What is scalping in forex? In this article, we explain how to start scalping in forex, covering tips that can help aspiring scalp traders.
July 1, 2021, | AtoZ Markets – Scalping is a widely used short-term trading strategy. In fact, this is one of the most common day trading strategies. It includes shorter time horizons, quick decision-making, and a good set of technical analysis and charting tools. As a result, many professional day traders set aside a portion of their trading account for scalping.
Since scalping trading strategies can work in many different financial markets, scalpers are active in the stock market, Forex trading, and cryptocurrency.
In this article, we explain everything you need to know about a trading method called scalping.
Let’s take a look at everything you need to know about scalping and learn whether scalp trading is for you or not.
What is scalping in forex?
Scalping is a trading strategy that involves taking profits from relatively small price fluctuations. Scalp traders are not looking for big profit targets. Instead, they tend to profit over and over again from small price changes.
Thus, scalping traders can enter many trades in short periods of time, looking for small price fluctuations and market inefficiencies. The idea is that by adding up these small profits, the profit will grow to a significant amount over time.
Due to the short time frames, scalpers will rely heavily on technical analysis to generate trading ideas. Since most fundamental events play out over a long period of time, scalping traders rarely engage in fundamental analysis.
However, fundamental narratives can go a long way in deciding which asset to trade. Stocks or coins with increased interest due to some kind of news or fundamental events tend to have high volume and good liquidity – at least for a certain period. It is at these moments that scalpers can step in and profit from increased volatility.
To achieve this consistently requires speed and focus, however, this is why experienced traders use cryptocurrency trading software designed to identify patterns and execute specific trades when using trading robots for scalping. Scalp traders will track the price of an asset, say Bitcoin or Ethereum, and take advantage of price fluctuations to make a small profit on the trade.
When the price rises, they take advantage of the higher trading volume for that asset to make multiple trades at once without ever holding the digital asset. They then exit when the asset peaks and stop trading.
One very important thing to keep in mind when implementing this strategy is trading and exchange fees. Since they will be making many trades in a row and most exchanges will charge at least a small commission per trade, it is important that the trader has risk capital to cover the trading fees they will incur when using a scalping strategy.
Exchanges that promote liquidity usually offer these traders incentives to lower their trading fees. These incentives are often associated with a specific exchange token that can be used to further reduce fees. Thus, scalpers use short-term spikes in volatility rather than large price movements. This strategy is probably not ideal for everyone as it requires a deep understanding of market mechanics and quick decision-making (often under stress).
How to make money in scalp trading?
So what technical factors do scalpers take into account? Trading volume, price action, support and resistance levels, candlestick charts are all commonly used to determine trading settings. Some of the most common technical indicators used by scalping traders are Moving Averages, Relative Strength Index (RSI), Bollinger Bands, VWAP, and the Fibonacci retracement tool.
Many scalpers will also use real-time order book analysis, volume profile, open interest, and other sophisticated indicators. In addition, many scalpers create their own indicators to gain an edge over the market. As with any trading strategy, finding a unique edge over the market is paramount to your success.
Scalping is based on the assumption that most assets will complete the first stage of the movement. But what happens next is unknown. After this initial phase, some stocks stop rising while others continue to rise. The scalper intends to make as many small profits as possible without letting them evaporate. This is the opposite of the “let your profits grow” mindset, in which the trader tries to optimize positive trading results by increasing the size of winning trades while allowing others to turn around.
Scalping achieves results by increasing the number of winners and sacrificing the size of the winnings. It is not uncommon for a trader with longer time frames to achieve positive results by winning only half or even fewer of their trades – it is just that the gains are much greater than the losses.
However, a successful scalper will have a much higher ratio of winning trades compared to losing trades, with profits roughly equal to or slightly greater than losses. Scalping is about finding small market opportunities and taking advantage of them. Since these strategies can easily become unprofitable once they become known to the general public, scalp traders can be quite secretive about their individual trading packages. This is why it is so important to create and test your own strategy. As we said earlier, scalpers usually trade on lower timeframes.
These are intraday charts that can be 15 minutes, 5 minutes, or even 1 minute. Some scalping traders may even look at time frames of less than a minute. However, with this time frame, we are starting to enter the realm of high-frequency trading robots, which may be unwise for people to look at. While machines can process large amounts of data quickly, humans can have a hard time making a decision by looking at 15-second graphs.
