10 June, 2024

What is scalping in trading?

Scalping, or scalp trading, is a trading method that aims to make quick profits from the tiny fluctuations in the markets, often the forex market.

Similar to latency arbitrage in forex trading, scalping is often frowned upon, as it can be seen as fraudulent, or a ‘cheap’ way to turn profits which uses market manipulation. In some cases, scalp trading can literally be fraudulent.

In this article, we will be giving an overview on what scalping is, where it’s used and why it’s often regarded as an unethical or toxic practice.

What is scalping in forex?

The forex market is where most scalping occurs as there is an extremely low bid-ask spread. It is also one of the most liquid markets, so trades will go through very quickly.

Due to the fact that scalping requires a huge amount of capital and extremely quick trading to be effective, it is generally done by institutional firms who have the tools to do it. 

How does scalp trading work?

Scalp trading works by trading large quantities of an asset within a very short period of time, sometimes just a few minutes or seconds.

The markets are constantly shifting and prices will fluctuate on even the most stable stocks – scalpers are looking to make profits from these tiny fluctuations.

However, due to the minute size of the trades, ordinary trading sizes would not be sufficient. Scalp traders must enter hundreds or thousands of positions on a security in order to turn a profit. For this reason, scalp trading is generally not a style adopted by beginners, as they don’t have the capital or the tools to be able to facilitate such a trading style.

Here is an example of how scalp trading works:

Scalp trading example

To demonstrate the scales of scalp trading, we have a hypothetical scenario for you.

In this scenario, you will be able to profit $10 from a trade. This trade will be using EUR/USD, the most liquid major pair. Imagine the exchange rate is at 1.2500.

With $250, and leverage of 1:50, you will have a position value of $12,500 which is 10,000 units – referred to as a mini lot.

If you enter a buy position at 1.2500, and then exit at 1.2510, a difference of 10 pips, you will have made $10 on your trade. This is a simplified example of a scalp trade, and in reality to turn a sizable profit, traders will take larger positions in the market.

This will obviously depend on your broker’s leverage and margin requirements. Make sure to do the appropriate risk analysis before making a trade and remember that investments can go down as well as up and your capital is always at risk.

Types of scalp trading

Scalp trading has many different forms and strategies that traders use to turn a profit on the small movements in the market.

Scalpers can also use various indicators to guide them on their trades.

These can include:

▪️ A stochastic oscillator

▪️ Using the moving average

▪️ Parabolic SAR indicator

▪️ Using the RSI

Each one will have its own style and own benefits, and traders may use a combination of these methods to build their scalping strategies.

Is scalp trading illegal?

Scalp trading is technically not illegal. It is a trading strategy used by many traders around the world in various financial markets.

However, scalping in some respects is considered to be unethical or toxic trading. Scalping requires making a large amount of trades within a short time period to exploit small price differences. These price differences are small but with a significant investment and leverage a profit can be made, but this opens up the possibility of market manipulation and contributing to instability. 

Other traders may experience volatility on trades simply because of scalping from other institutions.

Long-term investors therefore may find it difficult to make informed decisions and stable trading strategies if a particular stock or currency pair is experiencing scalping volatility.

Furthermore, institutions have access to computers and software that can execute a huge amount of trades instantly, allowing firms to enter and exit positions in the blink of an eye. This is yet another unfair advantage of institutional traders, and affects the reliability of the wider market’s investments.

Liquidity issues with scalp trading

Liquidity is also affected with scalp trading. As liquidity is provided with a high volume of trades, it is whisked away before it provides any use. It can therefore create issues where liquidity data is not reliable, as due to the speed of scalping, it can be true one minute and obsolete the next.

Market participants that rely on liquidity data to make stable investments can be harmed from this and cause them to make decisions on unreliable data. 

Fundamentally, scalping adds no benefit to the markets. It doesn’t produce anything or show any faith in a stock or currency and at the same time brings confidence down and increases volatility.

Broker & risk management issues

Any financial institutions or traders that engage in scalping are likely to be flagged to other traders.

As you can see from our chart, most brokers are savvy to scalping these days, and have specific tools in place to identify scalping behaviours.

Our full list of broker risk management tools shows many other kinds of toxic flow are covered. Once identified, brokers will normally take steps to limit trading abilities, which any institution engaging in scalping should be aware of.

Are day trading and scalping the same?

Day-trading is not necessarily scalping, but the two are very similar. 

Day trading is a term to describe trading against the small changes in the market throughout the day, and will only ever last a day. Scalping is essentially an extreme form of day trading, with much higher capital, advanced computers and shorter time frames. Many small-time traders wouldn’t be able to effectively run a scalp trading strategy.

Often day trading has more of a strategy to it, and could involve only a few trades throughout the day, but scalping is relatively instantaneous. Both have a similar mentality and method.

Conclusion

Scalping in trading is a trading method used across the market. While often disregarded as a cheap trading method, it’s important to understand as a significant amount of price movements are driven by scalp trading.

As mentioned earlier, LiquidityFinder has an extensive breakdown of risk management tools which gives an overview of the best risk management tools available for brokers – including tools to detect scalp trading activity.

It takes just a few minutes to register with LiquidityFinder, and once you do, you’ll have immediate access to our exclusive network of liquidity providers, as well as gain access to tools such as our Match Matrix and our multi-provider request form. 

Stay up-to-date with our Insights too, where we update our audience on everything they need to know about liquidity, crypto and more.

Author

Caleb is a financial copywriter with a specialisation in fintech and forex. Former copywriter at Barclays and Paysafe. Contributing writer for LiquidityFinder. You can message Caleb here.