Scalping

The Basics of Scalping Stock Indices

What is Scalping?
 Scalping Birthplace

“Control Your Mind – Control Your Future”,

A floor broker walks into a trading pit.

He has an order to execute for a client.

He begins to announce that he has an order to

fill. The floor traders begin to shout prices to
him.
 What Do We Know Now?

1. The broker gives up edge to get business done. He pays the bid-ask. Broker/client is now long.

2. The “local” sells to the broker. The local is now short. However, he has an edge.

3. The broker is immediately out of pocket by the size of the bid-ask spread.

4. The local is at breakeven. The local has a very small amount of transaction cost.

5. Now the work of the local starts in earnest!

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The floor trader now has to get rid of his short position. He will now begin to communicate with the pit in the hope of
finding another trader or a broker, who wants to go short at $1.10. If he can find someone who wants to short at
$1.10, then our local can take the other side, i.e. be long at $1.10. Then his position is closed. He shorted at $1.11, and
he closed at $1.10. “Facilitate – offload – repeat”. As I understand it, this was known as scalping (for a cent).
 What Can We Conclude?

1. The local takes on the risk in return for a neutral position. The locals role is to facilitate liquidity.

2. At worst the market begins to move against him.

3. At best the market begins to move in his favour.

4. From a status quo perspective, he should be able to get out at breakeven – minus t-cost.

5. If a local could do this many times a day, he or she should theoretically over time – statistically
speaking – make a near risk free living. However, when you factor in the cost of
owning/renting/leasing a “seat” on the exchange, and include transaction costs, however small, the
prospect for the “local” scalper was perhaps not as rosy as you imagined. It was noisy, dirty, smelly,
even dangerous, but some made it big: Tom Baldwin, Charlie D.

6. How is that different to what we do today as “off floor – screen based” traders.

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Are the Brokers now the “Local”?
 The Brokers Business Model

The typical CFD broker has 3 distinct advantages:

1. He is always at breakeven on entry.

2. He has two way flow.

3. He controls the size of the bid – ask spread.

“Control Your Mind – Control Your Future”

 The Brokers Business Model

The typical CFD broker has 3 distinct dis-advantages:

1. If his spreads are not competitive, he will lose business.

2. Flow may be one-sided during strong trends.

3. He has his own risk parameters to adhere to.

“Control Your Mind – Control Your Future”

 The Scalpers Business Model

The typical CFD scalper has 4 distinct dis-advantages:

1. If spread is not tight, or if it is a variable spread, he is

immediately at a disadvantage.

2. He will always be behind by the amount of the bid-ask.

3. He has no sense of “flow” like a floor trader, and he has

no visible or auditory feeling of the market whereas a
floor trader can sense the mood in the market by the
noise level, and he can perhaps see brokers coming into
the pit and can second guess their bias.

4. It is often impractical to enter quickly using limit orders.

I will never be able to “buy the bid” or “short the offer”.

“Control Your Mind – Control Your Future”

 The Scalpers Business Model

The typical CFD scalper has 4 distinct advantages:

1. He will have no problem with getting a fill. Even when I

trade £100/£200/£300 a point, I rarely encounter issues
with my fills.

2. I may not have noise or brokers to guide me, but I have

charts to aide me.

3. I have a calm work environment, with clear focus, I am

guaranteed a fill, I don’t have to worry about latency.

4. I often don’t have any commissions or fees to pay.

“Control Your Mind – Control Your Future”

 Risk In Scalping

All trading involves risk – scalping is no different

• The risk to a CFD scalper is that, once he is filled, the market goes against his position to such an extent that
he is obliged to trigger his stop loss.

• If he sets his stop loss too tight, he may be forced to exit positions that are initially unprofitable, but which
would have recovered and shown a profit, had he not exited the position.

• Conversely, if he sets the stop loss too close to his entry, the risk reward ratio is very low. A single loss-
making trade could wipe out the profit from a large number of smaller, profitable trades.

“Control Your Mind – Control Your Future”

 Rewards In Scalping

“One inch is too soon – one inch is too late” . . Al Pacino in Any Given Sunday

• If you are too ambitious in your profit target, you may never get to realize the gains the position is showing.
The market could reverse, leaving you with a loss on a position that was, initially, profitable.

• The flip side is you set too tight a target, you may give up too much potential in a winning trade to
overcome the effects of the occasional, large loss.

“Control Your Mind – Control Your Future”

 Exit In Scalping

“Everyone worries about entry – and not exit” . . Dr David Paul

• The obstacles that are facing a scalper are compounded by the fact that time is rarely on their side. There is
not the luxury of waiting.

• It stands to reason that the exit is just as important as the entry, if not more so.

