Short term Forex trading can be an exciting, but risky process. Various strategies exist that are rooted in technical analysis to take advantage of short term local trends and reversals. One of such strategies is scalping. Scalping strategies in FX are widely popular.
Scalping Forex trading strategies are for individuals that can afford to spend more time with their monitors, have fast fingers and can make up their minds fast. Scalpers place more traders than swing and position traders, which is why each trade size is smaller. The risks are spread out on many trades and having a profitable scalping strategy is crucial for success.
Core features of Forex scalping strategies
- Scalping is a day trading strategy that involves placing multiple trades in a session
- Scalpers use very short time frames for small profits
- Technical analysis is the predominant way of identifying scalping opportunities on the market
- Bollinger bands, moving averages and stochastic signals are some of the most useful indicators in forex scalping
- Major pairs, such as EUR/USD, GBP/USD, AUD/USD are most suitable for scalping due to high liquidity and tight spreads
- FX trading scalping strategies require good risk management. In general, risks and trade sizes are small per trade as traders place large amounts of orders
How do scalping strategies work in Forex trading?
Scalping is a highly risky day trading strategy that relies on technical indicators to quickly identify short term trends on the market to make an entry. Scalping requires great discipline, and many experienced traders use algorithms to automate routine trades.
Scalping does not offer high profit margin and a single trade may last mere minutes, meaning traders can easily place over a hundred trades per day, if possible. A few key factors can determine the success of a scalping strategy, and several subcategories of scalping have emerged over the years.
Breakouts are sudden moves in price and present significant profit opportunities on the market. Often, breakouts happen after an exceedingly volatile market that trades sideways for a while before triggering a large move in either direction. The key to a successful breakout strategy is to identify breakout points before they happen. When the market is consolidating, using technical indicators, such as Bollinger bands and Japanese candlestick charts, traders can spot consolidation and breakout points and make profitable trades. Using stop-loss orders is very important when placing orders using this strategy.
A reversal is what happens when a prevailing market trend changes course to the opposite direction. Reversals are typically preceded by retracements, which are smaller scale changes in price direction. Predicting reversals can be difficult as they require correctly identifying peak prices at any given trendline and finding support and resistance points to correctly assess the entry and exit points. The key in reversal strategies is to find short term pullbacks and take small profits. Momentum oscillators are most often used in reversal strategies. Stochastic oscillators, in particular, can be very useful, as they measure price velocity that can be used to identify trend changes on the market.
Mean reversion strategy
Moving averages can be used in mean reversion strategies. Rotational markets operate within rough boundaries defined by supports and resistance levels. In reversion strategies, traders sell the highest point and buy the lowest, based on the identified support and resistance levels. The key is to find the mean of the highest and lowest points and trade along those price lines for incremental profits. Unlike other scalping strategies, reversions profit from the lack of momentum on the market, rather than from increased volatility.
Different indicators are useful in scalping based on the strategy chosen by traders. Indicators, such as Bollinger bands, Stochastic oscillators, moving averages and the relative strength index are the indicators most frequently used by day traders:
- Bollinger Bands are momentum indicators that show the prices that are two standard deviations from a simple moving average
- Stochastic oscillators are momentum indicators that compare specific prices of an instrument to its price range over a specified period of time
- Moving averages are indicators that use price data to create an updating average price. Moving averages are essential parts of charting as they provide valuable insight into the direction of an instrument’s price
- The relative strength index (RSI) is a momentum indicator that measures the speed of price change of an instrument on a scale of 0 to 100
Best time for scalping forex
The best times for Forex scalping depend on the currency traded. Generally, the best time to scalp, or to trade forex as a whole, is during the London and New York trading sessions due to the fact that the markets are the most liquid and the spreads are tightest.
Scalping strategies FX traders use do not work when spreads are too high. Which is why traders need to take liquidity into consideration when planning their trading hours.
Pros and cons of Forex scalping strategies
Scalping comes with its fair share of advantages and disadvantages, and it is important for traders to analyze these factors before deploying such strategies in their day-to-day trading routines. Scalping strategies for fx traders are easy to understand, however, following the rules is not simple as it requires discipline.
- Trade sizes are typically very small, making scalping less capital intensive
- Smaller positions lead to less exposure and loss potential
- Small movements happen very frequently, making profitable trades easier to come by
- Each trade requires limited research and less time spent on news
- Scalpers place many orders, which can lead to higher trading costs
- Tight profit margins mean that each new error could erase the profits of prior trades
- Placing many trades per day can be stressful and affect future decision-making. Scalper need to have good discipline not to overtrade
- Certain time periods are more suitable for scalping due to high liquidity and trading schedules need to reflect this
Example of scalping in forex trading
To understand the process of scalping and how it works in real life, we can take a look at the scalping strategies example.
Let’s assume a trader is looking at the EUR/USD chart and notices price consolidation on a 30-minute chart. Due to this consolidation, the trader decides that a breakout is likely to happen. The trader uses Bollinger bands to assess volatility. When the bands are tight, this can signal an imminent breakout. The price has repeatedly hit a ceiling at 0.9900, so the trader assumes that a bullish breakout may be on the cards, so they deploy the following scalp:
- A buy order at 0.9903
- Stop loss at 0.9897
- Profit target at 0.9909
This gives the trader a 1:1 risk vs reward ratio. If the price reaches above, the trader will make a 6 pip profit.
A trader is looking at the GBP/USD chart and is using the RSI to analyze whether the pair is overbought or oversold. The price is pushing 1.1300 and the RSI shows 85, meaning the pair is overbought. That trader prepares their positions:
- A sell limit at 1.1295
- A stop loss at 1.1305
- Profit target at 1.1285
This gives the trader a 1:1 risk vs reward ratio. A pullback from the 1.1300 range is all that is needed to make this a profitable reversal.
Mean reversion example
A trader is observing the USD/CHF pair and sees that the price has been floating between 0.9825 and 0.9850 for a few hours. The trader deploys their strategy as follows:
- A sell order at 0.9849, with a stop-loss at 0.9859, and a profit target at 0.9839 (1:1 risk reward ratio)
- A buy order at 0.9826, with a stop-loss at 0.9816, and a profit target at 0.9836 (1:1 risk reward ratio)
The trader gets a 1:1 risk vs reward ratio in both cases, and stop-losses can quickly limit the drawdown.
FAQs on scalping strategies in forex
How long do scalp strategies traders hold their positions?
Scalpers typically hold their positions for less than a minute, or several minutes, depending on the strategy. This gives scalping traders the ability to place dozens of orders per day. FX scalping strategies are created to benefit from smaller price fluctuations.
How much money can you make from scalping strategies?
How much you can make depends on various factors. Some traders fail to profit from scalping while others benefit from it. In relation to other strategies, there’s no evidence that sculping is more profitable than position trading. Yes, scalpers place more orders but position traders spend more time finding high probability trades with great risk to reward ratios.
Which timeframe is the best for scalping strategies?
The best time to use scalping strategies is during London and New York trading sessions. Both sessions are highly active and give traders great liquidity and tight spreads. When intraday trading, high liquidity is essential.