The investing term scalping refers to individuals that hold a large number of securities for a very short period of time with the hope of profiting from small movements in the price of the security. Scalpers will conduct these trades in common stocks, bonds, derivatives, commodities as well as foreign currency.
The term scalping can refer to three different trading techniques, two of which are legitimate, while the third is considered fraud. The two legitimate techniques rely on speed, while one relies on deception and is considered illegal. All three techniques allow the trader to profit from relatively small changes in the security's price.
- Bid-Ask Arbitrage: this first technique takes advantage of a security's bid-ask spread. The scalper purchases a large number of securities, and then quickly sells them back into the market. Trading in large volumes of securities can result in substantial profits, even with relatively small margins.
- Momentum Trading: this second technique takes advantage of a sudden increase or decrease in the price of a security. The scalper monitors the price of securities, looking for a "breakout" that might signal short-term volatility in the marketplace. Once identified, the scalper takes a large position in the security, and then closes out their position before subsequent market corrections occur.
- Pump and Dump: this third technique involves a form of market manipulation. The scalper, oftentimes an investment advisor, purchases a security and recommends it to their clients. The increase in demand for the security results in an increase in price, allowing the scalper to profit by closing out their position in the security.
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