There are many methods of Forex scalp trading, but this article discusses the popular 3-EMA scalping strategy.
A Forex scalping strategy is a fast-paced trading style that involves placing several trades a day. Scalping strategies are traded on the smallest time frames and positions are held for only a matter of minutes. Scalping is the practice of trading tiny fluctuations in price movement and accumulating small profits across many, possibly hundreds of trades every day.
To be able to trade effectively using a scalping strategy, being able to identify optimal entry and exit points is essential. Using three Exponential Moving Average indicators can greatly assist in assessing current market sentiment, allowing a trader to enter a position just as trading sentiment is changing, the same techniques can be used to exit a trading position before market sentiment moves against a position.
In This Article
- What Is Scalping
- Importance Of Volatility
- What Is The Exponential Moving Average (EMA)
- Understanding EMA Time Frames
- How To Scalp Using 3-EMA Strategy
- Protecting Your Position
- Summary
What Is Scalping
Every trader will have their preferred method of trading and which method is adopted will depend entirely on the individual trader. There are several types of trading styles, ranging from long term trading where positions are held over several weeks or months (position trading), down to day trading and scalping. In this article we are focusing on scalping, a strategy that trades on the smallest of time frames, generally on the 5minute to 15minute charts. Positions will be held for a small period of time, looking to capitalise on small price fluctuations and exiting with small pip gains.
When trading with a scalping strategy, it is important that the perfect entry point is identified, this helps to ensure that every bit of profit can be extracted from a trade. Scalping suits traders that are able to dedicate time to watching the technical charts, pouncing on optimal entry points and existing once the profit has been gained. This is where the 3-EMA's strategy is useful as a tool to identify changes in market sentiment. Being able to see when market sentiment is changing, allows trader to enter early into a trading position, taking advantage of small movements and existing as sentiment changes against the position.
Importance Of Volatility
Generally speaking, volatility is not good for business! This however is not the case when Forex trading, volatility in prices is required so that trades can be placed and gains made. When trading on longer time frames this is not quite as important, positions will be help for a longer period and price movement can be allowed to move at a slower pace.
As a scalping strategy requires several trades to be placed every day, it is a traders worst nightmare to be caught in sideways price movement, as funds will be tied up in a position.
Forex trading is a 24hr decentralised market place that see's certain currencies trading in higher volume during certain trading sessions. If for instance a trader is located in Europe, they should be looking to trade EUR currency pairs, particularly EUR/USD and EUR/GBP, as these currencies will be mostly traded during the New York and London sessions. See our guide on market trading hours for further information.
What Is The Exponential Moving Average (EMA)
A moving average is a technical indicator that overlays current price action on a technical chart. It is designed to calculate the average closing price over a set period of time periods, smoothing out short term market noise so that the long term underlying trend is easily tracked.
The Exponential Moving Average (EMA) is calculated slightly differently, it gives more weight to the most recent prices on the basis that recent prices are a represent a truer sense of current market sentiment. While the EMA is still a lagging indicator (it lags behind current prices), the weighting system does allow it to react quicker to market sentiment than a standard Simple Moving Average (SMA).
Understanding EMA Time Frames
The 3 EMA trading strategy utilises 3 different EMA, each calculating a trend over different time periods.
5 Period EMA - this is the short term trend indicator and captures current market sentiment, it is calculated over only 9 time periods it reacts quickly to changes in momentum. When employing this strategy we are always looking for the 9 Period EMA to be either the highest indicator in a bull trend or the lowest in a bear trend.
20 Period EMA - this is the medium term trend indicator and should always be located between the 9 Period and 55 Period EMA before a trade is placed.
50 Period EMA - calculated over the longest time period the 55EMA is the long term trend. In a bull market this should always be at the bottom of the three indicator and at the top in a bear market.
The time periods are not set in stone and can be tailored to a traders bespoke requirements.
How To Scalp Using 3-EMA Strategy
It's time to see how using a variety of EMA's can assist a trader in spotting an entry position when scalp trading:
On the above EUR/USD 15min technical chart we have our three EMA's plotted and highlighted are two entry points, one short position and one long position.
When using this strategy traders are looking for crosses between the 5EMA and 20EMA. In the first highlighted section we can see that the 5 period EMA crossed the 20 period EMA in a downward direction. This is commonly known as a Death Cross and it is not unusual for a strong downtrend to follow. At this point all EMA's are in the correct position from top to bottom i.e. 50-20-5. This is a signal for a short position and a down turn in price action is exactly what followed.
The second highlighted section to the right of the chart is a signal to take a long position. Again, all the indicators are in order but this time bottom to top i.e. 5-20-50. Sure enough, an upward drive in price action followed.
Protecting Your Position
The purpose of the 3 EMA strategy is to identify entry points and it can prove very effective. However, it is no guarantee that price action will function as anticipated and it is always good practice to place a stop loss order when placing a trade. This is particularly true when using a scalping strategy as individual gains are relatively small and it would be easy to see a days work wiped out with a single unprotected position that went wrong.
To stop this from happening a tight stop should be placed. It is usually accepted that good practice using the 3 EMA strategy is to place a stop at the last swing high or low as indicated in the chart above.
Summary
A scalping strategy requires several trades to be placed over the course of day, each trade capitalising on the smallest fluctuations in price movement. In order to extract profits from the trades and leave nothing behind, identifying optimal entry positions is essential. Using technical indicators like exponential moving averages can help, using several to compare current market sentiment to longer term trends can be an even more powerful tool. The 3 EMA strategy is not fool proof and placing stop loss orders to mitigate losses is essential to avoid wiping out gains from other trades.
