Why I’m a fan of scalping

I’d like to talk a bit about ‘scalping’ today.

Especially since the meaning of the word has shifted somewhat in recent years.

“Scalping” can sound a bit intimidating, like you need to be some kind of psychopathic mercenary to do it.

And it’s not for everyone, no single way of trading is.

But let me try and set the record straight. I’d like to clear-up what scalping is and what it isn’t. And between us we might even uncover a more fitting label for this great style of trading.

So let’s make a start by looking at where scalping came from…

Scalping: the classic definition

So back in the days before computerised trading, each market had a central physical location. There were a number of different trading exchanges spread all around the globe.

And if you wanted to buy, say, a futures contract in Gold (futures were the main vehicle of speculation open to retail traders at that time) you’d phone your broker and he’d direct the order through to his representative at the edge of the trading pit relevant to that contract.

It might be New York, Chicago or London depending on the spec of the contract you wanted to buy.

And each pit had a ring of ‘pit-brokers’ around the edge. They’d take orders over the phone from head office and then they’d ‘arb’ the order into the pit.

(‘Arbing’ is the name given to the coded hand signals you’ve probably seen the old-time traders using. It lets them ‘semaphore’ their orders through to the pit very quickly. Speed of communication was critical in a fast moving market!)

So at this stage we have you sat in your office with a wish to buy a Gold contract. There’s your broker sat in his office with your order on the desk in front of him. And there’s the pit-broker at the exchange with the instruction from your broker scribbled on an order ticket.

What happens next? How do you actually get the contract bought?

Well first of all, the pit broker springs to his feet and starts gesticulating with his hands. He might hold one finger to his chin (palm towards him) and give a tug on the label of his jacket to flash a ‘buy one May contract’ order to the pit. He might add some extra flourishes if you only wanted to buy at a specific price.

But to get the order filled someone needs to sell the contract to you. For each trade there must be a buyer and a seller.

It’s not something we really give much thought to these days; we press a button on the keyboard and get almost instant execution of our trades anytime we want to buy or sell. The computerised exchange instantly matches your buy order with a willing seller.

But in the old days it was the guys in the ring – the pit traders – who took the other side of your trade.

It was their job to provide liquidity to the market.

There were pit traders working exclusively for one particular broker or institution. They were only concerned with fulfilling the instructions of their firm and would

And then there were the ‘locals’. These were the gunslingers: the guys trading their own account in a purely speculative way. And it was them that were probably most responsible for propagating the ‘scalp’.

Scalp = a trade that captures one ‘tick’ of the minimum unit of price in a given market

Now there’s no way you could have been competitive as a home based scalper under pit-trade conditions. The time it would take to route the orders by telephone would have put you out of business within hours, if not minutes!

So this was solely the preserve of the insider. And it was more of an exercise in risk management than a gung-ho aggressive grab at quick ‘n’ easy profits.

Now put yourself in a pit trader’s shoes and see why you might need to scalp

So let’s scoop you up from your office and magically transfer you to the exchange. We’ll slip you into a garishly coloured jacket and drop you into the pit. You’re now a buccaneering pit trader: a ‘local’.

You’re trading your own account which means selling at a higher price than you bought (or buying at a lower price than you sold) in order to make money.

Sounds simple right? Especially since you’re now standing at the centre of the universe as far as the gold market goes.

But there are another couple of hundred guys in the same boat standing all around you in the pit.

And they are all willing to rip your right arm out of its socket if it means jumping into a trade at a better price than you.

So how do you compete?

Well, if you only want to trade one contract your horizons are seriously limited. To catch the eye of the pit-brokers – remember them, the ones arbing the external orders into the pit – you need to be willing to take orders at size. It’s not often a sell order for a single contract comes through and the brokers will be looking out for the pit guys they know are ready and willing to trade come-what-may, even when they have 10, 20, or 50 contracts on their books to sell. It’s human nature: they just want to get their business done as quickly and easily as possible.

So here’s how you might get yourself noticed and involved…

You only want one contract for your own account – you think the market’s got a way to go to the upside yet – but you step in and take all TEN contracts off the pit broker who’s trying to sell.

This gets you into the trade at the price you wanted and you’ll now be on that broker’s radar for future deals too.

Next, you turn around to the pit and shift the 9 surplus contracts. You want to get rid of them as quickly as possible at breakeven, or ideally with a tick of profit: a scalp.

The small profit hedges you against the occasions where you are forced to sell for a 1-tick loss instead. And if you’re good at it, there’ll still be some profits left on your ‘scalping account’ even after that.

Of course, you’re still holding the one contract you actually WANTED in the first place, the extra scalping work just helped you get your hands on it, and maybe made additional profits on the side too!

So in essence a TRUE scalp is a trade that captures one unit of the minimum market movement.

What traders usually mean when they talk about scalping today’s markets:

The ‘scalping’ label has been skewed to mean something slightly different today.

A new generation of traders have come to understand a trade that targets a small profit, or one that lasts a short period of time, as a scalp.

It might target 8 or 10 pips instead of the single ‘tick’ so it’s a very different proposition to a scalp trade in the classic sense.

But times change and the meaning of the word has shifted too. There’s no point in protesting. The old timers just have to accept that common perception of the majority rules: If 9 out of 10 traders now call a 10 pip trade a “scalp” then that’s what a scalp has become.

I can’t help but feel the name alone scares a lot of people away though. I’ve been trying to think of a more fitting moniker: “Bite size trading”, or maybe “Hit-and-run trading”…

Have you any ideas? What other name would you best identify with a 10 or 12 pip trade?

Drop me a line and let me know: rich@tradersnest.com

Until next time…

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