Most scalpers try to benefit from price patterns in trading the markets. Those who like calmer markets choose to exploit formations like triangles and flags, while those who prefer trading the news tend to be active during breakouts. There’s no single type of market where scalping can be applied to best benefit, because there are many different kinds of scalpers. But there are some technical patterns which offer their greatest benefits to a scalping strategy, and those are the patterns which we’ll examine here.
First we’ll take a look at scalping during breakouts, and then study ranges. Afterwards we’ll discuss trend-scalping with fibonacci levels under a separate heading.
a. News Breakouts
The most typical and significant breakouts observed on any trading day are those associated with important news releases, regardless of their nature. Volatility maybe caused by an unexpected government announcement, at other times a surprising result from a statistical release, and sometimes a mundane piece of data which the markets choose to interpret in an agitated manner. The characteristic of these events is a rapid rise in volatility: a strong initial movement which then has aftershocks, so to speak, lasting over hours and generating swings and fluctuations which are then exploited by scalpers. Scalping in the aftermath of news releases is different from scalping in stale, range bound conditions with respect to its stop-loss requirement, the average life of a trade, and the necessary risk controls.
Although this kind of scalping has some resemblance to fundamental trading, in fact it is a purely technical approach, and has little to do with the real nature or significance of the news or data releases. It is not possible to fully evaluate the meaning of a piece of economic data in the ten minutes where market reaction is most intense, and as such, there is no point in giving fundamental meanings to the market’s behavior during the same time period. This is especially the case when we consider that news releases are revised frequently, and sometimes drastically following the initial release.
In the above graph we have the hourly EURUSD chart and the highlighted region shows the immediate price reaction to the news release at 8 am, followed by its subsequent legs. As soon as the important piece of news was released the market generated a rapidly increasing momentum which never gave traders a chance to look back. The maximum value around 1.4290 was also the opening price of the hourly bar, and it was never revisited. It is easy to conjecture that soon after the release, and in the period immediately preceding it, spreads had widened significantly, and opportunities for scalping were limited. Yet, right after the news release liquidity came gushing back to the market, as traders hastened to readjust their positions. Favorable conditions for scalping would exist within about ten minutes after the news release.
The most important rule while exploiting a news breakout is to stay away from the market during the short period around the news release itself. Unless one is using automated tools for scalping, this brief period is too agitated, and chaotic to allow informed decisions. Worse yet, in the short term the brief but powerful widening of spreads makes technical planning an insurmountable task at times. Instead, a successful scalper will use this brief period to identify the possible direction of the market before entering positions in accordance.
In the example above, we’d be able to scalp the market for a four-hour long period, during the four red candles in the highlighted area. The best way to ensure against suffering losses in the volatility of this period is using a reasonably tight stop with a somewhat looser take-profit order. In example, if we open a short position at around 1.4250 during the third hour, with a 3-pip spread cost to be paid to the broker, we’ll place our stop loss at 1.4255, while our take profit order will be at around 1.4240. This would ensure a 2:1 risk-reward ratio for the position being maintained.
It is a good idea to add a time-stop to a scalping position as well. What is a time stop? This is a kind of stop order which will close a position once a certain period of time is reached, regardless of the amount of profit or loss involved (although of course, both the potential loss or profit are less than what would be indicated by the stop-loss or take profit orders). For example, in our previous example, we had placed our stop loss at 1.4255, while our take profit order was at 1.4240. When we add the time-stop to our initial order at, say, 2 minutes, we’ll close and exit our position two minutes after its opening regardless of the profit or loss involved in the trade.
Why do we use the time stop? We had defined previously that as scalpers we don’t want to be exposed to the markets for a long time. But the market does not need to listen to our expectations, and might as well refuse to hit both the stop-loss and take-profit points for a long of period (at least in the terms of the scalper). The longer we expose ourselves to market moves, the greater the risk of a sudden, sharp movement against our expectations. In order to prevent being caught in such an indecisive, but also dangerous market, we use to time stop as a safety valve allowing us to bail out of our positions if things don’t turn out as we had initially expected.
Scalping of news breakouts can be very profitable, because all the ideal conditions required by scalpers are present. The swift, large, moves which occur in the brief timeframe during which scalpers are willing to expose themselves to the market allow the formulation of profitable forex scalping strategies.
b. Technical breakouts
What we term a technical breakout is the case where a range breaks down without any obvious news catalyst. News are released continuously all over the world during the trading day, and although it is often possible to tie a piece of the price action arbitrarily to a piece of news being released somewhere in the world, it is not always practical to identify what causes what in the chaotic trading environment with any certainty or exactitude. These seemingly inexplicable, sudden and difficult to predict breakouts will be termed technical breakouts in this text.
Scalping this kind of breakout requires a lot more conservatism in comparison to the scalping of the usual news breakout. There is very little clarity as to what is causing what, and a market that is up may soon reverse and go down with little or no warning. To avoid being caught up in the chaos of such conditions, it is a good idea to use even smaller trade sizes, sensible stop-loss orders,
In this chart we see the hourly movements of the USDJPY pair confined between 94.02 and 94.71. The highlighted area shows the region we would like to trade. Since the established range rests between support and resistance levels which are tested only twice, we would not have had the opportunity to trade the range itself developing on 28-29 July for profit, using scalping or any other method. On the other hand, we are ready to do some scalping in order to exploit the breakout which occurs at around 7 am on 29th July.
The volatile nature of breakout is demonstrated by the green candle next to the small red arrow on the chart where we see observe the closing price of the bar only slightly above the resistance line displayed. Scalping is suitable conditions such as these because scalpers do not need to think long and hard about the ultimate direction of the price. In the timeframe of a one or two hours, five, ten minutes, the price action is more or less random, and it is not very sensible to try to seek logical explanations for it. Scalpers can avoid doing so, and that is their advantage in breakout scenarios, and similar sudden and unpredictable markets.
While scalping this breakout, we’d use a chart with a shorter term, and not the hourly graph which we see above. Fortunately, the fractal nature of price charts allows us to trade a 5-minute chart in a way the same way that we trade a 5-month chart; the scalper only needs to apply the general rules of technical trading to the shorter time frame. The key issue is making sure that you’re on board the trend, or in harmony with the phase of the range pattern (up, or down) while scalping.
c. range Patterns
A scalper trading a range pattern will try to identify the time periods and price patterns where activity is most subdued, and will exploit them for profit. We have already discussed some of the general concepts in trading ranges, here we’ll try to apply them in greater detail.
Price charts are similar to fractals. They are self-similar at multiple time periods, with a price range at 30 minutes sometimes accompanied by a trend on a 30 second chart. While trading ranges scalpers must keep both the hourly, and the minutely price events in mind. We’ll use hourly charts to ensure that overall activity in the market is subdued, while using the short term price action to identify and trade profitable periods.
The hourly chart of the USDCHF pair presents an interesting scenario for scalpers. A large hourly range lasting for a number of days is coupled to fairly strong directional movements requiring some trend following skills for successful exploitation.
At this stage, observing the price action in the chart, we must ask ourselves the question: can we determine the severity of short-term volatility by examining charts which show long term activity? The answer is no. Although we can determine the ultimate direction of short term price movements by examining long term charts, volatility on an hourly chart, for example, does not need to be duplicated on a short term chart exactly. The price may move 100-pips in the course of an hour, and the chart would show a large green candlestick, but all that large movement could have happened in the last ten minutes of trading, with the previous fifty minutes presenting choppy, and boring conditions. In other words, the scalper must concentrate on the time period before him, especially if he is aiming to exploit random price movements that go nowhere (as in range trading), in contrast to scalping a strong directional trend. In the latter, the perspective provided by long term charts may be helpful, but in range scalping utmost attention must be devoted to the 1-minute, 5-minute graph which is being traded.
In the graph above the price is confined between 1.0654, and 1.0741. The three red arrows show us the opportunities where we can be confident that the range will hold: when the resistance line is tested for the third time, we will consider this an opportunity for sell-side scalping. When, at around 27th July 5 am the price rebounds from the support line for a second time, and later for a third, we’ll regard the market conditions as being ideal for establishing long positions repeatedly.
d. Flags
Many scalpers prefer to exploit range patterns as they present quiet, tame conditions where various strategies can be utilizied without the danger of large losses which would arise in conditions of high volatility. Scalpers who thrive in these conditions have no great expectations from individual trades, and are perfectly content with unexciting, slow markets where “nothing is going on”, from the point of view of a trend follower. In spite of the brief lifetime, and small profit of individual trades, great gains are realized as profits of several hours are combined at the end of the trading day.
In this fifteen minute chart of the USDCHF pair we observe a strong hourly trend only briefly interrupted by the highlighted flags. Although the formations are not perfect, they are perfect as continuation patterns, and present quite, subdued periods where the scalper can test his skills. Of the three flags highlighted in this chart, the first and the third are the tamest, and the easiest to exploit. In both of these the price moves up and down in a simple range, and doesn’t possess directionality.
