What is Scalping in Forex and How Does it Work?
Scalping basically means taking small individual profits from frequent short-term trades where the price movements in each are tiny. Scalpers buy and sell foreign currency pairs, with only a few minutes or seconds between the buy and the sell. This process is repeated many times throughout the day to build up profits.
Different Scalping Strategies
There are three main scalping strategies.
- In the first, the scalper tries to capitalize on the bid/ask spread by simultaneously posting a bid and an offer for the same currency pair. This is known as ‘market-making’ and it only works on currency pairs that trade large volumes but without significant price changes.
- In the second, the scalper purchases thousands of shares and sells when they have made a small move, usually just a few cents. This only works with a highly liquid stock where the scalper can be confident in liquidation thousands of positions instantaneously.
- The third strategy is the most similar to traditional trading methods. The scalper enters the market at a specific time or price point and exits when a pre-set signal is triggered, near the 1:1 risk/reward ratio.
The first strategy requires trading in large volumes on stocks that show very little price change. It is considered to be the most difficult strategy to execute successfully as there is greater competition from market makers and the profits involved per trade are so small.
The other two strategies require prices to change rapidly, but they also require expertise in reading and understanding the market.
Pros and Cons of Scalping
Scalping can be very profitable for traders with a strict exit strategy. Short-term positions mean that market fundamentals are largely irrelevant, so the trader doesn’t need to understand much about the stock itself. There is very little market risk involved and scalping works regardless of which direction the overall market is moving in. Scalping strategies can also be easily automated as the trader is dealing with a strict set of predetermined entry and exit conditions.
On the other hand, scalping has some potential downsides. A large number of transactions will mean transaction fees are higher and there is greater leverage required to make a profit. It is also a very time-consuming strategy that requires intense concentration, so it isn’t the right forex trading strategy for everyone.
Indicators for Forex Scalping
Forex scalping relies on technical analysis rather than fundamentals, such as economic performance, interest rates, and monetary policy.
Three of the most popular scalping indicators are Bollinger Bands, stochastic oscillators, and Keltner channels.
Bollinger Bands
Named after John Bollinger, who created them in the 1980s, Bollinger Bands are good for identifying assets that have deviated from the mean. A Bollinger Band chart is very effective at showing the volatility of the market and that is crucial for forex scalpers because their trades are so quick, usually less than 5 minutes.
Stochastic Oscillators
Stochastic Oscillators were first introduced in the 1950s and are a popular way of generating overbought and oversold indicators. They rely on an asset’s price history and vary around a mean price level. They are a popular indicator of momentum.
Keltner Channels
Keltner Channels are sets of bands placed above and below an asset’s price. This helps to show the volatility in an asset’s pricing and identify trends and directions of travel.
Simple Moving Average (SMA) and Exponential Moving Average (EMA) Charts
Simple Moving Average (SMA) and Exponential Moving Average (EMA) charts can be used to represent the short-term pricing trends of a currency.
Relative Strength Index
Also used for forex scalping is the Relative Strength Index (RSI). This is a momentum indicator that predicts the future direction of the forex market over a short period of time. This is useful for forex scalpers because it helps to identify a strategy appropriate to the current market.
Find more information on Forex Trading Strategies.
Things to Consider Before Getting Involved in Forex Scalping
Time Commitment: Can you dedicate the time and commitment needed to monitor the markets and make multiple trades daily?
Fees: Forex scalping requires you to make tiny profits on thousands of trades to see a good return. Each trade will attract a commission or transaction fee so that is something that will eat into your potential profits.
Volatile Market: The forex market can be volatile and instead of small changes there is the potential for a complete collapse or change of direction.
Speed: The speed of entering and exiting a position is crucial as you benefit from small price fluctuations, so choosing a broker that can support your trades instantaneously is essential.
High Frequency of Trades: You need to commit significant resources to potentially return a decent profit because the price movements are very small for each trade and therefore thousands of trades are required.
Analysis: While detailed knowledge of the macro-economic situation or the internal politics or monetary policy of a country is not required for a successful forex scalping strategy, knowledge of and experience in using technical analysis, such as reading Bollinger Bands is required for a successful forex scalping strategy.
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Originally published at https://sticpay.com on February 14, 2022.
