Stock Scalping Lessons from the Old Days (prior to 2001-)
Can a strategy that doesn’t exist anymore help us improve our trading today?
I say yes.
Core principles of stock trading are the DNA of success. The only thing that changes is your objective.
Stock scalping is often confused with momentum trading today. Pure stock scalping was level 2 trading. It later evolved into momentum trading.
This was probably one of the best stock scalping books from back then. My copy is well-worn.
Don’t let anyone fool you, this strategy doesn’t exist anymore in stocks. But that doesn’t mean we can’t learn from it.
Prior to stock quotes changing from fractions to decimals, stock scalping meant trading “teenies” between the bid/ask quotes. In the above picture, you would buy on the bid and sell on the ask.
The price did not need to change to make money.
A common trading plan was 1,000 share lots. You knew making a teenie meant a $62.50 profit. Making a teenie was buying at $54 1/16 and selling at $54 1/8. Trading started to get crazy when you placed trades in between the fractions many traders would go down to $54 1/256!
This meant you would get filled before the trader at $54. (Your bid was in front, technically the higher bid) The tough part about this is all brokers did not allow you to place this trade. Definitely put you at a disadvantage.
Stock Scalping Fractions
This strategy worked well if you had the right commission structure. Trading costs actually affected trading decisions. Most traders today couldn’t fathom this but it was up to $50 per trade. If you made a 1/16 profit on 1,000 shares you earned $62.50. Which means you only earned a net profit of $12.50 so you had to try to hold out for an extra 1/16 to make the trade worth it. (Making your gross profit $125)
Taking the stock scalping strategy deeper and relevant for you today…
There are different costs for HOW you executed your trades. You can buy on the bid or buy at the offer (ask). If you buy on the bid, you advertised and someone sold it to you. They paid your price. If you placed your order on an ECN, you GET PAID for the execution. You increased liquidity on that routing destination, therefore you got paid if you got filled.
If you buy at the ask, you are taking shares from someone else who is advertising and they would get paid.
Why would you do this? One word, urgency.
The more you need or want to get in our out of a trade, the more active you need to be getting a fill. So how does this help you today? It improves your ability to place limit orders at certain levels to get your price. Placing market orders on every trade is silly and expensive.
Trade smart and start to get a feel for urgency. The easier it is to get a fill on a limit order, the less of a reason you have to exit a position. If you have 1,000 shares for example, put out 100 and see how quick you get filled. This was discussed a lot in Reminiscences of Stock Operator.
Why sell if the buyers are hungry?
Back then, the money you earned for getting fills on limit order meant a lot to knock your costs down. Trading fees are so cheap today it doesn’t factor in as much but you can still benefit from getting paid. It’s money in your pocket. If you’re an active trader it adds up.
ECN fees are dramatically different. In 2000, you could get up to $9/1,000 shares if filled on a limit order (an order you advertised top buy or sell. Think about what that meant for the cost of the trade. If I bought 2,000 shares of stock on the bid and sold the 2,000 shares on the ask (offer) I got paid $9/1,000 shares for 4,000 shares.
This means I earned $36 to place those orders. So the $36 was subtracted from the $50 cost of the trade. I knocked my cost down by 72%.
You bet I was paying attention to urgency for better fills.
This is how many day traders earned a living. Trading the bid/ask spread.
So, how did scalping transform into modern momentum trading?
Stock Scalping Decimals
When quotes changed from fractions to decimals in 2001 the personality of stocks changed. A profit from 20 1/16 to 20 3/8 was ONE PRICE LEVEL.
That same 1/16 move is the equivalent of 6.5 cents. This means a stock now needed to trade through 6.5 levels of price points to move the same distance. Visually and practically this was a big change for day trading. Prices still moved from point A to point B but the mechanics of the trade were different.
We needed to adjust and technical analysis became the new Level 2. We needed a method to identify institutional order flow. Prior to this, if GSCO was on the bid with size, we would bid with conviction. If time and sales were spraying read and green prints we saw indecision and we would exit.
You can learn more detail in this post on tape reading.
Technical analysis was not new, but we needed something more than the one minute chart or the jig was up. (see more in the video below)
Figure out a solution or get a real job.
We needed a way to determine:
- Well bid or well offered (Goldman was buying or any large player)
- When urgency was obvious in one direction (buyers or sellers are in charge)
- When urgency turns to indecision (red and green prints in time and sales)
Momentum Trading Today Applying a Scalping Framework
Good planning always starts with the end in mind. We needed to answer the question: What is today’s equivalent of scalping a teenie?
We determined the meat of the trade would be, 3-6 consecutive candlesticks in the same direction.
Somewhere between 3-6 candlestick we would expect indecision. When it occurred, we would exit. First attempting to sell on the offer (getting paid). If we could not, we would “hit the bid” and sell to someone else.
For stock scalping, this became the new equivalent of a teenie:
For stock scalping this became the equivalent of indecision previously viewed in time and sales as red and green prints.
Any candle after a momentum move with a small body, displays indecision. It can be a trigger to exit a trade or as a signal to enter a new trade.
How can we improve this strategy?
A key goal for profitable trading is “pick a side, then pick a spot.” We need a filter for which side of the current market to look for entries.
The answer can be found on the next higher time frame. High-probability stock scalping should be in sync with a dominant trend.
In this case, a scalper looking for entries on a one minute chart should use a 5 or 15 minute trend. A scalper sing the 5 minute chart for entries can use the 15 minute or 60 minute chart for a trend.
This filter is crucial to success.
How can we make using a filter simple but effective?
This is easy. Simply use the candlestick on a time frame at least 10 times higher. If you scalp a one minute chart, scalp the direction of the ten minute candle. These are guidelines, use what makes sense for you. The point is the filter comes first. Direction to scalp comes first.
If this was a 60 minute chart, only scalp the 5 minute chart long. Eliminate the short-side of the trade. This keeps you in sync with the current dominant trend. You can do the same with moving averages but I have found this to work best for me.
Stock Scalping Video
I hope this was a cool history lesson for you but my ultimate objective was to give you a foundation for high-probability trades. Scalping or swing trading the principles apply. Look for an entry after you determine if buyers or sellers are in charge.
This video gives a visual of the lesson.