Scalping is the most difficult of all the trading strategies to do profitably as it is impossible for any trader to consistently make money without an edge that gives them an advantage over the randomness in the market. And in the Forex market, as is the case with almost every other financial market that I know of, the smaller the time frame the greater the degree of randomness and the greater the time frame the more significant the effects of an edge tend to be. Scalpers also have the problem that many brokers simply do not like scalpers and will put successful scalpers on dealer intervention or even stop accepting their trades altogether. And if that wasn’t enough, scalping is also the most expensive form of trading because the spread, or the small commission that ECN Forex brokers charge is quite significant when it is charged on highly leveraged trades where the traders is just aiming for a few pips profit. So, with odds like these, why does anyone want to be a scalper? The answer is that high frequency trading gives traders a huge number of opportunities to profit each day so for those who master this trade the rewards can be huge. In this short article I am going to look at how scalpers can gain an edge over the FX market.
If market prices were purely random price movements then no technical trading strategy could ever succeed, if however market prices are not random then they must be doing one of two things, trending or reverting back to a long-term average – this concept is often called reversion to the mean. As I have previously written in other articles, in the FX market currencies tend to trend rather than revert back towards their long-term average prices. And the trend, as I have also written many times on my website, can be detected and traded using long-term directional indicators such as new highs and lows or moving average crossovers and such like, or by shorter term methods such as price momentum. Price momentum is therefore the best edge I know of for trading the Forex market in the short-term.
Short-term price momentum strategies (or scalping) involve detecting rapid and sudden price movements and jumping in on the side of the rapidly moving price and then exiting a short time later for a small profit before the movement stops or the price movement reverses it’s self. I would therefore recommend that those looking for a successful scalping strategy consider doing the following –
- Measure how significant short-term price movement are for each currency pair you’re considering trading. For example, how many times per day does the GBP/USD move more than 15 pips up or down in two minutes, and when a movement of this size is first detected how likely is it that the price will move another 5 pips in that direction before going 5 pips against it.
- Consider adopting a stop loss no larger than your profit target. Tight stops losses do usually degrade the performance of any trading system, and normally profit targets should be even larger than stop-losses. However, scalpers and short-term traders do not leave their trades open long enough to ‘let their profits run’. Stop losses should also not be to large for highly leveraged scalpers as the one time their system picks the top or bottom and the price reverses on them they’ll be wiped out without a tight stop loss in place.
- Automate the trading system – scalping is very difficult and very emotionally draining without it.