Scalping is a popular trading style.
It’s used to buy and sell the same asset pretty quickly, within a short period of time, with the aim of making quick profits.
But the real question is, is scalping illegal?
Well, it depends on a few factors.
Like the region of the world, and its financial markets regulations.
But let’s look at them in detail.
The Legality of Scalping
The legality of scalping varies from region to region.
In some countries, scalping is considered a legitimate trading style and is not subject to any restrictions.
In others, however, scalping is regulated or even forbidden.
For example, in the United States, scalping is legal but is subject to certain restrictions imposed by the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).
In the European Union, the legality of scalping depends on the specific regulations of each member state.
The Regulation of Scalping in the United States
In the United States, scalping is regulated by two agencies, the SEC and FINRA.
These agencies aim to ensure that scalping is conducted in a fair and transparent manner and that it does not pose a risk to the stability of the financial markets.
There are two main restrictions that the SEC and FINRA impose on scalping.
These are restrictions on the use of high leverage and the imposition of limits on the number of trades that can be made in a single day.
Cap on The Use of Leverage in The United States
One of the key factors that makes scalping a riskier style of trading is the use of high leverage.
Leverage refers to the use of borrowed funds to increase the size of a trade, magnifying both the potential profits and losses.
The SEC and FINRA impose restrictions on the use of high leverage in scalping in order to protect investors from excessive risk.
This is because high leverage can increase losses, leading to rapid and significant declines in your trading account.
For example, if a scalper uses a leverage of 10:1, a small move in the wrong direction can result in a loss that is 10 times the size of the initial investment.
Scalpers typically use high leverage to maximize profits by trading larger positions.
They need to do it to be able to get decent profits from small market moves.
However, the use of high leverage also increases the risk of losses and can lead to rapid account blowups.
As a result, the SEC and FINRA have imposed restrictions on the use of high leverage in scalping, requiring traders to limit the amount of leverage they use.
In the US, the maximum leverage allowed for trading varies depending on the type of security and the broker providing the trading platform.
The Securities and Exchange Commission (SEC) sets the maximum leverage allowed for trading stocks, while the Commodity Futures Trading Commission (CFTC) sets the maximum leverage allowed for trading futures and options.
For stocks, the SEC requires that brokers offer a maximum leverage of 2:1, meaning that traders can control $2 worth of stock for every $1 in their trading account.
However, some brokers may offer different levels of leverage, so it’s always good to get informed with your broker first.
For futures and options, the CFTC allows for a maximum leverage of 50:1.
This means that traders can control $50 worth of futures or options for every $1 in their trading account.
It is important to note that leverage can greatly increase the potential for profits, but it also increases the risk of losses if you don’t set a proper stop loss to cut your losses quickly.
Limits on the Number of Trades in a Single Day in The United States
Besides the restrictions on the use of high leverage, the SEC and FINRA also impose limits on the number of trades that scalpers can make in a single day.
This is done to limit the risk of rapid and significant losses.
It’s regulated under the name of Pattern Day Trading Rule (PDT) and it’s applied to margin accounts.
The Pattern Day Trading (PDT) rule is a regulation imposed by the SEC that restricts the number of day trades (buying and selling an asset within the same day) that a trader can make in a margin account.
Under the PDT rule, traders who make four or more day trades within a five-day period in a margin account with less than $25,000 in equity will be deemed a pattern day trader.
Once a trader is considered a pattern day trader, they will be subject to the PDT restrictions.
At this point, if a trader’s margin account equity is less than $25,000 and he keeps day trading, he could be subject to a ban on trading for 90 days
The PDT rule is designed to limit the risk of traders over-leveraging their positions and incurring significant losses, as well as to prevent traders from engaging in abusive trading practices.
The rule is especially important for new traders who may not be fully aware of the risks involved in day trading and may be more prone to making impulsive decisions.
Traders who wish to avoid the restrictions of the PDT rule must maintain a minimum balance of $25,000 in their margin account.
This allows them to trade as often as they like without being subject to the PDT restrictions.
Traders should also keep in mind that the rule is subject to change, so it is essential to stay up to date on the latest developments in the regulation of day trading.
The Regulation of Scalping in the UK
In the UK, scalping regulations are set by the Financial Conduct Authority (FCA).
The FCA regulates financial markets and financial institutions in the UK to ensure that they are fair, transparent, and in the best interest of consumers.
The FCA has imposed several restrictions on scalping in the UK to protect consumers from excessive risk-taking and market manipulation.
These restrictions include limitations on the use of high leverage, the imposition of limits on the number of trades that can be made in a single day, and the requirement for firms to have adequate systems and controls in place to manage the risks associated with scalping.
Cap on The Use of Leverage in The UK
The FCA imposes restrictions on the use of high leverage to protect consumers from excessive risk-taking and market manipulation.
The specific leverage limits in the UK depend on the type of financial instrument being traded and the jurisdiction in which the trading takes place.
For example, the FCA has imposed leverage limits for retail clients trading CFDs (Contracts for Difference) of up to 30:1 for major currency pairs and 20:1 for non-major currency pairs, gold, and major indices.
These leverage limits were introduced in August 2018 to protect retail clients from excessive losses.
Limits on the Number of Trades in a Single Day in The UK
It is important to note that there is no specific limit set by the FCA on the number of trades that can be made in a single day.
However, the FCA may take action against firms or individuals who engage in excessive trading or market manipulation.
For example, the FCA may require firms to have adequate systems and controls in place to monitor and detect any suspicious trading activity, including scalping.
The Regulation of Scalping in the European Union
The regulation of scalping in the European Union is done by the European Securities and Markets Authority (ESMA).
ESMA is responsible for protecting investors and promoting stability and transparency in the financial markets of the EU.
The regulations of scalping may also vary from one member state to another.
Some countries have relatively relaxed regulations on scalping, while others, such as Germany, have stricter regulations.
The EU has attempted to harmonize the regulation of scalping across its member states but has so far been unsuccessful in doing so.
Cap on The Use of Leverage in The European Union
ESMA has imposed leverage limits for retail clients trading CFDs (Contracts for Difference).
They are:
- 30:1 for major currency pairs
- 20:1 for non-major currency pairs, gold, and major indices
- 10:1 for commodities, other than gold, and non-major equity indices
- 5:1 for individual equities
- 2:1 for cryptocurrencies
Conclusion
In conclusion, scalping is a popular trading style that is used by many traders around the world.
Whether or not scalping is illegal depends on the regulations of the region in which the trader is located.
These restrictions may come in the form of a cap on the use of leverage, but also on the maximum number of trades taken per day, or in a period of several days.
