There is a good amount of debate among active day-traders regarding the pros and cons of scalping vs. swing trading. Even when considering a single session of trading, there are significant differences in approach and style between a scalper and a swing trader.
In the case of the S&P 500 E-mini contract (ES), some day-trading proponents encourage a single-session goal of as little as two points profit, with profitability targets achieved by increasing the total number of contracts used per trade. Here, the sentiment is that the day-trading endeavor is so difficult that taking a certain two points is the more feasible route to profitability.
"Scalping shorts" (below) shows a typical scalping regime: When the 20-period exponential moving average indicates a trend change off session highs, local retracement short entries are made. A scalping mentality may follow the trend, but seeks to book profits quickly with every trade.
"Scalping shorts" is a 764-tick chart; the price bars are completed after 764 unique trades. Tick charts generate price bars based on market activity; more trades mean more bars. Some traders, especially scalpers, find the time distortion and increased activity unacceptable, but tick charts can allow the user to "see inside" fixed time bars, and often technical indicators are more responsive with tick-based bars.
The swing trading camp argues for more patience and will claim the ability to realize sizable intraday price moves. In the case of the ES contract, 10-point home run trades often are claimed as practical. "Swing higher" (below) shows a market-profile-based swing trade in the Russell 2000 mini contract (TF). When the market opens gap up (Jan. 3, 2011), a retracement to the previous session’s Value Area High (VAH) is a significant price action event that can be used by the swing trader. Scale-out profit-target exits may be used on fractional portions of the original position.
Trading is about finding a niche that works. Traders with moderate day-trading experience, or more experienced traders having recent difficulty with profitability, probably have the debate on their minds. In addition, the unpredictability of the market forces traders to make a decision regarding scalping or swinging a position at any point in time. Perhaps a successful trader becomes accomplished at both, much the way a golfer perfects both the long and short game.
We’ll look at both strategies and provide some data that will help refine our plan. While the discussion applies to day-trading any asset, the focus is the electronically traded mini stock index futures contracts traded during the U.S. day session.
An analysis of the two strategies begins with a model that quantifies the alternatives. To keep it as simple as possible, we begin with a single-position trade; no scale-in/out techniques are used. The goal is to make a relative comparison of the expected value of basic scalp and swing trades.
To do this, a directed trade graph is introduced (see "Trade directed," right). In the graph, x is the trader’s winning percentage; 1-x the losing percentage; PT is the trader’s profit-target in ticks; SL is the trader’s stop-loss in ticks. The graph’s equations and outcomes easily can be coded in a spreadsheet to evaluate trade strategy expected value.
A scalp trade with a 70% winning percentage on one contract with a one-point (four ticks) ES profit-target and stop-loss is used because we expect the scalper to have a high winning percentage with fast profit-taking and tight stop-loss. This gives a per-trade expected value of 1.60 ticks. We quickly notice that, under these assumptions, a high winning percentage is required (subtract approximately 0.25 ticks to cover commissions). Traders can increase the expected value by increasing the profit-target and stop-loss values equally, or by multiplying the value by the total number of contracts traded.
The baseline scalp is compared against a variety of swing trades where the swing trade winning percentage is fixed to match the profitability of the scalp (see "Technique comparison," right). The scalper matches the profitability of the swing trader at various swing trade winning percentages and profit-target and stop-loss levels. For example, the baseline scalp is as profitable as a swing trade that garners 10 points of profit (40 ticks), using a two-point initial stop-loss (eight ticks) and a 20% winning percentage.
As with any model, the "garbage-in/garbage-out" rule applies. The goal is a simple model that is useful. We find that with just a modest improvement in trade-winning percentage, the five- and 10-point swing trades become significantly more profitable than the scalp. This is highlighted in the bottom two rows of "Technique comparison."
Regarding profit-target and stop-loss values, the scalping baseline (first row) uses tight and balanced profit-target and stop-loss values, as we might expect when scalping. The swing trade cases use a modestly larger stop-loss based on the goal of staying in a trade longer. Winning percentages were chosen across the swing trade examples to create a normalized comparison with the scalping baseline. A winning percentage roughly will follow the ratio of stop-loss to profit-target; a small stop-loss to profit-target ratio will give low winning percentages. Large stop-loss to profit-target ratios can give high winning percentages. When working with the expected value models, reasonable stop-loss and profit-target values are chosen and then winning percentages are derived.
