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Scalping: A Review of One of the Most Common Forex Trading Strategies

   

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It’s a case of stating the obvious, but there are countless ways for any investor to approach the forex market these days. Trading styles take on all different shapes and sizes. For those new to forex trading—and even those with forex trading experience—scalping is a method that you have likely been pushed toward. 

Often unheralded, it represents the opposite of the highly popularized swing trading. Whereas swing trading will see you placing a couple of trades every few weeks, scalping is the opposite, prioritizing multiple moves over the course of a day.

Scalpers don’t tend to hang around, entering and exiting the market frequently during any trading session. Scalping might be a common forex trading strategy, primarily for those thinking short term, but it can be argued that it’s underestimated in its effectiveness.

What is Forex Scalping?

Scalping involves trading currency pairs based on real-time analysis. The entire purpose of scalping is to bring short-term positions to the fore as traders look to buy and sell countless times over the course of a day, attempting to generate small profits along the way. Scalping effectively presents the opposite of any long-term, position-driven trading strategy, avoiding overnight positions as a hard-and-fast rule. 

Take a look at the EUR/USD chart below. Although the time frame for this chart is much too long to use for scalping—covering days, not minutes—the trends at play are applicable to scalping. In this case, the price of the pair is reaching both a Fibonacci line and a line of resistance, which offers a great opportunity for scalpers to open a position just before a price decline:

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Remember: With scalping, it’s a case of little and often, rather than standing by an option over the long haul.

What are the Risks?

Like any forex trading strategy, scalping comes with risks. For starters, scalpers have a tendency to place too much emphasis on a single trade, which at times defeats the purpose of scalping. 

The whole premise of scalping is to move quickly, so the potential impact that a bad decision can have on a single trade can prove disastrous if the position is held open for too long. This can be magnified should emotion get tangled up in a poorly timed trade, which can trigger a domino effect that disrupts the entire strategy.

Scalping is often pushed onto novice traders by questionable brokers and more experienced traders. The reality is that scalping requires a moderately sized account to be effective, so novice traders who don’t have this luxury are often walking into the unknown. This isn’t to say that novice traders can’t find success with scalping—that can certainly happen—but capital of a moderate level is needed, or the small and frequent approach will deliver minimal returns at best.

Another danger that often presents itself with scalping is damage caused by wild price swings. Economic news releases—especially from countries that have known political instability—can send ripples and shockwaves throughout the market, triggering increased volatility. During this time, the price of active pairs can shift over 100 pips, disrupting any scalper’s trading efforts. It makes setting an accurate stop loss nearly impossible, essentially leaving the trader in a weakened position.

The Difference Between Scalping and Day Trading

Given the short time frames for each strategy, scalping and day trading can often get confused with each other. But these strategies have important differences that traders need to understand before they try either strategy.

The biggest difference between scalping and day trading is the time frame for keeping positions open. Day trading and scalping each limit their trades to a single day, but scalping operates on a far more condensed schedule. The typical day trade is opened and closed over a period of an hour or two. Scalping, on the other hand, can see a position opened and closed within minutes. As soon as the position is opened, the trader is preparing to close out that position and (hopefully) cash out a profit.

To generate worthwhile profits from these actions, scalpers tend to operate with larger accounts than day traders. And given the complexity of scalping, it tends to require a more extensive trading background than day trading, whose more flexible time frames are more accommodating to novice and less experienced traders.

Advantages of Forex Scalping

  • Scalpers can exclusively work within a set session every day, as no positions are carried overnight. This also means that no risk is ever carried forward day-to-day.
  • Trading short sessions are also highly possible, so if a trader wishes to do so they can choose to actively trade for just a few hours a day.
  • Scalping places heavy emphasis on speed, which means it can be used to grow a trading account balance faster than practically any other trading strategy.