How does the trader exploit this situation? In essence we’ll regard the flags as small range patterns the upper and lower bound of which can be used as trigger points telling us to reverse the direction of our trade. When the price rises and approaches the upper edge of the flag, we won’t trade, but wait until it is reversed and a sell order is possible (we don’t want to enter a sell order immediately because of the possibility of a breakout). After that we’ll enter and exit small and quick sell orders trying to exploit the established range pattern. Conversely, when the price falls and touches the lower bound of the flag pattern, we’ll wait until it begins to rise again, and then we’ll scalp the market with buy orders.
It is quite simple and easy to scalp the market when there are flags appearing. But flags are very strong continuation patterns, and we must be careful not to get caught in the breakout when the flag pattern dissipates and gives way to the momentum of the main trend.
Triangles can be traded in the same manner as well, and any consolidation pattern can be used for scalping within the range established. As we mentioned before, the rules of range trading can be applied, along with the appropriate strategies, while using the necessary risk controls inside the preferred brief time frame of scalpers.
It is possible to think of scalping in two different ways. In one approach, the trader is concerned purely with the slow price fluctuations that occur in a short period time, and uses technical methods to trade them. In the other approach the scalper can also be a trend follower, or a swing trader, but he uses very small, fast trades as a rule. The latter approach tells the trader to exploit rapid and sharp price movements, while maintaining an eye on the overall market direction in order to control risk exposure. The first approach, on the other hand, requires that the trader benefit from slow, and small price movements which go nowhere: while the price is moving slowly up and down, it will generally return to where it left, and it is possible to trade it without taking great risks.
In this section we’ll take a look at both approaches. We’ll discuss the pure scalping approach in the context of ranging markets where volatility is the main method for generating profits. We’ll also examine the combined approach while studying the subject of scalping with the Fibonacci extensions in trending markets. Let’s note here that technical strategies that can be applied in day , or swing trading are equally valid in scalping as well, and that there’s no difference (apart from the role of the spread) between a 5-minute or 5-month chart as far as analysis is concerned. The reader is invited to read about technical indicators and strategies here.
Before going on further and discussing the details of the subject, however, we wish to say a few words on the psychological aspect of scalping. As we mentioned before, scalping is an emotionally intense activity where the trader must keep calm nerves in the face all kinds of unexpected events. Clearly, overcoming these issues and maintaining a consistent and disciplined approach to trading is a precondition to achieving any kind of profit in the forex market. So how does the trader achieve this necessary degree of emotional restraint and composure?
People remain calm and composed in conditions with which they are familiar and knowledgeable about. Most of us are disturbed if a car makes a sudden movement, but are not bothered while an airplane is taking off with great momentum and speed. Similarly, the same person can perceive anxiety by a small unexpected cut on a finger, yet feel relatively composed while heading to the hospital in order to be operated on by a surgeon. In other words, our emotional responses to risky activities and disturbing conditions are not entirely dependent on the nature of what is being experienced, but more on what is being perceived by us.
As such, in order to be successful a scalper must accustom himself to market conditions in such a way that losses and profits in the markets are expected and acceptable. We need to convince ourselves, and teach that there is no danger, so that we can trade with confidence. Needless to say, if there are real causes for concern, fear is appropriate. If we are risking more than we should, taking too much leverage, or don’t know what we are doing, we’ll feel nervous, timid, and insecure about our trading decisions. In that case, the first step is ensuring that we are not taking unnecessary risks. It is difficult for scared money to profit, and even more so in scalping, therefore, we need eliminate the logical causes of fear from our practice.
If after removing such causes we still feel nervous and worried about what we are doing, it is necessary to take additional steps to deal with the causes of our irrational perceptions. These steps should involve the automation of our tactics. The suggestion for scalpers is to begin this learning process with very small sums which are then increased and combined as experience allows greater, healthier returns. Since at the earliest stages the purpose is not to make profits, but gaining experience, small accounts with minimal leverage are necessary. There is very little point in worrying about a small loss if by realizing it we are gaining important lessons about what should and should not be done in the markets. By being accustomed to difficult market conditions which accompany scalping in the markets, we can prepare ourselves for the ultimate challenge of trading significant sums in the forex market. As we like to say, no body can leap to the top of a mountain or a skyscraper, but by climbing on rocks, or using the stairs many people are capable of realizing such an seemingly impossible deed.
In scalping, the time period preferred will depend on the technical strategy employed. Some scalpers prefer choppy, directionless markets when utilizing this style, while others prefer to trade strongly directional, highly liquid and volatile markets. This choice is mostly a matter of personal preference, but the two kinds of markets do offer different environments where different strategies will bear greater profit. In this section we will not discuss the methods, but will consider the time periods when a particular approach is likely to bear the best results.
Also let’s add here that a scalper is under no logical obligation to exit a trade if there is enough reason to believe that holding it a while longer may be profitable. The rules that should not be broken are about money and risk management, and there is nothing iron-solid about trading styles. Although in general scalpers should liquidate their positions rapidly in order to maintain consistency, there is no rule which forbids the combining of several trading styles by the same trader. It is common that during the most volatile periods of trading, positions held longer than what is common with scalping can be more beneficial and prudent. If that is the case, there is no reason to avoid doing so just because the trader considers himself a pure scalper, so to speak.
Throughout this text, all times are ET (New York time).
7:00-8:00 am
This is the time period when European markets often experience choppy conditions as traders prepare for the opening of the New York market at 8 am. Since there are option expiries and news releases in this time period, and statistical releases of the European session (which are released around 4 am) have already been absorbed, most traders choose to sit back and reconsider their strategies before North American players enter the forex game. The London and Frankfurt markets are both open at this time, but liquidity lessens as trading desks reduce gear.
Scalpers preferring choppy conditions may find an excellent environment for practicing their skills and refining their talents during this period. Since the market is choppy, strategies that aim to exploit small oscillations in the price to either side can be applied effectively and consistently. It is important to remember, however, that in some cases some anticipated economic event may make the market agitated and stir the water more than what is appreciated by the scalper.
This period is a more volatile version of the last two hours before the North American market close around 7 am. Let’s also note that sometimes the pre-news release volatility in the market can assume a directional character as prices rise or fall significantly but slowly over the one and a half hours preceding the 8:30 release. In spite of the directionality, the slow nature of the price movement can make scalping a favorable option over a buy-and-hold strategy in the period leading to the release. Triangles are common, and it is possible to scalp them by remaining in side the range implied by the triangle.
8:00-10:00 am
During this period, the New York, London, and Frankfurt markets are all open; there are a number of important news releases, and option expiries also take place. As such, this is by far the most liquid and volatile period of the trading day, and requires appropriate scalping strategies for exploitation.
During these two hours micro-trends proliferate, in other words, rapid and sharp directional swings are commonplace as many market events and news releases stir the waters of the forex market repeatedly. In order to exploit these movements effectively, the scalper must possess a reliable technical approach which can be used to exploit rapidly changing conditions. Although we will discuss the technical aspects of trend scalping later, we will mention the importance of building up positions and letting profits run, if possible, in this highly trending market. Of course, scalping involves rapid opening and closing of positions, but unless we let profits run in the sharp moves encountered during this period, the rapid swings that cause us lossess will be able to erase whatever profit we gain with other positions. It is a good idea to be alert, and if caught in the middle of a strong trend which we have guessed correctly, there’s no reason to avoid exploiting it to the full.
If we decide to build up positions in this period, we may move stop-losses gradually to breakeven for our trades so that some of them can be left to run for as long as they can. Since the stop-loss will generate a profit even if it is activated, we can go ahead and continue our scalping while the positions which are safe continue running.
3:00-7:00 pm
This period can itself be divided into two separate phases. Between 3pm and 5pm, many banks in the U.S. are still open, but they are closing gradually as the day progresses. The period between 5 pm and 7 pm is the quietest part of the trading day. Almost all major markets are closed, and while trading is still continuing, activity is subdued significantly. This is the golden sixth of the scalper who prefers calm, and slow markets where small, directionless oscillations can be exploited with great effectiveness. During this one sixth of the trading day, scalping strategies can be employed both manually, and through automation by traders who seek rapid and low risk profits.
The first part between 3-5 pm is more suitable to scalpers who prefer some volatility in the markets in order to realize more sizable profits. On the other hand, since many banks in the U.S. are still open during this period, volatility and risk are somewhat higher than the following period. Between 5-7 pm, on the other hand, almost all major banks in the developed world are closed, and extremely choppy, quiet conditions prevail.
