Forex scalping is a fast paced trading strategy that is designed to capitalise on tiny price fluctuations between currency pairs traded on the Foreign Exchange markets. To maximise potential gains, identifying optimal entry and exit points is essential to ensure that nothing is left behind.
To assist in identifying trading opportunities, traders will use a variety of technical indicators within their strategy. This guide discusses the Moving Average indicator and the pro's and con's of its inclusion into a Moving Average scalping strategy.
In This Article:
- What Is A Forex Scalping Strategy
- Overview Of The Moving Average Indicator
- Using A Moving Average Scalping Strategy
- Importance Of Market Volatility
- Protect Your Trading Position
- Summary
What Is A Forex Scalping Strategy
Before we begin discussing the intricacies of a Moving Average scalping strategy, it is important that the basics to a Forex scalping strategy are first understood.
A Forex scalping strategy is the process of identifying and placing several trades each and every trading session, the amount of trades placed will determined by how much time is able to be dedicated by the individual. Scalping focuses on the smallest time frames and look to hold positions for only very short periods of time prior to closing, usually a matter of minutes and sometimes just seconds. 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 the implementation of a well written trading strategy that defines which market conditions must be met prior to entering a trade. This assists with being able to react quickly and enter a trading position when trading conditions suit the strategy. The individual trader must trade with discipline to ensure that the scalping strategy is implemented correctly.
The criteria set out in the trading strategy will depend entirely on the individual. Some traders will rely solely on technical analysis and patiently wait until the trading signals are met, reacting immediately on the signals provided by their chosen technical indicators, this guide focuses on the moving average indicator.
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, the trade is closed with no thought of holding onto the position. The desired outcome is to accumulate a large number of small gains.
» For more information on what should be included within a strategy, see our guide writing the best Forex scalping strategy.
Overview Of The Moving Average Indicator
A moving average indicator is a visual display of a simple calculation that is designed to smooth out price action over a fixed period of time. There are a range of long term and shorter term moving average indicators, but this does not mean that long term is to be used over a higher time frame, or a shorter term on a smaller time frame. When talking about long and short term, it is in reference to how many candlestick time periods are included within the calculation, therefore a 200-period moving average can be used on weekly charts and 5min charts alike.
A simple moving average (SMA) is calculated by adding recent prices and then dividing that figure by the number of time periods in the calculation average. For example, one could add the closing price of a currency pair for a number of time periods and then divide this total by that same number of periods. Short-term averages respond quickly to changes in the price, while long-term averages are slower to react.
There are several types of moving average, but for the purposes of this article we will focus on the Simple Moving Average (SMA). The Simple Moving Average calculation uses the most recent data i.e., if a 21-time period is used as the basis for the calculation, it is the last 21-time frames that are used. When a trading day closes, the oldest time period is dropped from the calculation and the newest included.
This may sound like a time a consuming exercise, but all online trading platforms will have a moving average indicator available within the user's toolbox. All that is left for the user to do is set the moving average parameters to suit their trading strategy.
Using A Moving Average Scalping Strategy
The purpose of using moving average indicators within a scalping strategy is to identify optimal entry points. This is best achieved by using 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. The EMA gives more weight to current market prices and 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, it is therefore 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.
Going back to a point that was addressed earlier about exiting trades when profits have been realised, it can be seen that following the initial sharp upward price movement, is a bearish retracement in price. If a scalp trader were to hold onto the position for too long, there is a risk of profits being lost due to predictable price retracements.
» This strategy can also be used when a "death cross" occurs. For more information see trading a Death Cross technical signal.
Importance Of Market Volatility
Unlike most other forms of trading, volatility is required when using a Moving Average scalping strategy. This is because of the nature of the short term trading and small gains that need to be accumulated. Scalping can only prove worthwhile if there are several opportunities to trade and those trades are able to be executed quickly. A scalp traders worst nightmare is finding themselves caught in a trade that is trading sideways. This means that funds are tied up in trades that are taking too long to realise a profit.
To maximise trading opportunity via volatility it is important that only major currency pairs are traded within their relevant trading 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 advisable 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.
Protect Your Trading Position
One of the most attractive qualities of scalping is the short-term nature of the trading style. Evidenced above we can see that a strong pip return can be made in a short period of time. However, not everything is a sure thing when trading and efforts should always be made to protect a position. This can be done in two ways:
Wait For Confirmation
It is always recommended when trading with a scalping strategy to wait for confirmation before placing a trade. Looking at the above chart, confirmation would be deemed to have occurred when price broke past the previous high, giving more credit for the potential of an upward price move. However, as scalping works on such short time frames and small gains, waiting for confirmation can eat into potential profits.
Place A Stop Loss Order
Getting into the habit of placing a stop loss order when entering a trade is nothing other than good practice and should be undertaken on every trade placed. As scalping is working on the smallest price fluctuations, any losses incurred could prove devastating to a daily running tally. It is therefore important that stop loss orders are placed tighter than would be considered when trading on longer term time frames.
Summary
The Moving Average is a useful technical indicator when scalp trading. Used to identify changes in short term market sentiment relative to longer term trends provides opportunities for early entry into a move. The Moving Average can be used in all market conditions, regardless of underlying trend direction.