“Control Your Mind – Control Your Future”

 Risk & Reward In Scalping

Hit rate is a misunderstood concept amongst retail traders, at least amongst newcomers. A high hit-rate does
not equate a profitable strategy.

Scenario 1: Scalping Dow with “R10P30” = Risk 10 Profit 30

I have set a stretched profit target. My win rate will be low.

Scenario 2: Scalping Dow with “R5P50” = Risk 50 Profit 5

I have set a small profit target. My win rate will be high.

“Control Your Mind – Control Your Future”

 The Critical Question
We assume that

P = profit

R = risk

P is our profit target and R is the risk we undertake. How do we optimise our P and our R? Does it matter? What
market factors if any do we have to factor into our decision process?

After all, there is a big difference between scalping in the following 4 scenarios:

• Highly volatile trading range

• Docile summer afternoon trading range

• Highly volatile trending market

• Docile trending market

“Control Your Mind – Control Your Future”

 Volatility Using True Range

1. YELLOW is for the “Daily High Low” between 300 and 500 Dow points.

2. BLUE is for the “Daily High Low” readings above 500.

3. PINK is for the “Daily High Low” readings below 300

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 Optimization of Scalp Parameters

1. My job in simplistic terms is to risk as little as possible to make as much as possible.

2. The problem is volatility.

3. When the Dow is trading in a “very low volatility” environment, I do well by using a larger stop loss
than my profit target. I will have an exceptionally high hit rate, but I will have the occasional larger
loss. The hit rate is around 90%, and the purpose is to make a large number of small gains.

Profit target 5 points 90 * 5 = 450 made

Stop loss 20 points 10 * 20 = 200 lost

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 Volatile Markets

1. As volatility grows, my approach to scalping has to change too. This is a dynamic approach rather
than a static approach. I can’t simply declare “I use a 25 point stop loss”.

2. As volatility grows to between 300 and 500 Dow points using True Range as measure, it becomes
evident that making 20 points is akin to being given a basket full of apples, and then you only take
one. The stop loss approach can now take one of two paths:

Increase profit target as well as the stop loss = 25P / 75L

Increase profit target but decrease the stop loss = 25p / 5L

3. The win rate naturally decline, depending on selected option, and it is far from 90%. As volatility
grows, I am aiming to make occasional larger gains, but I am willing to pay the price of sustaining
repeated small losses.

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 Very Volatile Markets

1. If the markets are very volatile, when Dow readings on True Range exceeds 500 points, the whole
dynamics of scalping changes dramatically. I am essentially doing a 180 degree U-turn from how I
scalp in a low volatility environment.

2. If you trade with large stops in a raging volatile market, you are likely going to suffer an increase in
larger losses. Therefor I have gone in the opposite direction, and I have opted to trade with very
small stop losses, but I am targeting occasional large gains.

3. The win-rate can be as low as 25%. The math though is compelling.

Profit target 50 points 25 * 50 = 1,250 made

Stop loss 10 points 75 * 10 = 750 lost

4. I have deliberately been overtly negative on the win-rate to portray a bleak scenario. I think perhaps
having stated that I am right 3 times out of 10 in volatile situations was more realistic.
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What is Intra-Day Volatility?
What is the volatility on the 10-min chart
over various time segments during the
trading day?

Next I will go through 3 volatility

environments which will highlight the
extent of the volatility under each time
segment.
 Split up Hour by Hour
Above 500 True Range – UK times – 10min chart
14:30 – 15:00 120 points

15:00 – 15:30 103 points

15:30 – 16:00 96 points

16:00 – 17:00 86 points

17:00 – 18:00 73 points

18:00 – 19:00 67 points

19:00 – 20:00 80 points

20:00 – 20:30 90 points

20:30 – 21:00 94 points

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 Split up Hour by Hour
300 – 500 True Range – UK times – 10min chart
14:30 – 15:00 81 points

15:00 – 15:30 64 points

15:30 – 16:00 61 points

16:00 – 17:00 54 points

17:00 – 18:00 53 points

18:00 – 19:00 50 points

19:00 – 20:00 55 points

20:00 – 20:30 59 points

20:30 – 21:00 59 points

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 Split up Hour by Hour
Below 300 True Range – UK times – 10min chart
14:30 – 15:00 53 points

15:00 – 15:30 45 points

15:30 – 16:00 40 points

16:00 – 17:00 37 points

17:00 – 18:00 30 points

18:00 – 19:00 24 points

19:00 – 20:00 25 points

20:00 – 20:30 25 points

20:30 – 21:00 30 points

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 Conclusions – So Far

• Scalping – manually as opposed to via an algorithm – is a serious endeavour which requires an immense
amount of concentration and focus.

• The scalping method is highly sensitive to the underlying volatility.