The best way to scalp in these conditions is to use very small and rapid trades, and avoid building up positions. Since directionality in such choppy conditions is unlikely, there is little point in accumulating positions, and tampering with take-profit or stop-loss orders. Quick, multiple trades taken in quick succession without much consideration given to the overall conditions in the market constitute the favored approach of traders during this time period.
Scalping is a highly specialized activity which requires a favorable technical and fundamental setup to yield its full potential. In the previous section we examined the necessary preconditions sought from a broker, here we’ll take a look at the currency pairs which are best suited to scalping strategies.
In general, the best currency pairs for scalping are those that are not prone to very sharp movements, or if they are, such movements are less frequent. In that sense, the best group for scalping is the group of major pairs discussed below, and among them, the most liquid and least volatile one is the EURUSD pair.
a. Majors
This group includes pairs such as the EURUSD, the GBPUSD, the USDCHF, and others which are formed by currencies of the most powerful and dominant economic powers in the world. Although the JPY (Japanese Yen) pairs can also be examined in this group, they behave differently and we’ll examine them under the heading of carry pairs.
The main property of the majors pairs is liquidity. Their second characteristic is relatively subdued responsiveness to market shocks. An event which can cause a 100 pip movement in the AUDJPY pair will move the EURUSD by 30 points usually, sometimes less. The major pairs are traded all over the world, by almost all banks and important institutions (since they are often reserve currencies). They are the bulky giants of currency market in terms of trade volume, and move slowly.
Scalpers who prefer to trade ranges, or to exploit slow, and small movements in currency pairs for conservative profits can concentrate their activities in the major pairs.
b. Carry pairs
Carry pairs are liquid, but volatile. Pairs such as the EURJPY or USDJPY are traded all over the world, and trading is activity is hectic, but they are also very volatile, because many financial actors use the Japanese currency to borrow and invest in various risky assets. As a result, when there is a market shock these pairs react in an excessive fashion which is difficult to interpret for trading decisions, especially so in the short time frame favored by scalpers.
The carry pairs are traded mostly for interest income. Although it is possible to scalp them as well, it is not a great idea because at times spreads widen so rapidly that even a stop-loss order cannot protect our account from a significant loss. The sudden widening of spreads is not unique to carry pairs, but while in the EURUSD pair it is often seen after the non-farm payrolls release, or major interest rate decisions, in carry pairs it is more frequent, deeper and longer lasting.
We do not advise beginners to scalp with the carry pairs. Experienced scalpers can trade them with typical trend following strategies in order to exploit breakouts and other sharp movements.
c. Exotic Currencies
Exotic is a term used in the options market, but we’ll use the term to discuss the comparatively rare, less liquid, and less well-known forex pairs which are mostly unsuitable to scalping. This group includes such volatile pairs like NOKUSD (NOK being the Norwegian Krone), the Russian ruble, the BRLUSD pair (with the Brazilian Real), and many other lesser known ones.
This group is not suitable to scalping because unpredictable price gaps are frequent, and it is difficult to use money management strategies in the short term. Especially beginners should avoid them to avoid getting scalped while trying to scalp the market.
Forex scalping is a popular method involving the quick opening and liquidation of positions. The term “quick” is imprecise, but it is generally meant to define a timeframe of about 3-5 minutes at most, while most scalpers will maintain their positions for as little as one minute.
The popularity of scalping is born of its perceived safety as a trading style. Many traders argue that since scalpers maintain their positions for a brief time period in comparison to regular traders, market exposure of a scalper is much shorter than that of a trend follower, or even a day trader, and consequently, the risk of large losses resulting from strong market moves is smaller. Indeed, it is possible to claim that the typical scalper cares only about the bid-ask spread, while concepts like trend, or range are not very significant to him. Although scalpers need ignore these market phenomena, they are under no obligation to trade them, because they concern themselves only with the brief periods of volatility created by them.
Forex scalping is not a suitable strategy for every type of trader. The returns generated in each position opened by the scalper is usually small; but great profits are made as gains from each closed small position are combined. Scalpers do not like to take large risks, which means that they are willing to forgo great profit opportunities in return for the safety of small, but frequent gains. Consequently, the scalper needs to be a patient, diligent individual who is willing to wait as the fruits of his labors translate to great profits over time. An impulsive, excited character who seeks instant gratification and aims to “make it big” with each consecutive trade is unlikely to achieve anything but frustration while using this strategy.
Scalping also demands a lot more attention from the trader in comparison to other styles such as swing-trading, or trend following. A typical scalper will open and close tens, and in some cases, more than a hundred positions in an ordinary trading day, and since none of the positions can be allowed to suffer great losses (so that we can protect the bottom line), the scalper cannot afford to be careful about some, and negligent about some of his positions. It may appear to be a formidable task at first sight, but scalping can be an involving, even fun trading style once the trader is comfortable with his practices and habits. Still, it is clear that attentiveness and strong concentration skills are necessary for the successful forex scalper. One does not need to be born equipped with such talents, but practice and commitment to achieve them are indispensable if a trader has any serious intention of becoming a real scalper.
Scalping can be demanding, and time-consuming for those who are not full-time traders. Many of us pursue trading merely as an additional income source, and would not like to dedicate five six hours every day to the practice. In order to deal with this problem, automated trading systems have been developed, and they are being sold with rather incredible claims all over the web. We do not advise our readers to waste their time trying to make such strategies work for them; at best you will lose some money while having some lessons about not trusting anyone’s word so easily. However, if you design your own automated systems for trading (with some guidance from seasoned experts and self-education through practice) it may be that you shorten the time which must be dedicated to trading while still being able to use scalping techniques. And an automated forex scalping technique does not need to be fully automatic; you may hand over the routine and systematic tasks such as stop-loss and take-profit orders to the automated system, while assuming the analytical side of the task yourself. This approach, to be sure, is not for everyone, but it is certainly a worthy option.
Finally, scalpers should always keep the importance of consistency in trade sizes while using their favored method. Using erratic trade sizes while scalping is the safest way to ensure that you will have a wiped-out account in no time, unless you stop practicing scalping before the inevitable end. . Scalping is based on the principle that profitable trades will cover the losses of failing ones in due time, but if you pick position sizes randomly, the rules of probability dictate that sooner or later an oversized, leveraged loss will crash all the hard work of a whole day, if not longer. Thus, the scalper must make sure that he pursues a predefined strategy with attention, patience and consistent trade sizes. This is just the beginning, of course, but without a good beginning we would diminish our odds of success, or at least reduce our profit potential.
Now let’s take a look at the contents of this article where forex scalping is discussed with all its details, advantages and disadvantages. Our suggestion is that you peruse all of this article and absorb all the information that can benefit you. But if you think that you’re already familiar with some of the material, to shorten your route, we present the table of contents of this article.
Contents
1. How scalpers make money: Here we will take a look at the logic behind scalping, and we’ll discuss the best conditions and necessary adjustments which must be made by a scalper for profitable trading.
2. Choosing the right broker for scalping: Not every broker is accommodative to scalping. Sometimes this is the stated policy of the firm, at other times the broker creates the conditions which make successful scalping impossible. It is important that the novice scalper know what to look for in the broker before opening his account, and here we’ll try to enlighten you on these important points.
3. Best currencies for Scalping: There are currency pairs where scalping is easy and lucrative, and there are others where we advise strongly against the use of this strategy. In this part we’ll discuss this important subject in detail and give you usable hints for your trades.
4. Best times for Scalping: There is an ongoing debate about the best times for successful scalping in the forex market. We’ll present the various opinions, and then offer our own conclusion.
5. Strategies in Scalping: Strategies in scalping need not differ substantially from other short-term methods. On the other hand, there are particular price patterns and configurations where scalping is more profitable. We’ll examine and study them in depth in this section.
a. Range Scalping: Some traders consider ranging markets better suited for scalping strategies. Here we’ll examine why, and how to scalp under such conditions.
b. Breakout Scalping: We’ll examine news breakouts, and technical breakouts separately and discuss suitable scalping strategies for both.
c. Trend Scalping: Here we’ll take a general look at forex scalping in trending markets.
6. Trend Following while Scalping: Trends are volatile, and many scalpers choose to trade them like a trend follower, while minimizing the trade lifetime in order to control market risk. In this part we’ll examine the usage of Fibonacci extension levels for scalping trends.
7. Disadvantages and Criticism of Scalping: Scalping is not for everyone, and even seasoned scalpers and those committed to the style would do well to keep in mind some of the dangers and disadvantages involved in using the style blindly.
8. Conclusions: In this final section we’ll combine the lessons and discussions of the previous chapters, and reach at conclusions about who should use the forex scalping trading style, and the best conditions under which it can be utilized.
