Source: Beyond Backtesting
I hear a lot of traders who want to try scalping the ES for a couple ticks. The new traders today have heard of this style but do not understand its origins, when it can work, why it is limiting, when it works best, and why it may not be the best way to trade today.
First, scalping with a tight stop is known to be notoriously difficult form of trading. Many traders who achieve profitability with swing, swing day, and active day trading have tried and failed at micro-scalping.
The dream of scalping the ES is probably rooted in two origins or original causes. The first is that during the early futures and electronic markets there was not as much automation as today. It meant that there was large size resting on both sides of the market.
Because institutions kept a deep book, it meant that in theory, you might be able to take a shot at a trade without taking any heat. If it didn’t work immediately in your favor then you could scratch it for break even. Today, while you can cut a trade or take it off at break even, the book is thin and you would surely take heat.
While I never traded during that era, there was probably a brief time where manual scalpers could do really well. So, those early stories were probably part of the origination of the idea. It also goes back to the floor traders.
Today, there are many difficulties. First, exchange-based HFT bots can pull their orders based on the changing book conditions before a manual trader can move their limit orders. Market orders are disadvantaged for similar reasons. There are advanced techniques that one can learn to try to adapt: however, without automation the click trader is significantly disadvantaged. While not the only reason, one of the reasons I built BeyondBot was due to these limitations.
Back to the story, the other major original cause of scalping style strategies was as a way to minimize risk. A two point trade in the ES is worth $100. Most systematic strategies that run on the ES will require much larger stops.
Many systematic strategies will look to use a minimum 10 point or larger stop ($500+). On a small account, that could mean risking 10% or more per trade. It is a recipe for large swings and traders to quit, even if they make money.
All that said, what is wrong with trying to scalp today? The first is one must be acutely aware of how volatility influences scalping.
In general, discretionary style scalping only works when the VIX is elevated. While a higher VIX is useful, extreme VIX spikes can make scalping simply too risky. While scalping during very volatile markets can lead to one to feel like it is possible to print money with no risk: if one makes a mistake or doesn’t cut a bad trade then large losses can quickly ensue. As such, scalping requires a much higher degree of discipline then other styles. There are generally only around 2 to 4 months where scalping the ES can be very profitable out of the whole year!
But, all of this is leaving out something important. The primary reason that most traders try to scalp the ES is because they were forced to scalp to manage the percentage risk. This simple fact is one of the primary reasons that futures trade fail at such a high rate!
Today, we have the MES with 1/10th size the ES. It means that there is no longer a reason to force a smaller stop loss then required.
All that said, are there any good reasons to scalp? Yes, there are a couple. Scalping can help a trader get a feel for the market better then most other trading techniques. Scalping is a very pure form of trading, in that sense. It may lead to greater consistency for the very best scalpers.
For myself, I will keep the following in mind if I want to scalp:
- Do not attempt scalping the ES with less then about 25k instead scalp the MES esp until you have proven profitable. One reason for this is that I personally found any form of day trading ES suffers with less then around $600-$700 daily loss limit. If your limiting risk to around 3% then that yields around a 25k account requirement.
- Do not expect to be able to use the same scalping strategies as market conditions change. You will need several types of strategies and you may need to trade at least a few markets.
- Do not expect to be able to scalp every day or even the majority of days. This is another reason to have systematic strategies and to be able to pick out a few good trades per day– so you can find profitable trades more often.
- Do invest in some forms of automation and more advanced analysis to develop edge.BeyondBot may help with partially automating market order scalps.
- Do develop some non-scalping strategies for when the opportunity is not present.
- Do setup some outside risk controls like daily loss limit with your broker.
- Do practice on market replay.
- You should certainly start with MES or another e-micro but also look at other markets. You might find better ways to manage market speed or R with more markets to choose from.
- Do not think scalping must translate to high frequency. It certainly can lead to more frequent trading especially when volatility is elevated. However, if you can rank your trades better then you should be able to reduce your frequency even if scalping. Discretionary scalping is intense and needs a “stop” to prevent giving back profits.
- Shop around for good brokerage commission with the proper support you will need. Commission is not the only factor when selecting a broker because some general purpose discount brokers may not be suitable venues for scalping. I think the futures focused brokers are more suitable for scalping, i.e. NinjaTrader brokerage, AMP Clearing, and Tradovate.
None of the above should be construed as investment advise but represent the author’s personal feelings on the matter.