Forex scalping is a popular trading style amongst traders that are searching for a fast paced form of trading. It requires dedication and commitment from the individual, as close attention to the currency markets is required to find optimal entry and exit points to capitalise on the smallest fluctuations in price movements. Constant analysis is necessary so that several trading opportunities can be identified throughout the course of a single trading session. Each scalp trade is entered with the expectation of small gains over very short periods of time and the aim of scalp trading is to accumulate many small gains.
There are many strategies adopted by a range of scalp traders, all will have particular nuances tailored to suit the individual. This article discusses a variety of factors that need to be considered to create the best Forex scalping strategy.
In This Article:
- What Is A Forex Scalping Strategy
- Categories Of Forex Strategies
- Analytical Basis For Scalping
- Required Market Conditions
- Summary
What Is A Forex Strategy
A trading strategy is important to have in place, regardless of what trading style has been chosen and no matter the level of experience an individual has trading. A well written trading strategy will provide a pre-defined set of rules and criteria for entering and existing trading positions. A trading strategy will form an integral part of an overall trading plan and will be a road map to achieving forex scalp trading goals.
A Forex scalping strategy is a considered document that will include key elements including, but not limited to:
Risk To Reward Ratio's
A risk reward ratio is essentially a calculation that determines how many trades are required to break even. The level of accepted risk to reward will be bespoke to the individual, do not try to compare yourself to anybody else, it needs to be set at a level at which you are comfortable.
A generally accepted level of risk reward is 1:2 i.e., for every £1 invested, £2 is expected in return. This means that only one in three trades needs to be successful to maintain breakeven.
» See risk rewards ratio's when Forex trading for more information.
Level of Leverage
A Forex scalping strategy focuses on capitalising on very small fluctuations in price, to make the trade worthwhile, the size of the position taken has to be much larger than would otherwise be needed if another trading style was adopted. Traders will likely be required to leverage their initial investment to achieve this, which will require a larger deposit.
All online Forex brokers will offer leverage, levels will vary, but some will allow a position to be taken up to 100x the value of their account. If a trader initially deposits £1,000 to open an account, leverage of 100x would allow a position of 100,000 units.
Which Trading Sessions To Trade
High volatility is required in the markets when using Forex scalping strategies, as this ensures that prices are constantly fluctuating, creating entry and exit points. There are several trading sessions over a single day and it is imperative that you trade the currencies that are most traded within these sessions. The periods of highest volatility are when trading sessions overlap, for example New York & London sessions are both open between 1pm - 4pm and Tokyo and Sydney are both open between 12am - 7pm.
If a Forex scalping strategy is focusing on trading either the USD or GBP, it is essential that the trader is able to operate within the relevant trading sessions.
Technical Indicators
The best Forex scalping strategies will focus on identifying trading opportunities by using various forms technical analysis. To assist with this, online brokers will provide a range of technical indicators that are easily overlaid onto current pricing and display a mathematical pattern derived from historical data. These are used by Forex traders to predict future price trends and make trading decisions. There are literally hundreds of indicators available to traders, some very simple and some very complex.
» See our guide best indicators for Forex scalping for more detail on this.
Categories Of Forex Scalping Strategies
There a huge variety of strategies used by traders and there is a constant debate on which is the best Forex scalping strategy. However, no matter how simple or complex a traders strategy is, it will fall into one of the follow three general scalping strategies:
Breakout Scalping
A breakout scalping strategy focuses on identifying a current price pattern, generally an underlying price trend in either an upward or downward movement. This requires a little analysis using the trading time frame and a longer term time frame. If for instance the longer term 5-minute trend is moving in an upward direction, this tells us that the longer term price trend is bullish. If this is compared to a shorter 1-minute time frame that is currently on a down trend, a breakout scalping strategy will wait for the price to break resistance and open a trade in the longer term upward direction.
Trend Trading
Trend trading is a strategy that is incorporated into many successful trading plans, particularly those that are written to be more risk adverse. Identifying the trend is a popular technical tool for traders of all experience, as understanding price movement and momentum will go a long way to reducing potential risk and creating higher probability trading.
Lets assume that a bullish trend line has been identified. A Forex scalping strategy that is based around the longer term trend will wait until prices fall near the trend line that is acting as support and take a long position.