Over the years, forex has acquired such a bad reputation that there are books published sold with statements similar to the below:
"And you're surprised that we suggest gambling strategies for forex? But don't be, there is no way of knowing if a currency will go up or down, and the likelihood of guessing the next movement is as good as it is with guessing a coin toss. But don't be alarmed: coin tosses and similar gambling strategies have been perfected by experts for generations. In this book you'll find all you need on how to profit from trading forex with the only methods that work: betting strategies that experts use to beat each other."
Though such innovative approaches to forex are bound to bring a smile to our lips, and very short term movements in the forex market are indeed very difficult to predict, solving the uncertainties associated with the market with gambling methods is like throwing fuel on fire. You're unlikely to make much from such a brave, but ultimately futile effort.
Before looking at these strategies we must make an assumption that the outcome of each movement at a chosen time period (say 1-minute, 5-minute, 30 seconds) is independent of the preceding or following period. In other words, if there are three or four 5 minute periods (say P1,P2,P3,P4) and in one of them(say, P2) the price is up, this result has no bearing on the outcome of the other two 5 minute periods(P1,P3) which follow and precede it. The opposite of this assumption, which suggests that there’s memory in the trading process, that the outcomes influence each other, would change the nature of our trading entirely. If this were true,we could apply mathematical tools, such as the z-score which we will discuss later, to maximize profits and minimize losses.
Let us look at a number of these strategies:
Martingale
This strategy was first developed in 18th century France, and has its roots in the mathematical and scientific developments of the enlightenment era.
The martingale strategy involves increasing bet sizes with every losing coin toss. When the trader bets with amount x that a currency will go up at P1, and his bet fails, he will simply double the amount to 2x, and repeat his bet that the price will be up at P2. When the bet fails again, he will double the amount to 4x, and bet the price will be up at P3, and will go on with this until he wins what he wants, or he’s bankrupted as he receives a margin call.
Period
| P1
| P2
| P3
| P4
|
Outcome
| Down
| Down
| Up
| Down
|
Amount bet
| 1
| 2
| 2
| 4
|
Account Value
| 9
| 7
| 9
| 5
|
Now the point of this trade is simple. Even if the trade was a failure at P1, and a portion of original capital (amount x) was lost, a win with twice the original capital would cover the original losses, and register a profit. The same logic is valid at P3, P4, and so on.
In order to win, the martingale trader is making the assumption that short term trade results (coin tosses) are not independent of each other. That is, one coin toss, or one losing trade, is somehow influencing the outcome of the next trade in line, and making it less likely to be a loss as a result of mean regression.
Unfortunately for him, as we stated before, the outcome of coin tosses or trades at each period is independent, and there can be any large or small number of heads or tails (or a sequence of up P1, P2, P3, P4, P5) without constituting an anomaly. We will come back to this subject when discussing the gambler's fallacy.
Anti-Martingale
In the anti-martingale strategy, the trader does the opposite of what the martingale player does, but still reaches at the same outcome, because events are independent, and it's not possible to sustain a winning streak infinitely.
So what does he do? Instead of doubling on losing trades, he doubles on winning ones, and for instance, if he bets x at P1, and loses it at P2, he keeps betting x at P2, until he makes a profit at P3, when he doubles his bet to 2x, and goes on like that until the account is wiped out.
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Period
| P1
| P2
| P3
| P4
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Outcome
| Down
| Down
| Up
| Down
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Amount Bet
| 1
| 1
| 2
| 2
|
Account Value
| 9
| 8
| 9
| 7
|
It's of course very simple to see the problem with this method. What makes the trader double his risk on a winning trade at P3 if the result of P3 signals nothing about the winning potential at P4? And we have already made the statement that outcome at each period is independent of everything else.
Gambler's Fallacy
Gambler’s fallacy is the unjustified expectation that outcomes that constitute a rare series will regress to the mean in the future. Thus, the gambler (for example, the martingale strategist) believes that a streak of four losses at P1, P2, P3, and P4 implies a higher probability of success at P5, because of the deviation of the series from the mean. A simple example of this is the belief that four successive heads in a series of 5 tosses will make the last outcome being a tail likelier.
In fact, the probability of heads or tails will remain just ½ at every single toss if the coin tosser has an infinite amount of opportunities of repeating the toss. If the number of tosses allowed is limited however, the probability of getting a successful bet actually diminishes with every successive failure.
Note that the opposite is also false: This is the belief that in a random process (such as short-term fluctuations, or coin tosses) developments that occur one after another influence the outcome of the next to conform to the series, exemplified in the expectation that if a coin toss returns a tail at P1, P2, P3, P4, the result at P5 will also be a tail. Or, we can say using familiar terminology that in a micro trend (on a thirty second, five minute, or one minute chart) an up movement at P1, P2, P3 and so forth, will imply an up movement at P5.
The gambler’s fallacy is only valid in random processes where there’s no relationship of causality within members of a series, or in other words, successive outcomes are independent of each other. So, as in our previous example, if the coins were somehow shaped to increase the likelihood of tails at each successive throw (that is, if the coin tosser were cheating), the gambler would be justified in expecting tails eventually, and the outcomes would not be independent of each other. How do we judge if the streaks of wins and losses generated by our method are random or not (and independent of each other)? To decide on that we use the z-score, and the interested may read the related article on this website.
Money management is about the proper application of the points we discussed: Capitalize the account sufficiently, do not overleverage, be disciplined about profit taking, and avoiding losses. There's nothing that difficult about doing this:. In general, decisiveness about one's plans, and prudence about taking risks will grant the patient trader success in a manner that might even be surprising for him. We must remember that a successful trader (unless his success is the result of extraordinary times and conditions) is not a flashy, exciting, boastful, or prodigious being: in many cases he's just a cautious, patient, modest, calm individual with good but not exceptional intelligence. His success is not the result of some very esoteric knowledge, revolutionary trading method, superhuman insight or intuition: but rather it's about diligence, hard work, and humility.
In the previous three parts we discussed what you, as a trader, should not do. In this section we'll take a brief look at the rules of money management.
Taking profit, and stopping losses are the two concepts that form the core a successful money management strategy; do not let greed erase your profits, and do not let pride prevent you from exiting a position that is proven to be wrong.
Entering a stop-loss or take-profit order is rather simple since in almost every trading software the program will prompt you to enter these orders as soon as you make a trade. In general, unless a trader has a clear schedule for the duration of his position based on fundamental analysis, a take-profit order is a must. A stop-loss order is almost always a must however, regardless of the basis of your analysis. Of course, the stop can be wide and tight at the discretion of the trader, and if there are good reasons behind the position you take in the first place, persistence against market swings can be appropriate and rewarding. The key point that distinguishes foolish persistence from logical resilience is that the fool persists because he's afraid of realizing losses, while the successful trader keeps to his position based on his analytical skills which were acquired after the realization of countless stop-loss orders during the learning process.
As with everything else, the trader must base his stop-losses, and take-profit orders on reason and logic, not on any kind of intuition, sixth sense, or emotional matter. The nature of forex is such that, due to constant volatility, even a well-conceived, and well-thought position will at some stage have to be in the red. Provided that we don't revise our initial purposes and schedules based on fear or euphoria, there's nothing wrong about that, and the trade should always be allowed to run its course, if the causes that led to our decision remain intact. If they are gone, the trade should be discarded too. But if the reasons are still valid, we shouldn't be afraid of unrealized losses: we placed the stop-loss order at where it is only to allow the position to run its course.
We mentioned before that regardless of our political or social persuasion, we must choose to be boring and conservative to achieve success in trading. Successful money management always aims at the preservation of capital, not necessarily great profits. We already detailed many of the reasons for that conviction, but another reason for our conservatism in taking risks is provided by the fact that it's a lot timelier and costlier to repair a mistake in comparison to the time it takes to commit it.
To give a very simple example: supposing that through reckless errors we lose about half of our account while trading, what would be the profit ratio we'd need to repair the mistake and get back to our beginning capital? Say we begin at 100 USD, lose ½ of it, and end up with 50 USD. We'll need to double our account just to get our losses back. In other words, for a fifty percent loss, we need a hundred percent profit, just to mend the damage caused by recklessness. With such facts standing against cavalier behavior in the markets, how can we avoid being conservative in trading?
Here are a number of time-tested methods the trader can employ in order to minimize his losses, and to achieve a moderately successful long-term career.
- Do not take a trade if you can't back it with very convincing reasons. Your capital is precious, and it's limited. Opportunities in the forex market are limitless, and there's always another chance, if you (and your capital) are there to take it.
- Do not trade on others' opinions, unless you understand and agree with them. We emphasized repeatedly that understanding what we do is the only way to gain confidence in our actions and minimizing the role of emotions, and we won't learn anything without understanding what we're doing.
