What is Scalping?
As a trading strategy, scalping aims to collect profits made on minor price changes. As a trader implementing this strategy, you might place, for example, anywhere from 10 to several hundred trades in one day. Most traders agree that often smaller moves in stock prices are easier to anticipate than larger ones. Scalpers know that before too long many more modest profits are likely to combine to become larger gains, providing they put in place a strict exit strategy to prevent large losses.
Scalping makes use of larger position sizes in order to make smaller price gains in the shortest period of holding time. You carry out scalping strategies in a single day and they are relatively easy to understand and to operate. The scalper’s goal is to buy or sell a number of shares at the bid/ask price, then to sell or buy them at a slightly higher or lower price for a profit. Holding times may vary from seconds to minutes, and in some cases a position may be held for up to several hours. However, the position is closed before the total market trading session ends, which can extend to 8 pm EST, which is 1 am the following day in the UK. The scalping trading strategy aims to either buy low and sell high, or buy high and sell higher: also, to short high and cover low, or short low and cover lower.
The Characteristics of Scalping
Scalping is characterised by extremely fast-paced trading activity, ideal for the most agile traders as it requires both exact execution and precise timing. If you are trading via scalping, you can make use of day trading buying power, four to one margin, in order to maximise your profits via trading the most shares in the shortest amount of holding time. You need to be clear that scalping is firmly based on technical analysis and short-term fluctuations in price.
This means you will need to focus on the smaller time frame interval charts, momentum indicators and price charge indicators. So, your preferred tools, resources and instruments are therefore likely to include:
- One-minute and five-minute candlestick charts
- Stochastic (for random changes in financial markets)
- Moving average convergence divergence (MACD)
- Relative strength index (RSI)
- Moving averages
- Bollinger bands
- Pivot points
You will quickly find that scalping is sometimes considered a high-risk style of trading, due to the extensive use of leverage. Given the typical features of this type of trading, a trader that executes four or more ‘day trades’ within a period of five business days is known as a Pattern Day Trader (PDT). Be aware that the equity in an account required for a PDT is higher than that required for a trader who is not a PDT.
Top 3 Forex Broker Comparison
Engaging in Forex Scalping
Despite those who consider scalping to be a high-risk trading style, forex scalping remains popular because it is often perceived as a safe strategy. This is because it involves the quick opening and closing of positions. Some scalpers maintain their position for only about one minute, whereas others may use a timeframe of between three and five minutes.
You may opt for scalping because you know that these short time periods reduce your exposure to the risk of incurring large losses, compared to other traders. However, bear in mind that forex scalping is not a suitable strategy for every type of trader. For instance, if you are an impulsive individual, who gets excited at the huge potential of trades or wants instant gratification, you will most likely find scalping is frustrating and possibly also boring. Scalpers need to have patience and diligence and to focus on making small returns, albeit a great deal of them, so that combined they amount to a significant gain.
Scalping is also a time-consuming trading strategy in comparison to some others. Due to the frequent opening and closing of trades on a particular day, as a scalper you need to remain vigilant and avoid becoming negligent. In essence, you need to develop your trading habits and practices to handle the volume of short term trades comfortably. As long as you develop your skills in this respect and remain attentive, you may find you enjoy scalping and can do it successfully.
Best Currencies to Trade in Forex Scalping
Generally, forex scalping benefits from making good use of currencies that are not liable to very sudden movements in any direction. When such movements do happen, it’s better that these only occur occasionally. For these reasons, major currency pairs are considered to be the favourites, particularly EUR/USD, GBP/USD and USD/CHF. The Japanese Yen (JPY) pairs are also within the major pairs arena, however they operate differently and are often considered to be in a separate category, such as carry pairs. The chief categories of currency pairs are:
- Carry pairs
- Exotic currencies
In fact, the EUR/USD pair is the most commonly traded major pair, no matter which trading strategy you decide to use. It makes sense that any factors that influence either economy will affect the pair, as will the differential between the interest rates at the European Central Bank (ECB) and the Federal Reserve (Fed). There are also strong mutual connections with other currency pairs. For example, close economic ties between the Euro and the Swiss franc or the British pound creates a positive correlation with EUR/USD; whereas there tends to be a negative correlation against USD/CHF.
The main characteristic of major pairs is liquidity, plus a secondary property of being able to better withstand market shocks. For instance, a significant event that may cause a 100-pip movement in a currency pair such as the Australian Dollar/Japanese Yen (AUD/JPY) may move the EUR/USD pair by only 30 points or less.