Here’s something else to consider.
We know that higher timeframe signals and levels are generally more reliable than lower timeframe signals. This is why most scalpers still pay attention to the structure of the market in the older times in the first place.
They first outline important levels with high time frames and then zoom in to find scalp trade setups. This shows that looking at the structure of the market on a long timeframe can be very helpful, even when it comes to short-term trades. Even so, trading and investment strategies can vary significantly from one trader to another.
There are no hard and fast rules for scalping, but there are guidelines you can take into account when setting your own rules.
We can consider two types of scalping traders – discretionary and systematic scalping traders.
Discretionary traders make trading decisions “on the spot” when the market turns in front of them. They may or may not have specific requirements as to when to enter or exit, but their decisions are based on the conditions at hand.
In other words, discretionary traders can consider many different factors, but the rules are less rigid and they rely more on intuition. Systematic traders take a different approach. They have a well-defined trading system that essentially defines entry and exit points for them. If certain conditions of their ruleset are met, they enter or exit a trade.
Systematic trading is a much more data-driven approach than discretionary trading. Systematic traders rely less on intuition and more on data and algorithms. In fact, this classification can be applied to other types of traders as well. However, the distinction is clearer when it comes to short-term strategies. After all, discretionary trading may not perform as well on higher time frames.
Some scalpers use a strategy called range trading. They wait for a price range to be established and trade within that range. The idea is that as long as the range is not breached, the lower end of the range will remain support and the upper end of the range will be resistance. This, of course, is never a guarantee, but it can still be a successful scalping system. However, good scalping traders will prepare for range breakouts by setting a stop loss.
Another scalping method involves using a spread between the buy and sell prices. If there is a significant difference between the highest and lowest selling price, scalpers can profit from it. With that said, such a strategy is more suitable for algorithmic or quantitative trading.
Well, humans are not as reliable in spotting small flaws in the marketplace as machines are. As a result, this field is heavily saturated with trading bots. Thus, people who want to adopt this strategy usually have to compete with algorithms.
Scalping usually involves the use of leverage. Since interest rate targets are relatively small, scalpers usually want to increase their position size using leverage. This is why scalpers often use margin trading platforms, futures contracts, and other types of financial products that offer leveraged trading.
However, since scalpers tend to profit from smaller moves with larger positions, they should be aware of slippage.
Scalping as a professional
A professional scalper will make several trades every day – maybe dozens. The speculator will mainly use tick or one-minute charts as the time frames are small and he or she needs to see the settings as they form as close to real-time as possible. This type of trading requires supporting systems such as Direct Access Trading (DAT) and level 2 quotes.
Automatic instant order execution is critical to the scalper, so a direct access broker is the weapon of choice. Traders trading on longer timeframes can use scalping as an additional approach. The most obvious way is to use it when the market is unstable or locked in a tight range. When there are no trends in longer time frames, moving to shorter time frames can reveal visible and usable trends that can lead a trader to scalp.
Another way to add scalping to trades with a longer period of time is the so-called umbrella concept. This approach allows the trader to improve their cost base and maximize profits.
Umbrella trades are carried out as follows:
The trader opens a position for trading with a longer period of time.
As the underlying trade develops, the trader defines new setups in shorter time frames in the direction of the underlying trade, entering and exiting them using scalping principles. Depending on the specific settings, any trading system can be used for scalping.
In this regard, scalping can be viewed as a kind of risk management method. In fact, any trade can be scalped by taking a profit close to a risk/reward ratio of 1: 1.
This means that the size of the profit received is equal to the size of the stop dictated by the setup. If, for example, a trader opens his position for a scalp trade at $20 with an initial stop at $19.90, the risk is 10 cents. This means that a 1: 1 risk/reward ratio will be reached at $20.10.
Scalp trades can be executed on both the long and short side. They can be done on breakouts or in range-limited trading. Many traditional charts can be used for scalping, such as cups and handles or triangles. The same can be said about technical indicators if a trader makes decisions based on them.
When is the best time for scalping?