- Do not change your stop-loss, or take-profit points once you enter them. If the reasons behind the trade are gone, discard it. If they remain, let the trade run its course. Sit back, and forget about it. Concentrate on your education. Remember, panicking will not gain you a dime, and however long you stress about your success or failure, the market will do what it wants: you cannot influence its decisions. Stress will ruin your nerves and wreck your career, but won't better your chances of success, and will not save you from realizing losses on an erroneous position.
- Do not expect your stop-loss order to absolve you from faulty analysis. The stop-loss order is not a safety valve to care for the mistakes of a lazy analyst, it's only a mechanism for recognizing that your analysis was wrong. Thus, if there's no good reason for the trade in the first place, the stop-loss order will be completely useless, regardless of how tight or wide it is..
- Do not be enthusiastic, do not be fearful. Neither will help you. Forex is not a game, it's a business, and you have the responsibility for your choices. There's nothing magical about it.
- Do not hurry to take profits, and tarry in liquidating an outdated position which the events have proven to be erroneous. Taking profits and stopping losses should both occur when the events provide the reasons for doing so, or the price action forces you to make choices.
- Do not use high leverage and tight stops together, as that is the fastest path to a wiped out account. Instead employ low leverage to control your risk, and use stop-loss orders to manage volatility and price swings. To repeat, use low leverage to ensure that when you make a faulty analysis, the results are tolerable; and use wider stops to ensure that the position can absorb random price swings.
- Do not average down, do not add funds to a losing position. If you have confidence that the position in red will eventually turn black, let it run its course, but do not ever add to it. Let time show you if your analysis was right or wrong, but do not attempt to fight the market by haughtily increasing the size of your losing position in order to average down the starting the price. Do not increase your risk while you're in the red.
- Scale in. You can use multiple entry orders on top of each other as the trend moves in the direction you anticipate. As your first order makes a decent profit, set its stop-loss order at the entry price, enter a second order in the same direction, and repeat as long as the trade is successful.
- Do not gamble. Do not use casino strategies in a financial business.
Thanks to the Internet and the relatively recent availability of online forex brokers, just about anyone with a computer and an Internet connection can open a demo forex account and trade forex with virtual money.
This feature allows newcomers to forex trading to get a better idea about what trading forex involves and also helps them improve their education about the huge largely-unregulated forex market.
Demo Trading Results Can Differ
Nevertheless, new traders need to be aware that the results they might achieve when trading in a forex demo trading account may be quite different from the results seen in a live forex trading account.
Even if a person performs extremely well trading a demo account, their results in a live account often differ considerably. In general, this phenomenon tends to arise because when your own funds are at risk, a different trading mindset often ensues than when trading with virtual money.
This key distinction tends to affect traders in different ways, depending on their psychological makeup.
Other Reasons Why Demo Trading Gives Different Results
Not only does the difference in a demo trading environment involve the psychological aspect, but the general market environment can also differ substantially.
Although a price is easily guaranteed by a broker for a demo trade when no funds change hands, getting that price for a live trade may be an entirely different matter when trading a live account. This can be especially true during a volatile or fast market when slippage often occurs in the execution of orders.
In addition, because of the lack of financial commitment, traders tend to overtrade and deviate from their set trading plans when trading demo accounts.
If you really want optimal results trading a live account, then it would be wise to trade in the demo account as closely and in the amounts that you will most likely trade once you fund an account.
Alternatively, you can just trade small amounts using a micro account to get a feel for a live trading environment before moving up to a standard account and dealing sizes.
Demo Trading Benefits
Trading virtual money removes the psychological element from trading, so for this reason, it cannot accurately assess a person's trading abilities. Nevertheless, virtual trading can have great benefits when testing the performance of a trade plan and also for trader education purposes.
When used as an educational tool, a forex demo account gives novices a risk-free start to trading in the forex market. In addition, strategies can be put to the test without assuming any risk, all in real time trading situations.
Also, live trading involves inherent risks that can affect the trader emotionally, while trading in a demo account tends to limit a person's emotional involvement in trading. In addition, considerably larger positions can usually be taken in a demo account that may lead to what seems like higher profitability, when in fact, the risk-adjusted returns are actually quite low.
Overall, trading in a demo account offers a great service to novices that would otherwise have to learn using, and probably losing, real money. While the emotional rush of risking real money while trading may be lacking in demo trading, trading a demo account allows you to learn to watch the market closely and can help you get a better feel for how the forex market operates without putting any real cash on the line.
Day Trading can offer a very exciting and lucrative way of trading the forex market for those who take the time to prepare appropriately for the endeavor. As the name implies, the basic idea behind day trading is that all transactions happen during the trader's normal business hours. Also, all day-trading positions are typically closed out before the end of the business day.
Advantages and Disadvantages of Day Trading
Day trading has the primary advantage that at the end of the day, the trader goes home with no positions and no overnight market risk. Another advantage of day trading is that the trader tends to be alert and can more easily focus on and take advantage of intra-day market movements.
Nevertheless, people with heart conditions or those overly-sensitive to stress may want to trade other strategies that are not as intensive and short-term in nature. Also, since the big moves in foreign exchange generally happen when the market trends over weeks or even months, day trading strategies may not give you the same sort of returns as successful trend-following trading systems.
Developing a Day Trading Strategy
If you think you might like to try your hand at day trading, the first thing you will need to do is come up with a successful day trading system. You can start this process by reviewing literature and online resources for information that can help you develop an objective trade plan.
The main idea behind having an objective trading plan involves minimizing any emotional interference that might sabotage your forex trading. Also remember to keep your trading system relatively simple and easy to follow so that you can do so quickly and with confidence.
One especially important consideration with day trading strategies is the risk/reward ratio of the strategy employed. For example, a day trader might set a goal of 30 pips of profit per day with a risk level of 20 pips to begin with. As their trading success improves and the equity in their trading account rises, they can also increase the amounts traded.
Many commercial automated trading robots risk hundreds of pips to make just a few and so they seem to trade well for a while before eventually blowing up on a serious adverse move. You will want to make sure that your day trading system avoids this potential pitfall and uses a risk/reward ratio that is conducive to long-term success.
Testing Your Day Trading System
The next step is to test your trading plan. Many day traders opt to first test their day trading strategy over historical data to find a system that has suitable profitability and draw down characteristics that suit their trading goals.
Then, they will want to trade their system on live data to gain experience and confidence in putting the strategy into practice. This process can also suggest refinements to the day trading strategy that can make it more successful.
Using a Forex Broker for Day Trading
Once an aspiring forex day trader has developed a day trading strategy and practiced implementing it, they can usually open up a free forex demo account with a forex broker without risking any money initially.
Doing so can give a trader a good idea of whether the actual work and returns involved in day trading in the forex market might be suitable for them. You can then usually upgrade and fund your account when you feel confident in your ability to day trade profitably on a consistent basis.
Fundamental analysis examines the reasons behind the price action. The analyst uses economic indicators and news flows to decide on the causes behind price movements. Since one cannot determine the cause of something which has not yet happened, the causal relationships demonstrated by fundamental analysis are always about present market behavior. Nonetheless, economic events move slower than market developments, and this is the real cause of the great predictive and interpretative power of fundamental analysis.
Technical analysis is a relatively new phenomenon. It has been developed mostly in the last century, for the most part by US-based traders, for providing some clarity to short term price actions. Fundamental analysis, on the other hand, has been with us for many centuries. The ancient speculator of the Peloponnesian War in Classical Greece used news flow (hearsay, public meetings) and economic data on supply and demand (starvation, poor harvest) for stockpiling resources and for deciding when to sell them. The ancient Chinese classic Shiji, which records the lives and exploits of important personages two millennia before our time, reports on successful traders and speculators who traded wartime shortages, or the needs of warlords for massive profits. Some of these people were middlemen who exploited the inefficiencies of ancient markets, others were producers themselves with good insight into macro-scale developments, and patience allowed them to successfully utilize their analytical capabilities. But all of them used news and analysis to profit from fundamental developments, without any tool other than common sense to help them.
During the Middle Ages there were the Fugger and the Medici families who took advantage of their good relationships with royalty and governments to stay one step ahead of the markets. The Rotschild family of the 18th-19th centuries also used fundamental imbalances created by warfare to undertake contracts with sovereigns states and for maximizing profits. The twentieth century, of course, has had more than its fair share of traders and speculators capitalizing on market distortions, imbalances and bubbles for very large profits. But at the basic level, the tools of the successful investor, trader or speculator are the same: a good understanding of fundamental data, deaf ears to hyperbole, euphoria and panic, and the strength of will to act when the time is right.
Human life and natural phenomena move on causal relationships. Causality is a major principle of scientific study. And, given how our brains function, it is not possible to make any meaningful decision, judgment or choice without backing it with sensible causes. This is also where the power of fundamental analysis originates. The charts of the technical analyst may give all kinds of profit alerts, signals and alarms, but there’s little in the charts that tell us why a group of people make the choices that create the price patterns. Ultimately, most transactions in the financial markets have reasons that are independent of technical values in the long-term. If a stock goes down in response to a temporary bout of panic among traders, the price will rebound once the dust settles; or, if a currency pair plummets in value because of a false rumor or a temporary squeeze of capital, the situation will inevitably be corrected once a stream of concrete data establishes the false nature of the fears.