A useful indicator to be used alongside this strategy is the Relative Strength Index (RSI) that provides information on when a currency pair is overbought or oversold. As prices are approaching the trend line, the RSI can confirm a signal to take a long position by showing a oversold signal. Equally, when trying to determine when to exit a trade, a the RSI will provide an overbought signal.
Range Trading
Range trading can be implemented when prices are oscillating between confirmed levels of support and resistance. As prices reach resistance, a short trade can be taken assuming that prices will revert towards the level of support. As support is reached, the trade is closed and a long position taken. Again, the RSI indicator can be very useful in gauging current market sentiment.
Analytical Basis For Scalping
The basis for which Forex traders form opinions on predicted price movement falls into two categories, fundamental or technical analysis. There is a long-term debate between professional traders about which method of analysis provides the more reliable information for creating the best Forex scalping strategies, both have there strengths and weaknesses and ultimately it will depend entirely on the individual:
Fundamental Analysis
Forex scalping strategies are most effective during periods of high volatility, as this is when the largest price movements can be seen. There are a variety of economic announcements that are made on a weekly basis, some have a more dramatic effect on the market than others. Spending five minutes at the beginning of day to see which announcements are being made can provide important insight into potential periods of volatility and trading opportunities.
Depending again on a the preference of the individual, a trade could be placed following the announcement and ride the resulting price move. Trading the announcement requires immediate response as the market movers act extremely quickly and often speculative traders miss the initial opportunity. Alternatively, the pullback or retracement following the initial move can be traded. This provides a trader with more time to assess the opportunity using various technical indicators and to make sure that the trade meets risk to reward requirements.
Technical Analysis
Technical analysts are of the opinion that price movement is governed by crowd theory and that historical analysis of previous price patterns can be used to determine prices. Support and resistance are examples of psychological price points that often see prices revert as the price points are approached. This form of self full filling prophesy is common, and forms the basis of technical analysis. Traders are aware of critical price points and expect to see a price reversal, in anticipation of this, trades are closed, forcing the price to revert.
Using a range of technical indicators provided by online broker platforms, identifying trends, levels of support and resistance, retracement levels etc help technical analysts identify optimal entry and exit points for a scalping strategy.
» See our guide to best indicators for Forex scalping to see examples.
Required Market Conditions
When drafting a Forex scalping strategy there are two key factors that must be taken into account, without them, a scalping strategy will be extremely difficult to trade:
High Volatility
The best Forex scalping strategies are based around the requirement to enter and exit several trades a day, possibly even hundreds, each trade making very small gains. High volatility is required in the markets as this ensures that prices are constantly fluctuating, creating entry and exit points. There are several trading sessions over a single day and it is imperative that you trade the currencies that are most traded within these sessions. The periods of highest volatility are when trading sessions overlap, for example New York & London sessions are both open between 1pm - 4pm and Tokyo and Sydney are both open between 12am - 7pm.
If a scalping strategy is focusing on trading either the USD or GBP, it is essential that the trader is able to operate within these trading sessions.
» For more on market hours and trading sessions see our guide Forex market hours and best times to trade.
Liquidity
The definition of liquidity when discussing Forex markets is that liquidity is related to the amount of pending orders that exist on the market at a certain time. This is an important consideration to Forex scalpers as trade entry and exit points need to be actioned immediately. When the buy or sell button is hit, the order needs to be executed at that exact price. The same happens when you want to close your trade. If a trade close is not executed at the price required, one small movement of the price may turn a trade close to a loss.
That’s why liquidity is an important factor to consider for beginners looking to learn Forex scalping strategy. The more liquid the market being traded, the more accurate the open and close orders will be. When implementing a scalping strategy, only the major currency pairs should be traded as they provide the most liquidity.
Summary
Implementing a Forex scalping strategy is not easy. Being able to constantly monitor markets, identify trading opportunities and action them quickly is essential. This can initially seem overwhelming due to the amount of constantly changing information. Creating a well written and considered Forex scalping strategy will provide a scalp trader with a set of predefined rules to entering and exiting a trade. This allows a trader to focus only on trading opportunities that meet the requirements of the strategy exactly and dismissing anything that does not.