• The setting of the optimal profit targets and the stop loss limit is a dynamic process and is dependent on
the current levels

• At low levels of volatility I use large stops, and small profit targets. The chance of being stopped out is
small, and the profit target usually gets hit. The win rate is 90%, which will compensate for the occasional
larger loss.

• At the opposite end of the volatility scale, it seems more prudent to reverse the strategy, by using large
targets but small stops. This is irrespective of whether being LONG or SHORT.

“Control Your Mind – Control Your Future”

Scalping Entry Techniques
 Trend Within Volatility

• Before I engage in the “main course” of the lecture, I would like to make an opinion known.

• Whether the volatility is high or low, we still have to figure out whether to buy or whether to sell short.

• How do we do that? We can use a trend estimator for example.

• The problem with “trend” within a highly volatile environment is that trend tends to get washed out or
drowned out on short time frames like a 1min chart.

• Fortunately not all scalping techniques are trend dependent.

“Control Your Mind – Control Your Future”

 If I gave this talk in the US…

• If I gave this talk in the US, I would have to consider topics such as slippage and fill rates.

• I would also have to factor in commissions and exchange fees.

• Outside of the US, we have CFDs at our disposal, which means that when we trade stock indices, we rarely
if ever pay commissions, and we certainly don’t pay stamp duty or exchange fees.

• We also have the advantage of being able to trade odd lot size as opposed to exchange set contract sizes.

• Finally because we trade through a financial middle man (the broker) we tend to always get the price that
we have requested.

“Control Your Mind – Control Your Future”

Buy On Close
 Buy On Close

• Buy On Close is an entry technique in its own right – scalp or position trading.

• The close is important. Is there a tail or no tail?

• Length of the bar is also a consideration. Is the market expanding or contracting?

• Example will show DAX on a 5min chart.

• I will show the chart and then break down the individual trades.

“Control Your Mind – Control Your Future”

 Buy On Close
• The vital criteria for Buy On Close is a strong close.

• The close is important. Is there a tail or no tail?

• Length of the bar is also a consideration. Is the bar expanding or

contracting compared to previous bars?

• The 3rd bar is the bar in focus. It is a bullish bar, longer in length than
previous 2-3 bars, and a decisive bullish close with nearly no “tail” at
all.

• This makes it a good candidate for a “Buy on Close” scalp. The stop
loss is a function of volatility, but here are three suggestions:

1/ Opposite side of entry bar (preferred)

2/ Halfway down bar (less risk – but high chance of stop triggered)

3/ Below day low (more risk – but less chance of stop trigger)
 Buy On Close
• Strong Momentum bar with the ultimate bullish close – zero tail.

• Length of bar suggest buying panic.

• The odds of continuation high.

• Stop loss as described on previous slide.

• Target set according to research on volatility.

• Reminder: low vol – small target and large stop – high odds of success.
 Buy On Close
• The bar itself – the third one in – is fine. It has the qualities I need.

• Context however, is a problem.

• Let us look at the big chart again:

 Buy On Close
• The bar itself – the third one in – is fine. It has the qualities I need.

• Context however, is a problem.

• Let us look at the big chart again:

• I will be buying exactly where resistance sellers will be selling short.

• My stop is either below the low of last swing, or volatility based or simply below
the low of the signal bar.
• Circle 1: happier to buy it – cleared sideways
congestion resistance. The bar itself is perfect.
Stop loss is very manageable.

• Circle 2: The bar itself is perfect, but the

context is a problem. I am bang up against the
trading range roof. A big stop and a small
target would alleviate the problem.

• Circle 3: The bar itself is fine, because it

signifies strength in the market. However, one
of the very important features of Buy On
Close is missing. It is a very small bar. Instead
of range expansion, I see range contraction.
 Buy On Close
• Circle 1 and the bar not circled immediately after are
good candidates for a Buy On Close Strategy.

• They are both significantly longer in length than the bars

immediately prior (there are 6 very tiny bars before the
first circled bar).

• The 2nd circle has a near identical setup to the first circled
bar.
Sell On Close
 Sell On Close

• Sell On Close is an entry technique in its own right – scalp or position trading.

• Like the Buy On Close, the close is important. Is there a tail or no tail?

• Length of the bar is also a consideration. Is the market expanding or contracting?

• Example will show DAX on a 5min chart.

• I will show the chart and then break down the individual trades.

“Control Your Mind – Control Your Future”

 Sell On Close
• The parabolic move higher has been met with selling. A
long bullish bar which comes after a market has already
pushed higher for 5-8 bars suggest that the buyers are
saturated.

• The red bearish bar closes at its absolute most negative

and there is no tail whatsoever to the downside.

• This suggest that there is more selling to come. As a

scalp trade, the odds are high that we will see more
down side.