If you know what to look for, with time and practice you will be able to see if the market favors a scalping trading strategy at a given time or not. Experienced traders tend to pay attention to three market factors:
Relative Strength Index (RSI)
This is a momentum indicator calculated based on recent price changes. The RSI evaluates whether an asset, such as Litecoin, is overbought or oversold, and is displayed as a line chart. It can range from 0 to 100. An RSI of 70 or higher usually indicates that the asset is overbought or overvalued, so now is a good time to sell. An RSI of 30 or below indicates the opposite: it is undervalued, ready for a rally, and therefore is a good time to buy.
Support and Resistance Levels
The support and resistance levels of an asset will change as it increases or decreases in price. This change can cause a concentration of demand and a downward trend in the asset (support) or an increase in demand as the price falls (resistance).
Traders use this indicator to get an idea of where the price of an asset is going, using past data to extrapolate what it will sell for in the future. Some traders use charts to manually track these indicators, but using trading automation software can help you analyze and act on the same data much faster.
We’ve added the video below that explains the best scalping trading strategy that could help you become more successful when trading the Forex.
Tips that can help aspiring scalp traders
Due to the low barriers to entry into the trading world, the number of people trying their hand at day trading and other strategies such as scalping has increased. Newbies to scalping need to make sure the trading style suits their personality as it requires a disciplined approach. Traders need to make quick decisions, identify opportunities, and keep an eye on the screen at all times.
Those who are impatient and satisfied with small, successful trades are ideal for scalping. Nevertheless, scalping is not the best trading strategy for beginners, as it involves quick decision-making, constant monitoring of positions, and frequent turnovers. However, there are some tips that can help aspiring scalpers.
Smart use of orders: The beginner needs to master the art of efficient order execution. A delayed or incorrect order can wipe out the small profits that have been made and even lead to losses. Since the amount of profit per trade is limited, order execution must be accurate. As mentioned above, this requires supporting systems such as direct access trading and level 2 quotes.
Frequency and Cost: A beginner scalper should be mindful of the costs involved in executing trades. Scalping involves many transactions – up to hundreds in one trading session. Frequent buying and selling will cost you dearly in terms of commissions, which can lower your bottom line. This makes it extremely important to choose the right online broker. The exchange should not only provide details such as direct access to the markets, but also competitive commissions. And remember, not all brokers allow scalping.
Trading: Identifying trend and momentum is useful for a scalper who can even enter and exit for a short time to repeat the pattern. The beginner needs to understand the pulse of the market, and once the scalper detects this, trading with the trend and trading with the momentum can help to achieve more profitable trades.
Another strategy used by scalpers is the counter-trend. But beginners should avoid using this strategy and stick to the trend.
Trading sides: Beginners are usually more comfortable trading on the buy-side and should stick to it before they gain enough confidence and experience to deal with the short side. However, for best results, scalpers must eventually balance long and short trades.
Technical Analysis: Beginners should arm themselves with the fundamentals of technical analysis to combat the growing competition in the scalping world. This is especially true in today’s markets dominated by high-frequency trading and the increasing use of dark pools.
Volume: As a technique, scalping requires frequent entry and exit decisions at short notice. Such a strategy can only be successfully implemented when orders can be fulfilled, and this depends on the level of liquidity. High volume trades offer much-needed liquidity.
Discipline: It is generally best to close all positions during the day trading session and not carry them over to the next day. Scalping is based on small market opportunities and the scalper should not deviate from the basic principle of holding a position for a short period of time.
Should you start scalp trading?
The answer to this question depends entirely on which trading style is right for you. Some traders do not like to leave open positions during sleep, so they choose short-term strategies. Day traders and other short-term traders can fall into this category.
On the other hand, long-term traders like to develop solutions for a longer time and do not mind when positions are open for several months. They can simply set their entries, profit targets, and stop-loss, and monitor the trade from time to time. Swing traders can fall into this category. So, if you want to decide if you want to trade with a scalp, you need to clarify which trading style suits you best.
In addition, you will need to find a trading strategy that suits your personality and risk profile so that you can apply it consistently and profitably. Naturally, you can try out several strategies and see what works and what doesn’t.
However, it is worth reiterating that if you do not have sufficient knowledge of technical analysis, scalping can seem like a rather complicated trading strategy, so before mastering it, you may need to take training courses for professional traders.
Scalp trading is a profitable, exciting, and interesting profession. But as in any business, knowledge, and experience are important here.