Traders have their own lingo to describe what they do on a day-to-day basis. (Like what, you may ask? Try these…) These terms of art will make your life a lot easier as you develop a portfolio, but up front, it can get pretty confusing.
What separates an iron condor from a long call? Isn’t the short put just a new way to cheat at golf?
The best way to answer those questions is one at a time, which brings us to the subject of scalping.
What is it?
“Scalping” is the practice of making lots of trades with small margins. This is a strategy highly associated with day traders and, often, a scalper may trade the same stock many times over the course of a single session.
Scalping is almost the polar opposite of most trading postures. Instead of trying to hold onto an investment over a long development period, a scalper looks to profit off dozens or even hundreds of minor fluctuations.
High volatility is the scalper’s best friend, as is an ironclad exit strategy. Without specific goals and targets, the trader risks holding onto a stock for too long. A single loss can wipe out an entire day’s gains.
The goal, ultimately, is to collect as many small profits as possible. By not taking major positions, a careful scalper can limit his exposure at any given time, and the strategy doesn’t require long-term predictions. The scalper doesn’t need a sense of where this company is going in the long haul, just a sense of how it will move in the next 45 minutes.
By way of example:
Susan is a day trader looking to scalp GameCo. Her strategy is to set a baseline around which she believes GameCo will move, in this case, $10 per share. When GameGo hits $10.05 a share she shorts it. When it hits $9.95 a share she buys it and, in both cases, she liquidates her position at $10.
She makes five cents per trade, but if Susan can make that much over and over she’ll eventually net a healthy profit.
How can it help your portfolio?
Now, day trading is not for everyone. It comes with lots of risks and requires a lot of research and knowledge before diving into this form of investing. With that said, scalping can play a few roles in the trader’s toolkit.
It can help correct for market volatility, allowing you an opportunity to invest when you don’t feel comfortable making long-term predictions.
Too, small moves happen faster and more easily, allowing you a chance to profit more quickly in a portfolio that needs liquidity. (Although, again, a single big loss can wipe out an entire day’s worth of trading.)
It can help limit exposure. A scalper with well-established exit points can generally escape before a stock can lose too much value.
Finally, it can be very useful for limited-asset portfolios. One of the benefits of scalping is that you’re not looking for blue chip investments because you’re not worried about stock performance in the long run. Almost any stock can have a 10 cent window of variance, which allows you to consider far less expensive investment options.
Scalping is a popular option for day traders specifically because it allows them three key advantages:
- It is a strategy with limited exposure
- It can show quick gains
- It doesn’t require long-term forecasting
If that sounds like a good fit, and if you have the risk capital available for that kind of volatility investing, this might be something to consider.