There are multiple ways of profiting in forex, including swing trading or trend following. However, scalping is the method with the shortest trading periods. With this method, traders usually open a trade for 1-2 minutes, or 5 minutes at the very most. The idea is to benefit from short fluctuations in the market.
This series of articles will serve as a guide for scalping, but for the purpose of introduction, we can ask what makes this strategy popular and effective. Many of these considerations will then serve as the topics of further articles.
The first major reason for scalping is perceived safety. Scalping has a far shorter time frame than the other forex methods, and many traders argue that this limits their exposure to the market.
Of course, this limited exposure leads to a second major characteristic of scalping—a large number of trades. Some scalpers may open and close as many as several hundred trades within a single trading day.
This points to one of the major challenges for this style of trading. Since the number of trades is extraordinarily high, scalpers must find forex brokers with low transaction costs and fees. Before considering this style, make sure that your broker’s commission structure allows for you to be profitable.
A third characteristic is the fact that scalpers rely on some type of leverage. The profit from each trade is generally quite small, and even with a huge number of orders, the results would hardly be worthy of the effort. Depending on the amount of leverage you use, this can eliminate any real security. In spite of their arguments to the contrary, scalpers can lose a day’s work in a few bad transactions.
A fourth characteristic of scalping is that it is generally a full-time endeavor. This is a significant limitation, since the majority of forex traders only do it in order to supplement their income. Scalping requires constant and undivided attention. If you decide to use this strategy, expect it to dominate your time and efforts for as long as you are trading. It is generally best to set aside an extended period of time and eliminate any other distractions. This is unworkable for many traders, though when a scalper finishes for the day, his exposure is finished as well.
Some scalpers try to eliminate this problem by automating the process. In recent years, a vast number of robots and software automation kits have become available for scalpers. Unfortunately, most of these are unproven, and many make wild claims that stretch far beyond plausibility. Still, there is a real benefit in automating certain parts of the process. For instance, you might use software to execute redundant tasks like stop-loss, take profit and other orders, while doing the analytical tasks yourself. In this limited role, the automation can be a significant help by allowing you to execute more trades with less drudgery.
Scalping is a workable strategy if you know what you are doing and are willing to dedicate your full time energy to forex trading. Unfortunately, too many beginners try scalping based on the assumption that they can avoid risk. As any experienced investor knows, risk accompanies any genuine financial opportunity. After several months of practice, and with plenty of education, scalping is a great way to enter the forex markets. This guide will tell you some of the main things you need to know when getting started.
The first step in any guide on scalping is understanding how scalpers actually make money. What does a scalping strategy look like in daily practice?
We already mentioned that scalping involves entering and exiting the market in short time spans. But what guides the choice to enter or exit? Actually, this strategy works on the basis of careful analysis and timing. What makes scalping different from other strategies is that it takes advantage of volatility rather than trending, ranging, or fundamental analysis. Recognizing that the market moves erratically in the short term, scalpers try to identify small patterns and exploit them.
The strategy works when traders can find short-term disruptions in liquidity, or other temporary abnormalities. For instance, a news shock or some other factor might suddenly increase demand for the yen. During that time, there will be a need for liquidity as too many people demand the yen with insufficient supply. The spread between bid and asking price will temporarily widen. A scalper might recognize that the liquidity has to return eventually and the price will eventually settle back into normal levels. Based on this, he can go long or short, as appropriate, and collect on the difference.
This means that scalpers actually benefit from volatility by trading on the assumption that prices will stabilize again. It’s not hard to see that after a major event, prices routinely zigzag for several minutes before settling again. Since this is an emotional over-reaction, a scalper maintains a realistic, stable viewpoint and profits from those who don’t.
It’s also easy to see that if trading wisely, scalpers act as “brakes” on the micro-volatility of the market. They actually profit by dragging irrational price-spikes back to meaningful levels. One other implication is that the most important time for a scalper is just after a market shock. Scalpers pay careful attention to announcements of economic data or news shocks and the disruption that follows.
But these observations lead to the other major topic of this article—leverage. The inherent limitation of trading on micro-volatility is that it will never be very significant. Therefore, scalpers use surprising amounts of leverage to make their trading more potent. Their leverage might range from 5:1, all the way up to 50:1. These kinds of leverage would be simply intolerable for other traders, but the important thing to remember is the short duration that scalpers use. During this time, there is little opportunity for wide swings in the market that would risk massive losses. It is also crucial to always use a good stop-loss mechanism and not adjust it for individual trades. If these measures are maintained and a trade turns out badly, it will be closed in a matter of minutes or even less when the stop-loss level is reached.
