Scalping stocks is the bread and butter of high volatility day traders. If you're wondering how to scalp for profits as a day trader, just head to the playground. Have you ever watched kids on a teeter-totter? Watch our video on how to scalp stocks.
Its a battle between one kid and the other. Or in the stock trading world, the struggle between buyers and sellers. As one kid goes up, the other goes down, and this is what stock prices do.
Did you know there's a way that day traders can profit from those movements? It's not exactly arbitrage; it's scalping, and I'm going to show you today how it works.
Can You Make Money Scalping Stocks?
- Traders want to make money right? So can you make it scalping stocks? Yes you can. In fact, if you scalp stocks with proper risk management you can be quite lucrative. And that's the goal. You just need to know what to look for when it comes to day trading strategies.
1. What Scalpers Do
Scalping is just one of a few intraday trading strategies available to day traders. Scalping stocks means trying to make many small profits on small price changes throughout the day.
Specifically, scalpers look to take advantage of changes in a security's bid-ask spread and have to move fast when they make many small trades.
A scalper has to work quickly to make many small trades. She may buy at $15.25, sell at $15.50, and buy again at $15.30. She follows this rinse and repeat process multiple times during the day.
2. The Charts
Typically, intraday scalping stocks uses one and five minute charts for high-speed trading. Especially on slow days, many intraday traders rely heavily on scalping.
But it's essential to have low commission costs, or your profits can quickly be eaten up by your brokerage firm. Done right, though, it's a great way to make some steady profits.
3. What Is a Bid-Ask Spread?
Broken down, a bid-ask spread is a difference in price between what the sellers willing to sell the stock for (bid) and what the buyers willing to pay for it (ask).
Typically, bid-ask spreads tend to be steady over time because there is a balance between buyers and sellers. We refer to this balance as market efficiency.
In an efficient market, everyone has the same information, so their trading is consistent and allows the broker-dealers to generate a steady profit.
After all, one kid is not typically bigger than the other in the teeter-totter, or it's not going to work.
Sometimes, however, the spread is a little larger or smaller than normal. In a situation like this, it's not because of a change in the market information.
We attribute these spreads to short-term imbalances in supply and demand.
How Do I Choose Stock for Scalping?
- When scalping stocks look for a tight bid-ask spread.
- Look for a lot of volume.
- Look for liquidity. You want the stock to move.
- Where is support and resistance? If you're near resistance, don't trade.
- What is your price target? Can you reach it?
1. A Small Bid Ask-Spread
When we have a close bid and ask price, we refer to this as a small spread. For example, if the bid and ask prices on LVIN, were at 1.50 and 1.52 respectively, the spread would be $0.02. We experience tight bid-ask spreads in actively traded markets with high volume.
2. An Abnormally Wide Bid-Ask Spread
A spread is large when the bid and ask prices are far apart. If the bid and ask prices on ABC, for example, were at 1.35 and 1.75, the spread would be $0.40.
We have a few different scenarios that give us a low spread. Firstly, when a market is not being actively traded on low volume.
Without a lot of demand, the spread creeps wider. Additionally, we can often see active day trading markets with large spreads during lunchtime. Or, when traders are waiting for an economic news release.
3. What Type of Spreads Are Best for Scalping Stocks?
No doubt, scalpers make their money on stocks with small bid-ask spreads. In the first place, most want small spreads because these allow their orders to be filled at the prices they want.
With this in mind, many day traders will temporarily halt if their stock develops a large spread.
4. What Is the Problem With a Large Bid-Ask Spread?
In the financial world, we call the difference between a trade's expected price and the actual price of execution, slippage. A large spread results in orders—especially market orders—to be filled at prices you don't want. We see slippage in high volatility markets and when there's a lack of buyers interested in buying the stock.
Which Time Frame Is Best for Scalping?
- Scalping stocks means you want to get in a out quickly. So the best time frames for that would be the one minute or five minute chart. The one minute moves quickly. As a result, you can miss your move. The five minute slows things down a lot more. Sometimes, using them together is quite helpful.
1. How to Prevent Slippage
Slippage occurs when a trader uses market orders. A market order is when you immediately buy or sell the stock for you at any price. Yes, at any price.
Aside from being hasty, you have no control over the fill price. Further to this, a market order buys at the ask (high side) and sells at the bid (low side). Unfortunately, you're filled on the wrong side of the bid-ask spread, a scenario you don't want.
Let's look at a real-life example. Say the bid-ask spread is $12.00-$12.02; a market order should buy immediately at $12.00 for you. Right? Wrong!
On the contrary, by the time your market order arrives at the Exchange, the stock soars to $12.15. Unfortunately for you, your buy market order gets filled at $12.15. When you do the math, that's $0.15 in slippage, and that is bad, really bad.
So what is the solution? In no uncertain terms, use limit orders instead of market orders. Unlike a market order, a limit order only fills at the price you want, or better.
The keyword here is limit; a limit order limits the price you are willing to pay for the stock. You tell your broker to buy or sell a specific stock at or better than a set price specified by you.
Certainly, the surest way to prevent slippage is to set a guaranteed stop (limit) order. Note that this is not the stop-loss order, but a guaranteed limit order that will always complete trades at the price at which you have set them.
Let's be clear; the important thing is that you avoid slippage and you're in control of your trades. In my opinion, this should be your ultimate goal.
2. A Few Words of Caution for Scalping Stocks
As I mentioned above, we have slippage in low volume, thinly traded markets with large bid-ask spreads. To prevent this ensure sufficient volume and float; my personal preference is a minimum volume of 300,000 and a tight bid/ask spread.
You can't totally avoid slippage; think of it as a cost, like commissions. Sometimes it's a cost worth paying, but not all the time. If you want to scalp for profits as a day trader, don't place market orders unless they are completely necessary.
Aspiring traders should realize day trading is not a hobby or a weekend pursuit. You need to study as seriously as a student would study while in university or trade school. If you're serious, why don't you join us today in the stock trading playground!