Scalping is a Forex trading style that is centred on trading the smallest time frames and capitalising on tiny price fluctuations. Forex scalping strategies generally consist of entering and exiting many trades per day, with positions being help for only a matter of minutes at a time.
For a scalping strategy to prove worthwhile, optimal entry and exit points must be identified and acted upon quickly. To help identify the perfect entry point into a scalping position, traders will utilise technical indicators like Bollinger Bands that can be used as a dynamic form of support and resistance during periods of low trading volume or consolidation. This article focuses on putting a Bollinger Band scalping strategy into action.
In This Article
- What Are Bollinger Bands
- Understanding A Scalping Strategy
- What Do Bollinger Bands Tell Us
- Building A Bollinger Band Scalping Strategy
- Summary
What Are Bollinger Bands
Before discussing how to implement a scalping strategy using Bollinger Bands, we must first understand what the Bollinger Band indicator is. Traders using technical analysis to determine a trading opportunity will frequently use technical indicators that provide a variety of information based on historical data. Data provided by a technical indicator will assist a trader in making an informed decision on future price action.
Easy to interpret and understand, the Bollinger Band technical indicator is one the most frequently used technical tools. Providing traders with a lot of useful information regarding current market volatility, along with overbought and undersold readings, Bollinger Bands are relied upon by traders of all abilities.
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, this gives a trader a better understanding of current momentum behind price action. If the current price trend is bullish and the upper and lower bands are extensively separated, it is a sign there is a lot of trading activity and substantial market sentiment supporting the bullish trend. Conversely, if price movement is in a sideways position and the Bollinger Bands are squeezed, this would indicate that the market is currently undecided and is awaiting further information.
Understanding A Scalping Strategy
Prior to commencing trading, it is important that a trader spends some time considering what it is that they want to get out of it. Perhaps the most useful process to assist with this is to draft a trading plan that sets out some key criteria:
- How many hours a day usable to be committed to trading.
- Levels of risk that the trader is comfortable with.
- How many trades are to be placed a day, week, month.
- Profit levels required from each trade.
Whilst the above list is not exhaustive, it will help with determining what sort or trading style will suit the individual. If a trader is looking to place only a few trades a week with the expectation of moderate returns, swing trading may be preferable.
If, after honest reflection, it is determined that a fast-paced trading style with many hours a week dedicated to trading is most suitable, a scalping trading style may be for you. This will require close attention to market prices, constant analysis of market sentiment and quick responses to economic announcements. Each position will be held for very short periods, usually only a matter of minutes, to capitalise on very small fluctuations in prices. Traders using a Forex scalping strategy will utilise a range of technical indicators including Bollinger Bands. to help identify optimal entry points.
This is the principle of scalping strategy, and we will now discuss how the Bollinger Bands indicator can help with this.
What Do Bollinger Bands Tell Us
We mentioned above that Bollinger Bands are a visual representation of market volatility, centred around the Simple Moving Average (SMA) which averages out the closing prices over a set amount of time periods. The purpose of the SMA is to smooth out short term fluctuations in price action so that the underlying trend can be identified.
The upper and lower bands expand and contract as market volatility increases and decreases, in short, the more volatility present in the marketplace, the wider the bands will be. These upper and lower bands are frequently used by traders as dynamic support and resistance levels. This will be demonstrated later, but it is quite often the case that as price action touches the upper band (resistance), a correction back to the lower band will be seen.
The same will be the case when price hits the lower band (support), it is frequently seen that price will bounce off support and return to resistance.
Building A Bollinger Band Scalping Strategy
Now that the principles of a scalping strategy have been discussed and Bollinger Bands explained, lets discuss how we can create a scalping strategy. It is important to acknowledge that Bollinger Bands used in isolation are not to be used as a trading signal.
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 200period 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.
Summary
Trading on longer time frames does not require the same attention to detail that is necessary to successfully scalp trade. Scalping is a strategy that is based on placing several trades per day accumulating small profits off the tiniest price fluctuations. Determining the perfect entry point is essential to ensure that nothing is left behind. Bollinger Bands are frequently used to assist with this, but they cannot be used on their own to signal an entry point, as they are simply an indicator of volatility. Combined alongside a moving average indicator, market sentiment can be cross referenced to volatility to assess the strength of the move.