• The risk is fairly easily defined. The stop loss is above

the most recent high, or potentially lower, depending
on how sure you want to be to not get stopped out.
Sell On Close – Within a Range
• These Sell On Close bars come within a trading
range retracement. The index is retracing the
morning move but over the last 16 bars, there is
a lot of “overlap” between bars.

• Context is always a consideration to be factored

in when you are scalping.

• The first circle shows a bearish Sell On Close type

of bar, but the problem is how close you are to
support.

• The second circle is much better to sell because

you have at least some distance to travel to the
low of the range.
 Sell On Close
• The first circle Sell On Close bar I considered to be a
really good setup. I was rewarded with a sweet “thank
you very much – but not this time amigo!”

• The second circle is a little different than the other bars I

have shown you. You actually a fair amount of “tail”, but
it is at the opposite end of the part of the bar that I care
about.

• I care about getting a negative close, one where there is

little or no tail at the close.

• The second circle is also a good sell. Neither scalps are

profitable, but the point is not to find pretty setups, but
to illustrate the setup.
 Sell On Close
• I regret taking the first circle with me
as an example, because I would be
sceptical to sell is as a “Sell on
Close”.

• It is an inside bar, and it is smaller

than bar prior.

• It also doesn’t close at its low. It is

not by a lot, but as a setup bar, this
is not a good example.

• That it didn’t turn into a winner is

inconsequential.

• The second circle has a lot of “tail”,

but close at the DEAD LOW.
Limit Scalps
 Who is Making Money?

This is in the context of very short-term trading. If we work under the assumption that more than 60% of all
trading executed in America is the result of algorithmic trading, and on very volatile days, they can account for
as much as 90% of trading, then it becomes a question of figuring out what THEY are doing.

Again, I stress this is not for position trading. This is for ultra-short term trading. The average holding time for a
stock in America is now 22 seconds. It is unfortunately not within the remit of a human mind to Observe,
Evaluate, Execute, Evaluate, Close - all within 22 seconds, all day long.

However, an active scalper can look to execute some 40 trades a day, or one about every 10 minutes. There are
78 5-min bars in the active Dow Jones session.

You always hear me talking about: “Are stop entry bears making money, are limit entry bears making money?
Are stop order bulls, are limit order bulls making money?” In a situation like this, where the only way to make
money is buying the market – right? – that to me is a market that is going to go higher. Probably some kind of a
measured move up.

“Control Your Mind – Control Your Future”

 Who is Making Money?

“Who is making money?” is a question geared towards understanding what is going on in an index on a very
short-term basis, in this case using a 5-min chart.

Are stop entry bears making money?

Are limit entry bears making money?

Are stop order bulls making money?

Are limit order bulls making money?”

This will probably require some explanation, I imagine.

“Control Your Mind – Control Your Future”

Dax 24.10.2019
 Explanation of Limit Order and Stop Orders

The points below are used to describe the price action of the third bar,
which is the last bar you see.

1. Limit Order buyers BOUGHT at, or below, the price of the 2nd bar low.
They are now making money.

2. Stop Order sellers SHORTED at, or below, the price of the 2nd bar low.
They are now losing money.

3. Limit Order sellers SHORTED the top of the 2nd bar or higher. They are
now losing money.

4. Stop Order buyers BOUGHT the top of the 2nd bar or higher. They are
now making money.
 The Fluid Balance of Buyer and Sellers

“It's not that I'm so smart, it's just that I stay with problems longer” Albert Einstein
 Entry Where Support or Resistance is Made

I will call the extreme left green bar Bar 1, and then the following bars Bar 2,
Bar 3 and Bar 4.

➢ Bar 1 is positive. It closes halfway down the length of bar.

➢ Bar 2 is negative. It pushes below the low of bar 1. It also closes below
the low of bar 1. It is not a full blown negative bar. Limit buyers are
losing, and stop sellers are winning.

➢ Bar 3 is meeting buyers below low of bar 2.

➢ Bar 4 pushes above the high of bar 3, but it loses momentum as “limit
sellers” overcome buyer strength.

➢ Bar 4 is the signal bar for my scalping approach using this method.
There is an “aggressive” approach and a “Closed Bar” approach. I am
showing you the Closed Bar approach.
 Explaining the Shift in Forces

What makes me bearish at the completion of Bar 4?

➢ Buyers pushed the market above the high of Bar 3.

➢ Sellers pushed the buyers back. There must have been more Limit
Sellers above the high of Bar 3 than there was Stop Order buyers.

➢ Bar 4 closes at its lows.

➢ Bar 4 closes well into the range of Bar 3. This and the above trigger a
“sell short” alarm and a stop above the high of the bar.

➢ The “aggressive” approach will be discussed at another lecture. Safety

first, and then sophistication later.
.
Example From Right Here and Now
 Thank you

[email protected]

Tom Hougaard
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