There are still a few cases when scalpers might still suffer significant losses. Significant news shocks might cause very wide spreads in a short time. Even the best brokers may not be able to complete stop-loss orders quickly enough, and losses can multiply exponentially. Therefore, traders should always be conscious of whether new economic data or another type of event has the potential to cause significant disruptions. In such cases, it is always wise to use caution and trade with lower amounts of leverage.
Scalping is an interesting strategy because it takes advantage of phenomena that might otherwise seem random. It is a simple testimony to the fact that on every level of the forex market, the same principle applies—profit belongs to the traders that use their heads and who are not carried away by short-term emotion. The scalpers that succeed are the ones that have mastered that art.
The next logical question in our guide to scalping is how to do it. When it comes right down to the pragmatics of this strategy, what do you need to make it work, and where do you start?
One of the most important foundational issues is choosing the right broker. In some cases, a brokerage may even have a stated policy against scalping. Without the right platform and broker, you simply have no chance of success. But what should you be looking for?
The first issue is the broker’s spreads. If a swing trader opens and closes several positions every day, a spread of several pips is hardly an issue, but scalpers might open and close more than a hundred daily. If you work out the math, this is a significant loss. For instance, imagine that a trader makes 50 trades with a nice profit of 130 pips. If the spread is three pips, he would end up with a net loss of 20 pips. Since the cost of the spread applies to every trade whether it is profitable or not, this loss adds up very quickly. The conclusion is fairly obvious—if you want to make any profit with scalping, you’ll need to find a broker with the lowest spread possible. In addition to spreads, you should also check for any commissions or hidden trading fees.
But this search is not always easy. Unfortunately, many brokers have a bad relationship with scalpers. The problem is that the number of trades scalpers make can sometimes overwhelm older systems. In addition, every broker has to countertrade the orders he processes to avoid being financially liable. Receiving large numbers of orders every day doesn’t make this easy.
For those reasons, many brokers try to eliminate scalpers. Sometimes this is a stated policy, but very often a broker will simply terminate a scalpers account or slow down his processes so that scalping is impossible. Therefore, you must also find a broker with the most up-to-date technology and a toleration for large numbers of orders. Look for a fully-automated broker with no-dealing desk (NDD).
There are several other things that can make scalping impossible. If the trades take too long to process (slippage), the price difference will quickly make trading unprofitable. Therefore, you should always look for efficient execution of your orders. Similarly, price quotes must always be precise and updated dynamically. Even a small delay (latency) makes trading based on micro-volatility impossible.
Finally, scalpers should look for platforms with a workable interface. For the most part, this should include the same financial tools that trader’s want with other strategies. Of course, you should look for an interface with a full range of execution tools. But in particular, the interface needs to be fast and easy to use. This is important because of the number of rapid orders that must be made. Customization is also a big advantage, as well as automation. You should also pay attention to the visual appearance of the interface. Scalping requires intense focus, and many traders report eye-strain after a long day of staring intensely at a screen.
In short, you should consider every angle before committing yourself to a particular brokerage or a trading platform. Be upfront from the beginning with your broker. If you try to use this strategy through a system that can’t handle it, the brokerage will intentionally make trading impossible. Of course, you should also be confident that your broker isn’t fraudulent. Most of all, you should never try to use scalping through a broker with wide spreads or other excess costs. The net result will always be a loss. Done right, and done through the right avenues, however, scalping can be quite successful.
Once you establish a broker, there are several other things you should know about scalping.
First, you should wisely pick currency pairs that will work well with the strategy. The best thing is to start out with the basic pairs, and move to riskier pairs as you become more experienced.
The most stable and liquid currency pair is certainly EUR/USD. Other majors have a similar stability, such as GBP/USD, USD/CHF and others currencies from the major world economies. All of these currencies change very slowly. Even major events will not produce significant jumps in these pairs, because of the volume that is regularly traded.
But isn’t the goal of scalping to profit from volatility? So it seems as though more volatile currencies would be better. The advantage of the more stable currencies, is that directional changes are much easier to predict. Remember that even small fluctuations can be magnified through leverage. This means that a trader can generate very large returns from these pairs, if he is willing to accept the risk.