Disadvantages of Forex Scalping

  • Concentration is absolutely pivotal when scalping, as it is effectively the act of doing the same thing multiple times during any single day. This consistent level of concentration will be difficult for some to maintain, eventually leading to problems.
  • Scalping isn’t the most headline-worthy way of trading forex, as scalpers probably won’t be able to ride the biggest market moves. Many traders make the link between big moves and big profits, so this can be a difficult psychological hurdle to jump.
  • Cost increases can wreak havoc on any scalper’s bottom line, as wide spreads, slippage, and a pip shifts all have the power to cut deep.

Best Indicators for Forex Scalping

The best way to identify scalping opportunities is to use indicators that illustrate a price movement taking place in real time. Unlike with other trading strategies, it’s important to use leading indicators for scalping because lagging indicators are too slow to catch up—by the time a lagging indicator identifies a trend, it may be too late for scalping.

Additionally, traders should use indicators only on charts with a short time frame, such as a 10-minute chart that considers only the latest data. The longer your chart’s time frame, the less value it has in identifying scalping opportunities.

Some of the top indicators for forex scalping include the following:

  • Simple moving average (SMA): Over a 10-minute chart, the SMA can use recent closing prices to quickly tell you whether the price is going up or down. You can then use that indicator to open a long or short position and close it out within a few minutes.
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  • Parabolic stop and reverse (PSAR): This indicator places dots below the price when the currency pair is trending upward, and then places dots above the price when the trend is moving downward. When the trend stops and reverses, the dots move from the bottom to the top of the chart, signaling to traders that it’s time to jump on board. Scalpers can use this reversal to quickly take a profit off the start of a price movement.
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  • Stochastic oscillator: The stochastic oscillator is a simple indicator to use when scalping, especially when seeking a leading indicator to help you maximize profits off a trade. In scalping, the stochastic oscillator is used to identify momentum in trading with the assumption that momentum leads to price movements. By tracking the stochastic oscillator and looking for opportunities where a currency pair is overbought or oversold, you can scalp a position just before the price movement occurs.
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Take a look at the middle of the CHF/JPY chart below. You’ll notice a sharp dip in the middle that corresponds with the stochastic entering oversold territory—which scalpers would use to predict an impending price increase:
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Within this short time frame, a scalper can open a position after the price drops and the stochastic enters oversold territory, and then cash out their position after the swift price increase. The entire position needs to be open for a total of only seven or eight minutes.

Is Forex Scalping Right for You?

This is the figurative million-dollar question, because forex scalping isn’t going to be for everyone. Those who like to operate with a longer stance toward the forex market—through a position trading approach, perhaps—aren’t likely to get much joy out of scalping. For those who find the idea of holding lengthy positions uninspiring, however, forex scalping will surely hold more interest.

Scalping can appear basic and almost effortless on the surface, even if the reality is significantly different. The illusion is that anyone can turn a full day’s profits in mere minutes, but that is seldom the case. When scalping, there is minimal room for error, which means it is perfect for those who are able to exhibit high levels of concentration in short bursts. Scalpers won’t be active around the clock, so if you have the ability to focus, this trading strategy could be the right fit.

Scalping won’t be for everyone, so nobody should be foolish enough to buy into the myth that states otherwise. Quick entries, quick exits, and quick profits are the calling card of any scalper, so if overanalyzing and overthinking are at the core of your trading personality, then this approach probably won’t be for you. However, if you find that you meet the description of scalper, it’s certainly a methodology that is worth exploring.

Conclusion

 Scalping is fast-paced, volume-orientated, and—at times—unforgiving. It presents a way of trading that can be reactionary and will often call on a trader to roll with the punches. If you meet the criteria and have the concentration levels that allow you to trade in short, focused bursts, then scalping could be the missing link in your forex trading efforts.

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Disclaimer:

The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.

This post was written by Graeme Watkins

CEO Valutrades Limited, Graeme Watkins is an FX and CFD market veteran with more than 10 years experience. Key roles include management, senior systems and controls, sales, project management and operations. Graeme has help significant roles for both brokerages and technology platforms.

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