Scalp Trading is a term that is thrown around a lot when you hear day traders talk but really scalp trading is a particular style of trading. It is a style that involves a high frequency of order tickets with a profit target of only a few cents. The profit comes from the size of the orders. An average scalp trader at most Proprietary Trading Firms uses between 5,000 and 15,000 shares per position with the bigger traders going up to 200,000 shares per position. This style of trading is not normally done by retail traders on retail accounts for two major reasons, good cost structure and special order routes.
The commission structure that the average retail broker offers is too expensive for this style to be viable. Most retail brokers will offer $6 to $7 per 1000 share trade with the best deals around $5. A scalp trader needs to be able to earn money from just a one cent move. So even with the best retail deal of $5, a one cent move would earn you $10 but would cost you $10 ($5 to buy and $5 to sell) in commissions which would leave you $0 net profit. At a Proprietary Trading Firm, traders can get a commission structure anywhere from 30 cents of $1 per 1000 shares. Now if you do the sum: a one cent move with 1000 shares grosses $10 but will only cost you 60 cents $2 which of course provides a more attractive net profit margin.
This brings me to ECN's and who you should be routing your orders though. If you add liquidity to the order book also known as the level 2 then usually the ECN you routed to will give you a rebate. However, if you take liquidity from level 2, the ECN will charge you. You may be thinking what does it mean to take or add liquidity? Well as an analogy; imagine you want to buy a car. You open a car trader magazine. In the front section of the magazine are adverts from people who want to buy cars. They are listing the mileage and value they are prepared to pay. Now in the back section of the magazine are people advertising cars for sale. Well you may be asking why don't the people in the front part of the magazine call the people in the back section of the magazine? This is because there is a difference in price between what the buyers want to buy at and the sellers want to sell at. Now these people who have put these adverts in this car magazine are all adding liquidity. The people who read the magazine and eventually either sell their car to one of the buyers or buy a car from one of the sellers are taking liquidity. This is how the stock market works and the left side of the level 2 screen is like the front section of the car magazine and is referred to as the "BID". The right side of the level 2 screen is like the back section of the car magazine and is referred to as the "ASK" or "OFFER."
I mentioned earlier the ECN routing. So what is an ECN? ECN stands for Electronic Communication Network. When you look at a level 2 screen you will see different ECN's, Exchanges and Market Makers at each price level and it is your choice which one you send your orders to. Your choice will be based on how quick the route will fill your order and how much it will cost you or how much your rebate will be depending on whether you are adding or taking liquidity.
Special routes: Some routes will fill you very quickly but will still charge you even though you are adding liquidity. It is these routes that retail traders trading with retail accounts don't have access to. Traders at Prop Trading Firms will have access to these routes giving them an edge over the competition. These special routes are not essential to become successful in scalp trading but they do make the job far easier.
Now that you know what scalp trading is, you will need to know the necessary tools. The most important tool is your platform. You will need a Level 2 Direct Access Trading Platform which there are many to choose from.
You will also need a news service such as Briefing or Trade-The-News. When scalping you should be watching a handful of stocks. They should be low priced and have good volume on the Bid and Ask.
For each one of the stocks you watch you should have a level 2 screen and time and sales. Also, you should have a daily chart for each one of the stocks you watch. Believe it or not, the daily chart is the most important chart for intraday traders, which also includes us scalp traders. Lastly, you should have a 5- and 15-minute chart of the overall market. To view the market, the Standard and Poor is best. You can watch this by watching the ES futures or the SPY. There are other things you will want to add to this set-up which I will cover in my next article, but the above are the most essential.