Another group can be called carry pairs. These currencies are liquid, but much more volatile than the majors. A good example here is the Japanese Yen. Interest rates are very high on the Yen, and many investors also use the currency for risky assets. One of the results is that market shocks will have extreme results that might result in very wide spreads. Within a scalping strategy, this might result in extreme losses that a stop-loss order cannot protect from. Furthermore, excessive volatility can be quite unpredictable. Therefore, it is generally best for beginners to stay away from pairs that involve the Yen (JPY) or other carry pairs.
Finally, exotic pairs involve small or developing nations with a low volume of trade. Examples might include the Norwegian Krone (NOK), the Turkish Lira (TRY), the Brazilian Real (BRL), or any of the developing currencies. These pairs are quite unpredictable, and often run into significant liquidity problems. Trading with one of these is a significant risk.
Any experience trader also realizes that the markets change during the course of a day. So when is the best time to trade? From 7:00-8:00 (EST), markets are quite choppy, because worldwide traders anticipate the opening of the New York market. Late morning brings higher volatility, but also great liquidity. Many announcements also direct the market during this time. Early afternoon tends to be quite choppy, with higher risks but potentially greater profits. Late afternoon sees the closing of most large banks in developed countries, and the market becomes its quietest.
Really, your preference for each of these times depends on your style. In choppy conditions, scalpers should look for shorter trades without concern for directionality. Of course, during the time that the markets are open, there should be more attention to larger trends, and the possibility of more extended trades.
All of these factors are significantly influenced by your particular style and your experience. Risk may be just the thing if you know how to handle it, and experienced traders often had straight for more volatile times and currency pairs. If you’re only beginning, the key is to stay with major pairs and avoid times of wild fluctuations. Learn how to predict the market with low leverage and minimal risk. Once you’ve seen and handled various market conditions, you can consider taking bigger risks, and pursuing larger profits.
This guide has sought to introduce scalping and discuss the pros and cons of the strategy. After a brief introduction into the characteristics of scalping, we discussed how scalpers profit and how they use leverage. We also pointed out the major necessary things to make scalping successful, including a good broker and an efficient platform. Finally, we discussed the best currency pairs and times of day when scalping works best.
But this guide runs the risk of being overly simplistic if we fail to talk about the variations on scalping. Traders might use any one out of a number of techniques to make their strategy successful. Trend scalpers follow the direction of the market and try to profit from where it is headed. Think of this as following the macro-direction of a currency, but on a much smaller scale. Other scalpers prefer to take advantage of news events and other shocks to the market. These traders stay away from the period closest to the news event, but profit in the time just afterward.
The more important point to recognize is that scalping varies drastically according to conditions. At times the distinction between scalping and other strategies is quite unclear. For instance, if a scalper opens a position and then observes a longer profitable trend, it only makes sense to take full advantage of it. Depending on what is happening, a trader might switch back and forth between all of the strategies, or form his own hybrid.
However, this points to a very important issue that applies to all forex trading. There is a deeply psychological aspect of dealing with risk and loss that every trader should be conscious of. Here are a few qualities to aim for.
First, scalpers and all forex traders for that matter, must exercise discipline in their trading. This is the only problem with moving between various strategies—it becomes too easy to make emotional decisions and take foolish risks. Let your strategy control your decisions. In particular, don’t make the mistake of varying the size of your trades too much—especially when you have a string of successes. One bad trade can erase a lot of progress.
A second, related point is cool-headed thinking. When markets become chaotic, it is easy to be controlled by the volatility and make foolish mistakes. At those times, remember your strategy and follow it assiduously.
Third, you must be patient for the long-term. Scalping works when lots of small but profitable trades add up to a large sum. Be willing to wait for that, even if it requires persistence and temporary loss.
Finally, it is imperative to know yourself. Know what style works well for you. Observe what market conditions tend to reap the best profits for your trading. At certain times, it may be best not to trade at all. When you recognize that conditions mirror what has worked well for your strategy in the past, you should jump into the market fully.
Beginning traders sometimes assume that scalping is the easiest way to earn a quick profit. However, scalping is actually one of the most challenging strategies. Some scalpers suffer losses at the beginning, but with a lot of practice, discipline, education, and the right tools, this method can be one of the most profitable forex strategies.