A Forex scalping strategy is a fast-paced trading style 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 price movement and accumulating small profits across many, possibly hundreds of trades every day.
To be able to trade effectively using a scalping strategy, being able to identify optimal entry and exit points is essential. Moving Average indicators can greatly assist in assessing current market sentiment, allowing a trader to enter a position just as trading sentiment is changing, the same techniques can be used to exit a trading position before market sentiment moves against a position.
In This Article
- What Is Scalping
- Which Currencies To Trade When Scalping
- Moving Average Definition
- Types Of Moving Average
- Using Moving Averages In A Scalping Strategy
- Protecting A Scalping Position
- Summary
What Is 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 existing once the profit has been gained. Being disciplined when scalping is essential as there will always be temptation to hold onto a winning position, but on the smaller time frames there is a lot of movement and holding a position can often see profits quickly evaporate.
Before starting a scalping campaign, it is recommended that time is spent developing a trading plan that details risk to reward ratios and entry and exit guidelines.
Which Currencies To Trade When Scalping
Unlike most other forms of trading, volatility is required. This may seem unusual, but a scalpers 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. Don't forget that fundamentally a scalping strategy requires several trades to be entered and closed each day, so price movement is required.
Forex trading is a 24hr decentralised marketplace that see's certain currencies trading in higher volume during certain markets. If for instance a trader is located in Europe, they should be looking to trade EUR currency pairs, particularly EUR/USD and EUR/GBP as these currencies will be most traded during the New York and London sessions. See our guide on market trading hours for further information.
Moving Average Definition
A Moving Average indicator is a technical tool that overlays current price action on a technical chart and is designed to smooth our price action over a fixed period of time. When looking at technical charts it can sometimes be difficult to identify the current trend, moving averages remove the market noise so that the underlying trend can be easily seen.
Types Of Moving Average
There are two types of moving average that are frequently used by traders:
Simple Moving Average (SMA)
The Simple Moving Average is calculated by taking the closing price of a set amount of period and averaging them to give an average. The SMA uses the most recent closing period so as a period closes it is included in the calculation and the oldest dropped.
Exponential Moving Average (EMA)
The Exponential Moving Average is calculated on the same basis as the SMA, although it gives more weight to the most recent closing prices. It deems the most recent price action more relevant and consequently reacts quicker to market sentiment than the SMA.
Using Moving Averages In A Scalping Strategy
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.
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, followed is a retracement. If a scalper holds onto a trade too long, they always run the risk of profits being lost due to predictable price retracements.
Protecting A Scalping 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 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
A scalping strategy requires several trades to be placed over the course of day, each trade capitalising on the smallest fluctuations in price movement. In order to extract profits from the trades, identifying optimal entry positions is essential and using technical indicators like moving averages can be a powerful tool. It important to have a trading plan in place that sets out risk to reward and profit ambitions. Positions should also be protected by using tight stop losses to avoid the smaller gains being wiped out.
