Scalping is for Tooth Fairies

by Bill Brower on January 6, 2017 | Categories: Uncategorized |

Scalping is for Tooth Fairies

There are literally thousands of ways to trade for a living. Very few traders bother exploring even a small percentage of those possibilities. With few exceptions I know of no other software than Tradestation for developing and testing your ideas. If you manage to become proficient at the programming language behind Tradestation you can explore and test ideas for the rest of your life. It seems a no-brainer to become at least somewhat adept at the programming language.

One concept which by far has attracted the greatest interest is scalping. I define scalping as targeting anywhere between 1 and 5 ticks of profit on a trade. It is probable that in most cases that range could be expanded from 1 to 10 ticks. The allure of repeatedly capturing a small profit goes hand-in-hand with the risk of capturing small losses. The difficulty is to find an edge that allows the profits to outweigh the losses. This is made more difficult by the burden of overcoming slippage and commission on each trade. Longer-term strategies anticipate much larger trades and the slippage and commission burden is more easily absorbed. The hurdle for scalping strategies is often underestimated because there is a myth that limit orders avoid slippage. The real definition of slippage includes all losses that a trader may incur including failure to get filled on entries and on profit target exits, power outages, loss of Internet connection, failure on the part of Tradestation to properly fill your trades, Tradestation rejected orders, and canceled or rejected orders by the exchanges. If your back testing assumes no slippage, then you have no buffer in your historic back test for the risk. It is sadly not uncommon to find traders back testing scalping strategies without properly accounting for slippage. You would have to have an unbelievably successful strategy to capture profits in any scalping strategy in light of the true slippage.

Unfortunately it gets even worse for scalpers. Although Tradestation data appears to be live and in real-time, time is all relative. All you need to do is go on YouTube and search for “nanex high frequency trading model” to see what the professionals are up to. For them, 1/3 of a 1000th of a second is an eternity. They are placing bids and orders with such speed that it is difficult to imagine. In Tradestation the lowest timeframe of trading is using one second bars. For the professionals, this is simply laughable because it is so slow. But it gets much worse. By the time Tradestation has received the data from the exchanges and displayed it on your screen, anywhere between 2 and 5 seconds has elapsed since the tick was time stamped by the exchange. By the time your strategy fires a trade and it is placed on the exchange servers by the Trademanager even more time has elapsed. No doubt this is often a cause for the exchange canceling some orders. However, it gives professional traders a golden opportunity to get in front of your out of date order and fill it if they know it’s going to be a loser or avoid it if they think it will go your way. There is no way to compete with them at this level.

The solution is to pick longer time frames for your trading opportunities. You should be thinking of hours or even days for the duration of your trade. In this case at least you have a chance and the hurdle for slippage and commission will be more easily overcome by your average trade size. Leave scalping to the Tooth Fairy.