as low as the previous open.

The size of the candles that make up the chart pattern is also important. If the average bar size on the chart is say $0.10, then a chart pattern with less than that is usually insignificant. For better results, the chart pattern should form with candles that are at least double the average bar size.

Hammer

The hammer is a single-candle chart pattern that usually appears after a long downward run. Preferably the price drop comes with a steep incline. The shape is formed ideally when the candle’s low is far away from the close, leaving a very small body at the top of a long tail. The wick of the candle should measure at least three times the length of the body.

Scalping stocks with hammers

An upside-down hammer can also occur at the bottom of a downward trend. In this case, the candle should have a small body with a close below the previous candle’s close. The wick should extend up from the body by at least three times the length of the candle.

Using Patterns & Indicators for Scalping Stocks

As mentioned earlier chart patterns and indicators work best when they are used together. For example, you could also use chart patterns in conjunction with the MACD indicator or RSI. 

Where you would look for points on the chart where the RSI or MACD indicators may be showing overbought or oversold territory. When the MACD line and the signal line are far apart and well below the zero line you would look for double bottoms for example.

Always stick with the ongoing trend. Remember that no technical indications should be taken as conclusive. If the market is experiencing a strong downtrend on the day and there is a small swing upwards look for indicators to give you a short entry.

Trading Platform & Technical Tools

As with all trading platforms, you must have top-tier software that gives you real-time pricing and 1 or 2-click trading. The trading platform should allow you to preset the stop and profit targets to reduce the number of clicks needed to enter the market. A few seconds on some occasions may see you priced out of a trade.

The technical tools available on the platform must also be of the highest level. You may have exactly what you need from your broker, or you can try a third-party online tool such as TradingView. In either case, the platform must have a full array of technical indicators, chart types, time frames, alerts, and preferably a news feed.

If you are looking to automate your trades, you need to check the broker’s platform offers you this service. Not all brokers have the capability to offer automated trades.—-

Pros of Scalping Stocks

  • You are never exposed to overnight risk. For example, with positions open the day before earnings are released. Or weekend headline news that can create price gaps.
  • Quick win and loss rate. You will see your profitability quickly as trades are opened and closed sometimes within a matter of minutes.
  • Your trading strategy may function well even when the market is trading within a range on the day chart. However, as you are scalping, small daily moves can be enough to cream a profit.
  • Stocks have lower volatility than other markets such as forex or commodities, which means scalping stocks should pressure you less.


Cons of Scalping Stocks

  • Scalping stocks comes with higher costs as you will be trading multiple times a day, for small profit margins. Commissions can bite into your bottom line in a big way.
  • The emotional impact can be high. Selling when you are long can prove harder than envisioned. Always stick to your plan.
  • Stock trading offers lower leverage ratios than other markets such as forex. This factor can make scalping stocks profitably harder. Although if you are in Canada, you could use a CFD broker to increase leverage.
  • Trading hours are limited, you will only be able to trade during exchange hours. So, you don’t have the choice of trading after office hours like you would with other markets that are open 24/5 such as futures trading.


Conclusion

Scalping stocks can be a tricky game. You need to measure carefully how volatile the stock’s price is, and how much you can afford to risk on each trade. You will probably be placing tens of trades a day, so spread out your stop loss size, or a string of bad trades may burn you out.

Trading stocks as a retail trader can be an overwhelming adventure, and your best bet is to get some qualified help. Several companies offer professional and expert advice when it comes to picking and trading stocks. You don’t have to go it all alone, you can read about the top stock-picking services here.

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