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
|
Outcome
| Down
| Down
| Up
| Down
|
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.
