Forex scalping is a popular short-term form of trading that appeals to traders that are looking for a fast paced trading experience. A Scalping strategy aims to make a gains from the small price fluctuations between currency pairs. Scalp traders will buy or sell a currency pair, hold the position for an extremely short period, usually a few minutes, before exiting the trade. As it is the aim to accumulate a series of small gains, the process of entering and exiting a trade is completed several times within a trading session.
To capitalise fully on a trading opportunity it is essential that optimal entry and exit points are identified so that nothing is left behind. There are a huge variety of strategies that are used by traders, this article focuses on the best indicators for Forex scalping used widely to provide trading signals for entry and exit points.
In This Article:
- What Is Forex Scalping
- Introduction To Technical Indicators
- Moving Averages
- Relative Strength Index
- Bollinger Bands
- Other Considerations
- Summary
What Is Forex Scalping
A Forex scalping trading strategy is the method of identifying trading opportunities on the smallest time frames and holding positions for very short periods of time prior to closing. The trading style is best suited to traders that are able to dedicate sufficient time to consistently monitor currency markets and quickly identify optimal entry and exit points.
Forex scalping requires a well written trading strategy that includes details of which technical indicators will be used to identify trading signals. This will assist with being able to react quickly and enter a trading position at the optimal entry point and capitalising fully on the trading opportunity.
Whichever method of identifying a trading opportunity is used, the common element is that trades are held for a short amount of time, taking advantage of gains that can be as small as a few pips. Once the required targets have been reached of the technical indicator provides a signal to exit, the trade is closed with no thought of holding onto the position. The desired outcome is to accumulate a large number of small gains throughout a trading period.
Introduction To Technical Indicators
Most 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. Below we discuss four of the most popular and best indicators for Forex scalping.
Moving Averages
The purpose of using moving average indicators in a scalping strategy is to identify optimal entry points. To do this we use two indicators, a 200SMA a 20EMA. The purpose of the SMA is to plot the longer-term trend line and to trade only when price action is in line with the underlying trend. For instance, if the long-term trend is bullish, a scalp trader will be looking to place a trade as sentiment turns bullish, looking to capture short term bullish price momentum.
The 20EMA is overlaid to plot short term market sentiment. As the EMA gives more weight to current market prices, it reacts quickly to market sentiment allowing the trader to place an early position in a shift in momentum. Let's look at an example:
On the above EUR/USD 5minute chart the underlying trend highlighted by the 200SMA is horizontal so it is possible to trade both bullish and bearish short-term markets. The 20EMA has a strong upward trend, indicating a current bullish sentiment.
Traders are looking for a cross of the EMA over the SMA. Highlighted on the chart is the "Golden Cross" (as it is known in a bull move) and the immediate price action that follows. It can be seen that over the next 5 candles (25 minutes) there is a sharp increase in price, in total 34 pips.
» For more information see our guide an overview of Moving Average indicator.
Relative Strength Index
The Relative Strength Index (RSI) is an oscillator that can provide extremely useful information on the momentum of a price movement. It is a simple line graph that is displayed generally at the bottom of a technical chart so that it can be cross referenced to current price activity. The RSI measures price gains and losses and provides readings from 1 - 100. Anything above 70 is considered as overbought and under 30 is oversold.
As demonstrated on the above EUR/GBP 1minute technical chart, when the RSI indicator shows that prices are overbought, there is a sharp drop in price. Conversely, where the indictor shows oversold, a short bullish move follows.
» For more on this see our guide trading using the Relative Strength Indicator.
Bollinger Bands
The Bollinger Band indicator consists of three lines, the Simple Moving Average (SMA) that is in the centre of the indicator and two positive and negative deviations, represented by upper and lower bands respectively.
The upper and lower bands expand and contract as market volatility increases and decreases, giving the trader a better understanding of the momentum behind current price action.
Bollinger Bands used in isolation do not provide trading signals. With this in mind, we will also overlay a Moving Average indicator set to average out 200 time periods. The purpose of this is to smooth out price action of an extended time so that the underlying trend and this will be used as a point of support and resistance. A position should be taken when the Bollinger Bands break support or resistance. Take a look at the example below:
On the left-hand side of the EUR/USD 5m chart we have indicated an entry point for a short position. The entry signal is when the SMA crossed the 200-period Moving Average. As both the Bollinger Bands and 200-period Moving Average are lagging indicators, entering a short position at this point will mean that some of the potential gains will have been lost, but the move is large enough to still be worthwhile and it is always preferable to wait for confirmation of the move before entering on the expectation of the cross and it not occurring.
The same move but for a long position is indicated on the right of the chart when the SMA crosses the 200period Moving Average. Again, there are some gains lost due to the lagging nature of the indicators, but the move is large enough to be worthwhile.
Using Bollinger Bands to scalp trade is not limited to trading crosses, scalp trades can also be entered between crosses. When the Bollinger Bands are trading above support, a trader should look only to place long positions and when the bands are trading below resistance, short positions only should be taken.
In the example above we have highlighted three entry points for short positions. As was previously mentioned, the upper and lower bands can be used as a form of dynamic support and resistance during periods of low trading volume or consolidation. When the price point reaches the upper band in a downtrend as shown above, placing a short position often proves worthwhile.
Other Considerations
Now that we have discussed some of the best indicators for Forex scalping, there are a some other important factors to consider that may have an impact on your trading:
High Levels Of Leverage
Forex scalping is centred around 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.
The purpose of forex leverage trading is to create a trading position that is worth taking. Trading at higher levels increases pip value in accordance with the leveraged trade size, therefore increasing potential gains that would arise from small pip movements.
» For more information see our beginners guide to leverage.
Tights Spreads Are Essential
Understanding spread is in Forex trading is essential as it is the primary cost of placing a trade. Essentially, spread is the broker fee, charged in the form of commission for placing a trade on the traders behalf. Online brokers charge a spread for every single trade placed, whether it is a tight or wide spread will be determined by market conditions at the point of placing the trade.
Forex scalping should only ever be actioned on the major currency pairs. Liquidity is a key element when brokers calculate the spread and trading only within high liquidity markets will minimise the risk of being caught out by a large spread.
Assume by means of example that a trade has been taken with a view of making a gain of 10pips. If the broker spread is 4pips, 40% of the potential gain from the trade has been lost to the spread. Look to scalp markets that offer a spread in the region of 1-2%
» For more information see our guide what is spread in Forex trading.
Summary
A Forex scalping strategy is popular form of trading for individuals looking for a fast paced form of trading. Most scalping strategies focus on constant technical analysis, assessing several markets and using technical indicators for trading signals. In this article we have discussed three of the best indicators for Forex scalping that present key information in a simple visual format.
Although the strategies discussed can for the basis of a scalping strategy, it is important to understand other factors that may limit a traders potential. Using high levels of leverage may be essential to make the strategies viable, but this will require large initial investment. Trading with tight spreads is essential so that gains are not stalled up by broker commissions.
