Scalping penny stocks, or scraping, is when a trader is using the imperfections in the pricing system to make small amounts of money on multiple trades. Essentially you are attempting to fill in as a market maker.
There is a spread on all stocks which is the difference between what people are selling stocks for and what people are buying stocks for. When stocks are thinly traded and low in value this spread can be quite large as a percentage of the value of the stock. As a scalper you are attempting to buy towards what people are asking to buy for and sell towards what people are asking to sell for. Often this requires a little patience or a good understanding of the direction of the stock by the orders that are being executed at the moment. Here are some key areas of understanding for penny stock scalping.
Fundamental Analysis
Fundamental analysis or the study of the mechanics of the business generally carries little water within the ultra small time frame in which you intend on holding the stock. However, some momentum investors use it as a first stock screen. They will use fundamental analysis to separate stocks into three categories, those that are grossly overpriced, those that are grossly underpriced, and those that are in between. Then they will continue on with their analysis only on the stocks that they feel are in the category they are looking to trade.
Technical Analysis
In technical analysis the investor studies the change of price over time to draw conclusions about future buying and selling patterns of the stock. In regular swing, momentum, or day trading traders will use these indications to make their trade. There is not enough time or information for this in stock scalping.
As with fundamental analysis technical analysis is used as a precursor stock screen to narrow the choices of stocks you are willing to invest in today. Especially important in technical analysis for stock scalping is looking at price channels. Price channels or price bands are upper and lower limits a stock tends to be trading in. If the stock breaks out of these bands they are likely to take off in a direction. This is bad for the scalper because he is working within the normal price bands and a big move in the wrong direction can wipe out all of his day’s work.
Execution
The hardest part for the scalper is they are working within time frames too small for conventional automation. Standard stop losses will do them no good here because they won’t execute over such a small time frame. Often the scalper only holds a penny stock for minutes and makes tens or hundreds of trades a day. The scalper can’t only have a plan, but must have his plan internalized to consistently make decisions in line with his plan. You don’t have time to run math on percentages in your spread sheet; you need to do them quickly and accurately in your head before the window of opportunity is gone.
Why Scalp?
Clearly penny stock scalping is not the easiest of the trading methods. It requires a high level of attention with demanding decision making skills. Why would someone scalp? Traders scalp mainly because the risk level is low if it is done correctly because your capital is tied up for a small period of time. Also, if your plan is accurate you get hundreds of trades a week to allow the law of averages make you a winner. Like the 1% house advantage in a casino, lots of bets consistently make the house a winner.