RSI, or Relative Strength Index, is a technical indicator used by traders to monitor markets and make wiser investment decisions. RSI works by comparing recent gains and losses in a market in order [...] Momentum traders are similar to trend traders in that they monitor movement in market prices and look for upward or downward trends they can take advantage of. They take either a long or short posi [...]
RSI, or Relative Strength Index, is a technical indicator used by traders to monitor markets and make wiser investment decisions. RSI works by comparing recent gains and losses in a market in order [...]
Momentum traders are similar to trend traders in that they monitor movement in market prices and look for upward or downward trends they can take advantage of. They take either a long or short posi [...]
Best Brokers for Scalping
It has to be said that some forex brokers don’t support scalping as a trading strategy. Having said that, there are plenty of online currency trading brokers that do actually specialise in and allow scalping and they will not get in the way of the trading strategies you prefer to use, even if this involves opening a number of trading positions during relatively short time periods.
Generally, it’s best to seek out companies with no trading restrictions and you can find listings of many of these brokers online. In the main, they are not deterred by a deal that is opened for a matter of seconds with tight stop losses. Some of the principal brokers include:
- Admiral Markets
It’s important to take note of any additional features that may be attached to the general terms and conditions of those brokers who do allow scalping. Also, it’s a good idea to catch up on reviews and comparisons of individual brokers that are published online, as these can offer a good steer when you’re trying to decide on which broker may be right for you. You may find, for instance, that you’re already with a broker that will be fine should you choose to change your trading strategy from a more traditional one to scalping. Additionally, you also have the option of seeking out a direct-access broker.
Alternative Trading Strategies
Before adopting any trading strategy, you should look around to see what others are available. For this reason, before making a final decision about scalping you may wish to consider some of the alternatives.
Take swing trading, for example, the main objective is to capture gains in a financial instrument or in a stock within an overnight hold to several weeks. Using technical analysis, swing traders look for short term price momentum and stocks. Sometimes they utilise the intrinsic or fundamental value of stocks and also analyse price patterns and trends. Investors use breakout trading in order to take a position within a trend's early stages. This trading strategy can be viewed as the starting point for any major price moves and can also signal expansions in volatility. If you manage it well, it can limit risk levels.
Gap trading is generally regarded as a fairly disciplined, yet simple approach to buying and shorting stocks. As a trader, you find stocks that have a price gap compared to the previous close and you watch the first hour of trading in order to identify the trading range. A rise above that range signals a buy, and a fall below it signals a short. Position trading is sometimes described as a buy and hold strategy rather than active trading. This is because it involves the use of longer-term charts plus other methods to determine trends. It may last from several days to several weeks, or even longer.
Using a Direct Access Broker
If you’re serious about scalping as a trading strategy you may want to consider working with a direct-access broker. This is a broker that concentrates on speed and order execution. Normally, a traditional broker mainly focuses on undertaking investment research and providing advice. A direct access broker, on the other hand, will usually have access to complex computer software that will allow you, as a client, to trade directly with an exchange or with other individuals using electronic communication networks (ECN).
Direct access brokers often charge a lower commission than full-service brokers. They can do this because they effectively eliminate any third party, thereby reducing their own costs. They have become popular mainly because of their fast transaction times, but also because of the other facilities they offer. These include:
- Interactive charts
- Streaming quotes
- Level II Nasdaq quotes
- Other real-time features
Traditional online brokers tend to cater to retail swing traders and self-directed investors. Their platforms tend to prioritise research and functions to provide market analysis rather than focusing on execution services only. Client trade orders are pushed to a centralised trading desk, which then re-routes them to the company’s own market makers. Alternatively, trades may be sent to other liquidity providers via order flow arrangements that have previously been negotiated.
Scalping is a popular strategy because the speed of executions means you are not exposed to the fortunes of the market for very long. Fast transactions on small price changes limit your risk, and a lot of small gains in a single day can soon amount to a large profit when combined. Scalping requires a trader to be agile and to closely monitor all trades, taking rapid action as soon as this is necessary. For this reason, it’s a time-consuming activity.
Technical analysis plays a major role in scalping, so as a trader you will need to be familiar with the various charts and other tools required to effectively monitor price movements and market changes. You will also need to be disciplined in terms of your exit strategy, which can mean sacrificing larger gains on occasion. Not every broker permits scalping, so if you decide to opt for this strategy you will need to find a broker that supports it, perhaps a direct access broker rather than a conventional one.