Fundamental analysis allows us to decide on the value of an asset. We are unable to be certain about the future value of an asset, and past value is never a good indicator for future prices. But, by all means, we posses the faculties and resources necessary for deciding if the price of an asset is expensive or not, and that is the basis on which the fundamental analyst bases his choices. We can establish the causes behind a trend, we can establish if they are ongoing, and we can exploit that knowledge to bring us profits.
There are many traders who successfully used fundamental analysis to obtain great wealth, but the exploits of George Soros, and his Quantum Hedge Fund have made them household names in our era, particularly after the notorious Black Wednesday on which Britain was forced to drop out of the European exchange rate mechanism. In the rest of this article we will examine this interesting event to drive home the great power of fundamental analysis and how accurate and profitable its predictions can be.
Most traders today know that the British pound is not a part of the Eurosystem. It is an independent currency managed by its own central bank. While some may attribute this fact to the insular mentality of the British and their typical desire for independence from continental customs and habits, this is not the real cause of the existence of the pound today. The real reasons are to be found in the developments of September 16th 1992, and the events leading up to them.
Before it was launched, the nations which today share the Euro as their national currency had to abide by an agreement known as the European Exchange rate mechanism (ERM) which was the precursor to the eventual unification of currencies. The ERM stipulated a fixed currency exchange rate between each national currency and the ECU (the European currency unit, which would eventually be called the Euro), but bilateral currency values were allowed to float within a margin of 2.25 of the the fixed rate. The ERM was created in 1979, and Britain was one of the later members of the EU to join the mechanism in 1990.
At the time Britain joined, the government of Margaret Thatcher was lost in intrigues and disputes about the benefits and the need for ERM. With inflation at 15 percent, to restrain the expansionism of the previous era, the British government had for a while been mirroring the Bundesbank’s policy rates. The decision to join was partly taken to formalize this policy of copying the central bank rates of Western Germany, and also as a result of an argument between the chancellor of the exchequer (the equivalent of the Treasury secretary), Nigel Lawson and the prime minister’s economic advisor, which resulted in the resignation of Lawson. He was replaced by the future prime minister John Major, who in turn finalized the entry of Britain into the ERM in 1990 at a rate of 2.95DM to the pound, with commitment to intervene at 2.778.
As we just mentioned, at the time of Britain’s entry inflation was quite high, due to the expansionist policies of Nigel Lawson. The easy money policy had created a period of boom at the end of the 80’s, but it had also created a property bubble and high inflation which had to be restrained by higher interest rates and a period of economic downturn. Thus, when the crisis struck two years after UK’s adoption of the ERM, economic conditions were already far from being ideal. Unfortunately for the British, this was also a time when German interest rates were even higher than the British rates, as the Bundesbank tried to control the inflationary impact of reunification-related spending.
Mr. Soros, who enters the scene at about this point, had established his Quantum Fund in the early 1970s in partnership with the equally famous Jim Rogers, his initial capital being provided by a number of wealthy acquaintances including the aforementioned Rotschild family. Before his rise to notoriety through his role in the British debacle, he had already made massive profits in trading the collapse of currency pegs and economic deregulation of the 70s. He and his analysts had impressive skills in analyzing the fundamental factors that drive the international economy. Indeed, apart from being a rich financier, Mr. Soros has books published on philosophy and politics, and he is equally well-known as a philanthropist and for his contributions to liberal movements around the world.
Upon analyzing the fundamental situation of the British economy and the increasing gap between the performance of the British and German economies at the time of Britain’s adoption of the ERM, Mr. Soros was increasingly convinced that the British would drop out of the system regardless of the choices they made. The fundamental health of the UK economy was incapable of coping with the demands of matching Germany at the time. Thus, he began shorting the pound as early as spring 1992, in anticipation that high interest rates would eventually deepen the recession in the UK economy, and the resulting fall of asset prices would prove unpalatable to the government authorities. It is thought that he accumulated short positions reaching 6.5 billion pounds (about 10 billion USD), at a leverage of 1:10.
Meanwhile, the situation of Britain continued to deteriorate as the USD kept depreciating, making British exports less competitive on a global basis. The breaking point came, as it often happens, through political turmoil. When in spring 1992 the Danes refused to join the ERM, and it was decided that France would have a referendum on the issue as well, the resulting nervous atmosphere reached climax in a general distrust of the currency pegs of nations that were suffering the worst of the ERM.
On Wednesday, 16th September 1992, as speculators kept selling the pound, the British cabinet held meeting after meeting on how to defend the nation’s currency. They first raised the main rate to 10, then to 12, eventually promised to raise to 15 percent in order to convince the speculators that they were facing the full determination and might of the UK government. The government also bought billions of pounds to prop up the currency, but all that was in vain. Heedless monetary expansionism of the Lawson Boom had created massive imbalances in the British financial system, and the British economy would never be able to function under such a high interest rate burden. Speculators like George Soros had already made their calculations and had discovered the untenable nature of the British peg a long time ago through fundamental analysis, and they would not be cowed into submission by the frantic, but ultimately futile endeavors of the John Major Government.
By 19:00 it was already clear that the peg couldn’t be defended, and the Chancellor of the Exchequer had to declare that the government would leave the ERM framework, and the main interest rate would remain at 12 percent. The credibility of the British government was destroyed in a few hours, the speculators left for new hunts, and George Soros pocketed an estimated 1 billion USD in the process. As the person who took the largest bet, he was instantly notorious across the globe, and to this day he’s known as "the man who broke the Bank of England".
Later, it was also admitted that the 15 percent promise was just a ruse created to calm the markets, and as many speculators believed, the government had no intention of holding the rates at such a high level given the difficulties the British economy were going through.
It is an exciting story, but the sensational value of the events has no use for our trading practices. What are the lessons that we gain from this disaster for the UK economy?
- Fundamental analysis is always right. Imbalances will always be corrected. But it takes time and patience to exploit them successfully. Mr. Soros held his position for months before market developments confirmed his expectations.
- Neither government authorities, nor company heads are immune to the temptation of lying, or “bluffing” as it’s sometimes called. If you’re a speculator, nobody will have any sympathy for you if you lose money, and the only person you can blame is yourself. So be careful about your leverage, your risk and who you believe.
- Macroeconomic events are often triggered by political developments. Political events rarely cause major economic shocks by themselves alone, but accumulated imbalances are usually balanced as a result of political shocks.
- The payback time of expansion fueled by monetary expansionism is exceptionally destructive in any economy. If the economic leadership of a nation is constrained by political obstacles when the payback time arrives, the results are doubly disastrous.
If you intend to use fundamental analysis in the way George Soros used it, you will need a good understanding of both politics and economics. Achieving such a skill is not that hard, provided you have the commitment and the patience to complete your task.
Technical strategies aim to predict future prices on the basis of past developments. All that the technical analyst is interested in is the price, and news, or data have no bearing on his decisions. In this article we will examine some of the basic concepts behind technical strategies, and will attempt to summarize the main tools used by technical traders in braking down price patterns.
As we noted technical analysis chooses to ignore everything except the price in its decisions. A technical strategy will usually involve several phases, each clarifying some aspect of the price action, until a credible entry or exit point is determined. The phases for this are.
1. Identify the type of the market and the type of the trade..
Needless to say, the first step in technical analysis must be the identification of the market with which the trader is interacting. After that he must determine the time period of the trade he will enter. What kind of charts will the trader use for his trade? Will it be a monthly trade, or an hourly one? If it’s a monthly trade, there’s no need to worry about the hourly changes in the price, provided that the strategy regards the present value as an acceptable monthly entry or exit point. Conversely, if the trade is for the short term, the trader may desire to examine charts of longer periods to gain an understanding of the bigger picture which may guide him with respect to his stop loss or take profit orders.
The trader will use trend lines, oscillators, and visual identification to determine the type of market that the price action is presenting. Strategies in a flat, ranging, or trending market are bound to contrast strongly with each other, and it is not possible to identify a useful strategy without first filtering the tools on the basis of the market’s character. Once this is done, and the time frame of the trade is determined, the second stage is -
2. Picking the technical tools
On the basis of the criteria discussed in the previous item, we must pick the appropriate technical tools for the chart we examine. If the market is trending, there’s little point to using the RSI. If it’s ranging, the moving averages are unlikely to be of much use. If the underlying currency pair is strongly cyclical (for example, if the currency is issued by a commodity exporting nation) the commodity channel index could be a good choice. If it is highly volatile, smoothing out the fluctuations with moving average crossovers could be very beneficial for identifying the trend.
