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What Is Scalping?

Although the term scalping most likely originated in the heritage of the wild, wild American West, the contemporary trend for outrage at the mere mention of ethnic issues prompts me to side-step the derivation of this term. Simply stated, the scalper attempts to trade futures markets for only several ticks, taking advantage of fairly narrow trading ranges in order to "buy the bid and sell the offer." The scalper, who is usually a floor trader, attempts to capitalize on relatively quiet times in the markets, buying at the prevailing price (the bid price) or hopefully at one or two ticks below the anticipated fair price and selling at a slightly higher price or what is called the offer price. The best way I can drive home the point of what it is that scalpers do is to state succinctly that scalpers attempt to buy at wholesale and sell at retail.

As you can understand, the price markup from wholesale to retail, although very high in some businesses, is not too high in the scalping business. Frequently, the markup amounts to only one or two price ticks. However, at $30 or more per price tick in Treasury bond futures, the prospects for profitable scalping are considerable. If the trader is paying very small commissions ($14 or lower per trade), then a good portion of each price tick per contract is profit. What the scalper may give up in the way of price movement, he or she can compensate for in terms of position size. From the scalper's point of view, a trade of two ticks' profit on 500 contracts works out to 1000 ticksтАФ1000 ticks after approximately $15 in costs (which is a very high cost for the floor tradВэer) works out to roughly $16,000 profit. Assuming a commission rate of $8 and often much, much lower for the floor trader, the profits are even more substantial.

It is now possible for traders who are not on the floor of the various exchanges to trade in a fashion very similar to what floor traders do when they scalp the markets. Using some of the techniques discussed in this book, the average trader who is willing to sit at the computer screen and watch the market tick-by-tick all day long can scalp in a fashion similar to floor traders. During the last few years, many floor traders, realizing that scalping is possible without being on the floor of the exchange, have left to become upstairs traders. An upstairs trader trades as if he or she were on the floor but is, in actuality, trading from an office, usually located in the exchange building.

Rules for Scalping

In order to scalp the markets effectively, you must apply certain rules which do not necessarily apply to other forms of day trading. You will need to know and observe these rules carefully and consistently if you plan to become a successful scalper:

1. To compensate for the relatively small size of moves which you will attempt to be capturing as a scalper, you will need to trade considerably larger positions.

2. If you are not willing to accept the risk of trading larger positions, then you cannot scalp the markets in a fashion which makes trading worth your while. After all, if you plan to scalp bonds for one or two ticks at a time three or four times a day, and if you are unsuccessful in your efforts one or two times a day, then the bottom line of your trading on a one-contract basis may only be one tick. Subtracting from this commisВэsion costs, your scalping will prove to be a losing proposition or a miniВэmally profitable venture, above and beyond what you have lost in terms of time. Therefore, it is necessary for you to make a commitment to largВэer positions, perhaps 5 or 10 contracts at a time, and to increase your position size once you have mastered the various scalping techniques I will suggest in this chapter.

3. To be a successful scalper, you will need to take your losses as well as your profits very quickly. If, for example, you are long T-bonds at $105.20 expecting a move to $105.22, then you must enter orders to sell at $105.22, since you have set yourself a two-tick target. To expect $105.23 or $105.24 would not be consistent with your scalping goals. The idea is to take numerous small profits of several ticks on large positions throughout the day. Only by following this goal will you achieve sucВэcess as a scalper.

4. You must pay close attention to the market you are trading at all times. This means that you will be able to trade only one market at a time, since you will need to be at the screen watching every tick. If you have a multiple screen monitor, it may be possible to scalp more than one market at a time; however, I think that pragmatically this would be diffiВэcult. In addition to these rules, which are more operational rather than methodological, important techniques are explained in the next section.