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A Forex scalping strategy is a fast-paced form of trading 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 the price movement of a chosen currency pair, accumulating small profits across many, possibly hundreds of trades every day.
To be able to trade effectively using a scalping strategy, identifying optimal entry and exit points is essential. Fibonacci ratio's and retracement indicators can greatly assist in gauging likely forthcoming resistance levels, providing insight that allows a trader to enter a position just as trading sentiment is changing.
Whether your chosen strategy is to trade retracements, or wait until a retracement is complete, incorporating Fibonacci into a scalping strategy provides essential information to gauge entry and exit points.
In This Article:
- Introduction To Forex Scalping
- What Is A Fibonacci Ratio
- Using Fibonacci Retracement To Scalp
- Risk Management When Using Fibonacci
- Summary
Introduction To Forex 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 exiting once the profit target has been achieved. This is where Fibonacci ratio's are useful as a trading tool. The Fibonacci retracement tool is a calculation based on the Fibonacci Sequence that is a series of numbers that expand consistently by 1.618 and are a phenomenon seen in the natural world and can be used to anticipate market behaviour.
What Is A Fibonacci Ratio
The Fibonacci Sequence of numbers was first identified as significant in the 13th Century by an Italian mathematician called Leonardo Pisano. The Fibonacci Sequence is a series of numbers, where each number is the sum of the preceding two and return a constant ratio of 0.618 when dividing a chosen number with the next in the series (excluding the first few numbers). The sequence of numbers continues to expand by 1.618, this is known as the Golden Ratio.
The sequence begins with 0 and 1 and continues as 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377.
If a number is divided by a number 2 places to the right, it returns a ratio of 0.382, this and the Golden Ratio are used by traders to determine to which level prices will retrace. Being able to estimate how far a retracement will extend provides a very useful piece of information for two reasons:
1) Being able to predict the likely extent of a retracement allows a trader to calculate whether placing a trade works within their trading strategy. Being able to set a take profit order at the point of which it is determined the retracement will end, means that suitable risk reward ratio's can be implemented. If the opportunity to trade the retracement meets risk management criteria, a trade can be placed.
2) If a trading strategy determines that retracements are not to traded, knowing a likely retracement level means that a trader can monitor a trade and prepare for re-entering the market as price reaches resistance.
Using Fibonacci Retracement To Scalp
Traders adopting a scalping strategy will focus on the smallest market movements and will use the shortest time frame technical charts to focus on the perfect entry point. Having an entry point pre-determined is essential so that when price action hits the point of entry, traders are already waiting and can jump on the opportunity, or perhaps even place pre-set orders that enter the trade automatically when the price is reached.
To effectively employ a Fibonacci scalping strategy it is wise to use a time frame chart higher than that on which a position is likely to be entered. This allows longer term patterns to be identified and Fibonacci indicator overlaid, ready to pounce on an entry point on a small time frame chart. Lets look at an example:
The above screen shot of a 15min GBP/AUD technical chart shows that there has been a sharp bearish impulse wave. The Fibonacci retracement tool has been overlaid onto the wave connecting the beginning to the end and key ratio's have been automatically plotted. On the above chart, only 50% retracement and the Golden Ratio have been used for chart clarity, but the indicator can be configured by a trader to show whichever ratio's they prefer and matches their trading strategy.
The key ratio 0.618 is plotted and is a likely level of price resistance. Using the 15min chart allows a trader to keep an eye on the price and when it approached this key level, enter a trade. Let's take a look at what happens when price reached the projected level of resistance on a smaller 5min chart.
Zooming into the 5min chart we can see that price reversed when the Golden Ratio level of retracement was reached and reversed back in the direction of the longer term trend. In this instance 92pips were made on a short position in a couple of hours.
This is a clear demonstration of how a Fibonacci scalping strategy can be used, either trading the retracement or not.
Trading The Retracement
If a traders strategy does not prohibit retracement trading, the Fibonacci ratio can be a powerful tool in risk management. Assume that a trader is planning on trading a retracement but has strict risk to reward ratio's, having an assumed target for exit at 0.618, means that accurate assessment of the potential trade can be made. If it does not meet necessary pip gains or risk ratio's the trade can be written off as not being viable option. Equally, if it meets all of the pre-defined rules of entering a trade, the retracement can traded with a likely exit point.
Trading The Trend
Many traders will not trade a retracement as they can take a long time to complete and many traders also don't like to trade against the trend. If the retracement is not to be traded, overlaying the Fibonacci indicator can still provide useful information on when re-entry into a position can be expected.
Risk Management When Using Fibonacci
What we have been discussing in the example above, is how technical analysis can assist a scalping strategy by identifying key price points. The scalper can then execute their trade on the smaller time frame charts, knowing that a price retracement is likely and where the retracement may incur resistance. However, as with everything else when trading, the Fibonacci Retracement indicator is not a guarantee to success, particularly as the plotting of the indicator is subjective in the first instance.
To depend entirely on support and resistance levels would be a mistake, and it is a common mistake made by novice traders. As a scalping strategy depends on placing multiple trades a day, extracting lots of small profits, one big losing position could exceed profits on existing trades. To mitigate risk of exposure, tight stop loss orders should be placed just above or below the support or resistance level.
Summary
A scalping strategy can be an effective method of trading, but requires paying attention to the bigger picture in order to identify key price points that can act as support and resistance. Using indicators like Fibonacci Retracement tool can be key to optimising and executing entry points on a smaller time frame chart. Using stop loss orders is essential when engaging a Fibonacci scalping strategy, as letting a losing trade run, can risk overwhelming existing profits on other trades.