Of course the list can be extended. The trader must refine his approach to trade over time by deciding on the kind of indicators which he understands best, and then combining them later to form a simple and concise method.
3. Refine the periods, and other inputs
Upon deciding on the technical tools, the analyst must decide on the periods, and ranges for which values must be supplied to the software. Today’s traders have many advantages over those in the past, but diligence and patience may not be one of those. As we’re so used to having everything automated and performed by the computer with no questions asked, many don’t even bother to tinker with the minutiae that can in fact be all the difference between success and failure for the trader’s analysis.
Thus, before going any further, the trader must check which periods, which values provide the pattern that is most fitting for the price action on the chart. For example, for the RSI, will we pick a period of 14, 10, or 7 for the chart we examine? Or what will be the periods of the moving averages that constitute the MACD indicator? These can only be answered through trial and error, and for each price pattern, a different value may be necessary.
4. Seek the signals
Once the technical tools are setup, we must now seek the signals that will show us the trade opportunities created by investor sentiment and temporary imbalances in the supply and demand for a currency pair. The signals that we seek are the ones created by the interaction between a number of indicators, such as that between moving averages, various oscillators, or between the price and the indicator. Our purpose is to confirm our ideas with various aspects of technical analysis. If there’s an oversold or overbough level, we will confirm it with a divergence/convergence. If there’s a breakout, we will seek to ascertain it with studies of crossovers.
We will examine the signals in greater detail a bit later, but in summary they are channels, crossovers, divergence or convergences, breakouts, consolidation patterns, the various price patterns like triangles, flags, and head and shoulders. We will keep our indicators simple, but we will make sure that the signals generated by them are examined and exploited to the full, allowing us to draw a complete picture of the price action.
5. Perform the analysis
After deciding on the signals and their meaning, we will perform our analysis by identifying actionable signals, and deciding on capital allocation in light of proper money management techniques. When analyzing the data we must make our utmost exertion to ensure that we focus on signals relevant to our selected period and trading plan. This stage of analysis will involve the separation of wheat from chaff, and data from noise.
6. Compare the results, execute the trade
After examining the various scenarios presented by the charts, and determining on which of them are actionable, the trader will compare them in terms of credibility and profit potential (for example, how extreme are the indicator values, how much profit or loss will be generated in case a take- profit or stop-loss order is realized?) Once that is done, he will pick the trade that offers the highest returns with the lowest risk on the basis of the technical scenario that is the most contrarian.
What the above implies is that, when a trend follower trades, he will wait for the corrections, acting on a contrarian basis to the short term movement, while conforming to the main trend. When he desires to bet against the trend, he will await the most extreme valuations generated by the trend, and when the momentum is highest, he will make a contrarian bet at the first credible reversal.
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A forex trading strategy is created by using many different types of price phenomena that are manifested on many different kinds of indicators. We will examine strategies later, but at this stage let us examine the signal types that are used to create them.
1. Channels
Channels are two parallel trend lines that constrain the price action in opposite directions. The upper line prevents bullish breakouts, while the lower line checks the bearish ones. A channel is a very regular formation, and offers great potential for realizing a profitable trade, but it’s also relatively rare.
Channels are used to generate signals that help us identify breakout points. If the indicator used to analyze the channel stayed above or below a certain level for a long period of time, a breakout can be confirmed by excessive values. But given how regular and controlled the price movement must be while inside a channel, the trader can devise many other ways of trading it, and some of his methods can be based on fundamental analysis too.
The existence of a channel will allow the trader to use other tools, such as overbought, oversold indicators, to generate additional signals. A channel also signals that market participants are expecting a major development to decide the direction of the trend, and that the trader must be alert about potential 
2. Crossovers
Crossovers occur when one indicator’s value suddenly rises or falls below that of another one which is used as a signal line. Crossovers signal momentum change in the market, and are often used to generate trade signals that are more reliable than those indicated by single indicators.
In the hourly chart of AUD/USD we see the 14-day moving average shown by the yellow line falling below the 100- day moving average shown by red, and we notice that the price later made a major move in the same direction. Crossovers are not limited to one type of indicator, and of course, the trader can use them in many different situations for analyzing price patterns.
The disadvantage with crossovers is born of the fact that they’re fairly common, and thus prone to generate conflicting and false signals. Unless confirmed by other, more reliable phenomena like divergence/convergence, the trader should be cautious about regarding the crossover as an actionable signal. 
3. Breakthroughs, breakouts
This signal is generated when a range or a consolidation pattern breaks down, allowing the price to move violently and rapidly in the direction of the breakout. Potential breakouts are identified first by direct visual examination (for instance, an uptrend is fluctuating around a price level for a prolonged period ), and then confirmed by the behavior of indicators (a very calm MACD registering strong values, or an moving average crossover).
A consolidation occurs when a trend fluctuates around a value for a relatively long period without jeopardizing its strength. A breakout is when a range pattern breaks down, and the price action is no longer constrained. A breakthrough is the situation where a previously strong resistance level is breached by an ongoing trend.
Consolidation, breakout and breakthrough may all occur on the price chart, or on the indicators themselves. The interpretation will differ depending on the significance of the levels breached (for example, the price breaking through a multi-year resistance line is more important than the RSI reaching a previously unbreached level.)
False breakouts are relatively common in the markets, and many traders try to avoid them by getting into the trade when the breakout is going through its correction phase. Deciding on the nature of a breakout will of course depend on probability analysis. Experience, and proper money management methods are our best friends.
4. Divergence/convergence
The tendency of all indicators to create false signals is well-known among technical traders, and to overcome this problem, traders have been looking at divergences between indicators, or between an indicator and the price for quite some time. Convergence occurs when successive values of two indicators are closer to each other with the passage of time. Divergence occurs when the values are farther apart as time passes. In both cases, the principle behind convergence/divergence dictates that the indicators make movements in opposing directions, and the phenomenon is used to signal that the ongoing trend is getting weaker.
In the above example of AUD/USD, we see that the MACD is making lower values even as the price keeps getting higher. In other words, the price action is not only comfirmed, but contradicted by the indicator. Traders seek these signals to decide on opportunities that offer a greater risk-reward potential. 
5. Price patterns
Price patterns, such as triangles, head and shoulders, pennants, flags can all be used to identify a potential trade, or at least be used to signify an emerging opportunity. These patterns all have different ways of being interpreted, but the seasoned analyst is unlikely to move on any of them without receiving a confirmation from a secondary source, such as an indicator. We will examine the patterns in detail later.
Conclusion
Technical strategies are created by the combination of the above signals and patterns. It is a good idea to combine signals of indicators with price patterns to receive more reliable indications on a potential trade. For example, an MACD crossover after a major counter-trend move can be much more reliable as a trade signal than any value of the MACD, however extreme it may be. In a major triangle movement, a divergence or convergence between the RSI and the price can be far more reliable than the extremes registered on the indicator.
In short, instead of absolute values, the technical analyst will choose to focus on the rarer phenomena which we just discussed. In following chapters of this section, we will discuss technical strategies in greater detail.
Trend following is perhaps the most popular long-term strategy in all financial markets. It is exceedingly effective and profitable when the conditions are favorable, is quite straightforward in its methodology, and there are many individuals, past and present, famous or obscure, who have used this strategy to success and riches. We should note that the technical aspect of trend following is in fact quite simple, but also that it requires, before everything else, discipline, sound money management, and patience from the trader. Trend following is not a short-term method, and patience and determination are as important as correct analysis as a result.
Trends are created by powerful underlying economic factors which may not be all that clear to those who are not very familiar with fundamental analysis. But the simple patterns created by the price action in response to the economic events can often be identified through methods that are easy to learn and apply. Thus, the retail trader has as much potential of success as the most experienced analyst if he can control his emotions and behave logically.
To apply this strategy we must first be aware of the existence of a trend. Without identifying a trend we would be gambling, and that’s not the purpose of trading forex. Both fundamental and technical analysis can be employed for identifying a trend, and both of them have their advantages and drawbacks. It is in general a good idea to use a combination of them for deciding on the trend’s character, and deciding on our entry and exit points.
From here, let us use the dialogue between the successful trader and the beginner in order to explain the principles in an easier way.
B: I want to use the trend following method. How do I do it?
ST: You must first choose whether you want to employ technical or fundamental analysis for your method, or a combination of both.
B: Is there a difference between these methods?