The first conclusion drawn is that scalping is only preferred when swing trade winning percentages are low. If the winning percentages can be increased to a moderate level, then swing trading becomes more profitable. We might expect that successful swing traders claim their percentages are at, or above, the 33% and 45% levels, thus making their trading more profitable than scalping.
Given the meager results from our comparison, we might wonder why scalping is practiced at all. If not executed from automated algorithmic trading, or by professionals who have found a unique and specialized regime, scalping profitability appears too meager to justify the time, energy and commissions it requires.
Regular experience day-trading the ES indicates scalping occurs for three reasons:
- The market’s immediate trading range forces a scalping mentality. If the market is congested, there might not be anything more than scalping profits to be had. Many traders try to avoid these periods.
- A trade placed with the expectation of becoming a reasonable winner does not turn profitable quickly enough. The trader loses patience and exits the trade as a scratch or with scalping profits. Seasoned traders consider this a sign of mature day-trading, even setting a timer to exit a position if it does not move quickly in their direction. Positions may be exited due to a technical price level that forces the trader’s hand, as well.
- The trader is mentally beaten down and trading nervously. After witnessing too many failed trades and amid a drawdown, a reflex reaction to take any profit, no matter how small, develops.
The first two cases can be defended as good trading practice, while the third is poor trading that can be difficult to overcome. Because of this last point, the trader may look for some middle-ground between scalping and swing trading and develop a hybrid scalp-swing trading approach.
We can combine the strategies in a two-tiered scale-out trade strategy, where one set of contracts is scalped and a second set is left open for a possible winning runner. This type of scale-out trade management is often advocated. Its expected value can be calculated using a directed graph.
"Hybrid solution: Two strategies" (below) shows a directed graph (top right)that models the two-tiered scale-out trade strategy along with results. While slightly more complicated than the basic model, this graph’s equations and outcomes also can be coded in a spreadsheet. In the model used here, if the trade moves to the first profit-target, which is the scalping portion of the position, then final stop-loss is moved to the entry price.
Using the same 70% winning percentage on the first half of the position and a 40% winning percentage on the second half, the strategy is almost twice as profitable as the basic scalp. Note that the final profit-target will be reached just 0.70 * 0.40 = 0.28, or 28% of the time.
We can take the two-tiered model and extend it to three or more tiers. In this way, the trader gets an understanding of the relative profitability of various scale-out strategies.
A two-tiered, scalp-then-swing strategy almost doubles expected trade value over the baseline scalp. For some, the two-tiered strategy has psychological benefits: The scalping portion gives an early successful trade then establishes a "no-lose" position for a possible winning runner.
Compression and price action
Some price action scenarios can suggest a move from a scalping to a swing-trading mentality. One of the best known is a breakout from a period of price compression. Some technicians draw a correlation between the duration and narrowness of a consolidation and the strength of a subsequent breakout. If the trader has entered the market in the direction of a breakout following a well-defined compression, then a swing trade becomes the goal.
Breakouts that occur off key price levels, for example the first-hour high or low or the previous day’s high or low, may help convince the trader that a sizable move is afoot and every attempt should be made to keep a position open.
Likewise, if a trade entry is believed to be near the day’s high or low, then consider leaving the trade on. Some traders practice intraday swing trades and scalps simultaneously, even on the same contract using multiple accounts. Generally, a swing position that uses perceived intraday highs or lows can be left open with a relatively small number of contracts, perhaps using wider trailing stops.
The trader who understands the pros, cons and relative profitability of scalping vs. swing trading is better equipped to sustain success in today’s markets. Ultimately, the active trader may need to employ both approaches to be successful, taking advantage of the risk controls and rewards that both strategies provide.
For 20 years Michael Gutmann was a software engineer and manager at Intel Corp. He trades his system daily and recently has published the second edition of a popular trading text: "The Very Latest E-Mini Trading: Using Market Anticipation to Trade Electronic Futures" (2nd Edition). He can be reached via www.anticipationtrading.com.