The Hidden Dangers of Scalping

Scalping is a type of trading approach which seeks to profit from small moves in an underlying trading vehicle on an intraday basis. Scalp traders aim to get in and out of a market many times in a day looking to profit from these quick moves. Scalping can be a profitable strategy if executed flawlessly however traders MUST be aware of the hidden dangers which scalping brings.

The number one hidden danger of scalping is transaction costs. Whenever you enter into a trade, there will be a cost associated with doing so which is usually referred to as the spread. The spread is the difference between the price in which you can buy a product to the price in which you can sell a product. For example the spread on something like USDCAD might be 2 pips; therefore the buy price might be 1.1330 whereas the sell price will be shown as 1.1328.

Continuing on with the USCAD example, let’s assume that we think the price is going to have a quick bounce so we buy USDCAD at 1.1330. We place our stop loss just 10 pips lower at 1.1320 however because the spread on USDCAD is 2 pips, if we want to make a dollar for a dollar risked then our target price will have to be 12 pips away from where we bought USDCAD to pay for the spread. In this example our costs associated with the trade make up 20% of the total trade value (2 pip spread for a 10 pip stop loss) which is where the danger in scalping lies. The fact that scalpers get in and out of trades quickly looking for small moves means they have to have a very strong edge in the markets which is going to cover transaction costs and still produce profit on top of that.  

Let’s compare that to a swing trade which might have say a 50 pip distance between our entry and stop loss on USDCAD. The spread cost associated with this trade would be just 4% of the total trade value (2 pip spread for a 50 pip stop loss). So right away you can start to see a huge difference in amount of transaction costs associated with different trading styles. The edge of a scalper’s trading strategy has to be much higher than that of a swing trader’s strategy to be profitable. Once you understand this relationship you will start to be more aware of how transaction costs can hinder scalp trading strategies.

To mitigate this issue find a broker with the lowest possible spreads if you are a scalp trader as small changes to spreads can have a big impact on your trading results over a large sample set of trades. Also make sure you're trading a strategy with a well defined edge that has proven results over a long period of time. 

Happy Trading!

The TWP Team