ST: Yes. Fundamental analysis can provide you with information which can predict the strength and length of a trend., while technical analysis can show you how it develops. It is possible to base your strategy on one of these to the exclusion of the other, and it is still possible to turn a profit if you are lucky enough, but our principle has always been to reduce the role of luck to as little as possible. Fundamental analysis is more reliable than technical analysis in defining a trend that has long term potential, but without technical analysis it would be extremely difficult to decide when or how to trade. Technical analysis can suggest the beginning of a trend, but it’s unlikely to tell much about the length or strength of the same. Thus, I suggest that you use both technical and fundamental methods for your trend following strategy, with fundamental factors eliminating the false signals of technical analysis, and technical tools providing you with a time-price frame for deciding on entry points.
B: How do I decide on the existence of a trend?
ST: There are many technical tools that can signal the phenomenon, but there are an equal number of false signals generated by them. Remember that there are only three kinds of trends that can exist at any time: flat, up or down, and it is possible to speak of trends between any two points on a price chart. Simply take two random points on a chart, draw a moving average on it, and the pattern that arises can be analyzed as a trend. Thus it is always necessary to have at least a basic of understanding of the economic factors that can create trends, before deciding on the validity of a chart pattern.
B: And how do I do that?
ST: Familiarize yourself with the big picture; understand what drives market participants; recognize the stage of the business cycle.
B: What kind of price pattern will create a trend?
ST: The trend that we seek to trade is different from random fluctuations, range patterns and similar price movements in that the price itself, in the absence of any technical indicator, can still be recognized as showing a trend. In other words, there is some driving conviction behind the price action which allows the trader to easily identify it visually. Depending on the type of the trend (that is, an up- or downtrend), successive highs and lows should constitute a rising or falling pattern, with relatively few irregularities. But such a case is often a rarity, and the trader will have to back his technical patterns with conviction that can perhaps only be gained through fundamental analysis.
B: If the trend can be identified visually, why use technical tools?
ST: Even though we can notice the existence of a trend, we still need technical tools to trade it, and time it.
B: So will you try time the market? I’m told that never works.
ST: Market timing never works when one is trying to predict reversal points on a technical basis. However market timing in the context of a trend, with the purpose of picking the counter-trend extremes, and using them to enter a trade, is necessary and profitable. And there lies the main principle of a trend following strategy: recognize the trend, identify counter-trend moves, and use them to enter a trade in the direction of the trend.
B: In a sense, then, you’re behaving as a contrarian of short scale moves, and the follower of the long-term trend
ST: Yes. Indeed, there lies the soul and spirit of all trading. To utilize short-term irrational behaviors of the market in order to enter into long-term positions in positive alignment with fundamentals (or, sometimes just the trend), is the core of all successful trading.
B: How long should the trend follower maintain his position?
ST: Forever, or to be exact, for as long as the fundamental reasons that back the trend are dominant. If the trader cannot identify those reasons, if he’s unwilling to do so, or if he doesn’t believe, for some unfathomable reason, that they are useful, he can use technical patterns to time his exit point. Even if the trader is aware of the fundamental factors, and is able to evaluate them correctly, technical analysis can still provide him with a very useful early warning system. If the price action is suggesting strongly that there’s some error in the trader’s fundamental outlook, he can use the technical signals as an occasion to reevaluate and reexamine his fundamental picture.
B: How do I time my trade with technical analysis?
ST: The best tools for trend following are supplied by moving averages and simple price charts. Bar charts, candlesticks and many others can be equally useful if employed with moving averages. For example, between October 2007 and April-May 2008, the price action of USD/SGD always remained below the 100-day moving average. When the pattern broke down, in June of the same year, the trend had also broken down, and the price went on to break the 200-day average, and a medium-term upward trend was established. It is also possible to use moving average crossovers, and myriad other methods, but whichever you choose to use, you should ensure that you do not complicate the main aspect of your strategy, which is trend following.
B: Which time frame do you recommend for the moving average?
ST: If you want to trade on a weekly or daily basis, the 100-day MA will probably be able to capture most of the important trends for you. Anything with a longer period is likely to be meaningless because of too much data discarded , and any time frame that is too much below the 100-day period may be too sensitive to price action. But as usual, one can use other timeframes below 100, provided that he doesn’t clutter his screen with lots of indicators, charts, tools.
B: When trend following, where should I place my stop-losses and take profit orders?
ST: This partly depends on the term and nature of your trend following method. A stop-loss order can be placed a short distance above or below the trend line, whether it is provided by the moving average, or a simple line drawn on the chart. In our opinion, the trend follower should not realize his profits until he has a good reason to do so. The purpose of this strategy is to focus on underlying price dynamics by stripping out volatility and short term movements, and there is little logic to realizing profits in response to fluctuations which are irrelevant to the main action of the trend.
B: But I still have to take profit at some point. Where should I do that?
ST: Go as far as the trend goes, then stop. There you can take profits.
B: How do I know how far it goes?
ST: As we just explained, you can use the MAs to decide on that, but it’s far better to identify the fundamental causes behind a trend, and then to exit the trade once those causes are eliminated.
To sum it up, we can repeat that trend following is the easiest and most straightforward way of making money in the forex market. But successful trading requires the foresight provided by analysis and the patience that only comes with confidence. Those of us who prefer quick profits and instant ratification will find the method uninspiring, but it is reliable and will work wonders if you give it the chance.
That high leverage is dangerous is well-known to most people, but it is not unusual to make spectacular profits with a highly leveraged account, just as it is not unusual to throw three heads in a row during a coin-tossing competition. The sad fact is that even those spectacular profits are highly likely to be wiped out if the trader continues to make bets utilizing high leverage, as we examined in the previous articles on gambling strategies in forex. The inability of the trader to get rid of high leverage after a bout of successful trades is related to a concept called the “gambler’s conceit”. The gambler’s conceit is not caused by high leverage only, but we will limit our discussion of this subject to high leverage since it’s so common among traders.
Many of us have that genie beside our ears who whispers to us all the time that risking too much is not a problem because we are wise enough to exit a risky bet while still running profits. High leverage may be wrong, undercapitalization may be dangerous, but our trades have so far been profitable, and as soon as the profits diminish or losses are being registered, we will close our positions, and exit the game, be it gambling with cards or gambling with forex.
It's very convincing. After all, why would one want to risk losing the profits of such a risky practice as high leverage? What is the point of continuing to practice a losing strategy even after your profits have been halved by a string of losses?
Many beginning traders who make a lot of money randomly in the forex market in a short period of time are convinced that it is their method, style, attitude that makes those large profits possible. On the other hand, the experience and knowledge possessed by a trader at the start of his career is insufficient for practicing self-control or employing money management methods successfully. Thus, in many cases (but not always), the doubling, or tripling of the account of a new trader is just a chance event, regardless of the rationalizations which the trader uses to explain his situation. What is more, even in the case of a highly successful, highly disciplined trader, the occasional very large profits are not at all a sign of increased efficiency or better understanding: There’s nothing extraordinary about the occasional extremes in a trader’s career. Instead of emphasizing them too much, and thinking about what he did right or wrong to deserve such large profits or losses, the seasoned trader will evaluate them for what they are: statistical anomalies on which neither a career, nor a trading strategy can be based.
The Gambler’s conceit prevents such a rational explanation. Instead of understanding the gains after highly-leveraged bets as random developments, the trader ties these results to his own exceptional luck, skill, or insight in evaluating the market action, or to his superior trading strategy, and convinces himself that he will be able to terminate his trading activity due to his controlling power over his trading results. With such false confidence, when the inevitable large losses occur he will ponder on what went wrong with his trade, which indicator, which scheme he needs to revise and refine, instead of accepting and understanding that gains on highly leveraged bets are illusory, and unlikely to remain with him permanently. When a peer confronts him about the unusually high leverage of his trades, and his irrational expectation that he can keep profiting with such high risks, he will protest by mentioning his past successes.
In fact, gains on a highly leveraged account have the potential to be even more destructive than losses. Losses will teach the trader to be humble, and will lead him to revise his methods. Gains, on the other hand, will addict him to his errors. Sadly, such an addiction can only be broken by the pain of a totally wiped-out account sometimes. Fortunately for you, we’re here to warn you about the dangers associated with this risky practice.
The best remedy of the gambler’s conceit is avoidance of the addiction entirely. Instead of consoling yourself that you will give up the practice once the profits are gone, convince yourself to never begin the unhealthy game. Do not aim at exceptional results; aim at consistency. But if you find that you’re already deep into the game of high leverage and risky practices, our advise to you is to cut it off right now, without waiting for the losses to show up. Just close the chapter, quit trading for a while, and a few weeks later, or maybe a month, restart your career by practicing sane and sensible strategies this time. Not only will you find intellectual satisfaction at having overcome a dangerous addiction, you will also have a profitable path before yourself as you improve your skills, recognize your errors.
To repeat, brief periods of enormous profits is never the purpose of a successful trader. Such periods are always temporary, and the false confidence that becomes instilled your psyche is often destructive to your career as a trader: aim at consistent profits, do not aim at high very high profits.
