Trading can be a very risky venture, especially if you are just getting started. Traders are always looking for ways to lower their risk in the market. One way traders manage risk is simply by choosing the right trading system or method for their personal level of risk tolerance.
A trader might use a day trading strategy, some scalp trading methods, swing trading techniques, or investment strategies. Each of these trading methods carry a different level of risk and required skill.
For instance, day trading systems can carry less risk than swing trading or investing strategies. The reason being that day traders rarely carry an active trade overnight. Day traders limit risk by limiting the time in which their investment capital is exposed to the market.
That being said, is day trading less risky than swing trading or investing? Not necessarily. Trading on shorter time frames always adds noise to your technical analysis; the shorter the time frame, the more likely the market will show changes in price due to small investors getting in or out of positions.
Therefore, the shorter time frames inherently have more noise than the longer time frames (4 hour, daily, weekly, etc…), and it takes a more experienced trader to be consistently profitable in those conditions.
In other words, each trading methodology has its own strengths and weaknesses. None are really superior to any other, and some methodologies are better for beginners than others. This concept is important in understanding the strengths and weaknesses of scalping techniques.
Are Scalp Trading Methods Less Risky?
Is scalping really any safer than day trading or any other trading method? The whole appeal of scalping methods is that traders can limit their time in the market (risk) as much as possible with such techniques, however, these techniques generally require a more experienced trader in order to become profitable.
When scalping, traders are generally not concerned about which direction the market is heading, because they are only concerned with taking very small profits many times. A scalper might use the crossover of two moving averages as an entry and get into a position, only to close the position after gaining a few pips.
In fact, scalpers often exit positions after gaining as little as 1 pip. To be profitable with a scalp trading method, a trader must take many trades, “scalping” a few pips at a time. This increased trading frequency comes with its own problems.
Overcoming Your Broker’s Spread
Scalpers have to overcome the spread over and over again, whereas day traders might only have to overcome the spread a few times each day. Therefore, the spread becomes a major expense to a scalper.
Example: Let’s say you only take 10 scalping trades per day on average, and your average spread is 2.5 pips. In one trading year (if you traded every day), you would have to overcome 6,500 pips just to cover your broker’s spread.
In that same scenario, a day trader that takes 3 trades per day on average would only have to earn 1,950 pips to cover the broker’s spread during that same time period. As you can clearly see, there is a huge difference in spread cost (or business expense) between these two trading methods.
In the above example, our scalper only took an average of 10 trades per day. The reality is that most scalpers take more than 10 trades per day; many take hundreds of trades each day.
Risk to Reward Ratio
When using scalp trading methods, a trader is not concerned with the typical risk to reward scenarios. For instance, scalpers don’t shoot for 1:2 risk/reward targets. As mentioned earlier, scalpers close trades with as little as 1 pip profit.
What this generally amounts to is losses that are bigger than average wins. The key to scalp trading methods is to win often, and this point alone is why inexperience traders often fail to make scalping profitable.
Conclusion: Scalping can provide the best, lowest-risk trading scenarios for an experience trader, however, amature traders will find it difficult to remain profitable using scalp trading methods. Also, choosing a broker with low average spreads will greatly benefit a scalper, which is why ECN’s are so popular with experience scalpers.