What is Scalping in Forex
Find out in this article what is scalping in Forex and what are the pros and cons of this small winning trades of short duration strategy. Scalping, altough dangerous, is very appealing because it requires a relatively insignificant amount of funds and provides several trading opportunities. There are those who criticize it but also many who are greatly interested in it.
The defining characteristics of a scalping system are:
- High Winning Percentage
- Win size is small and consistent
- Frequent trading of short duration
High Winning Percentage
High winning percentage accuracy of 70% or more is the single most important feature of a good scalping system. This is very difficult to achieve. One cannot turn any system into a scalper by just decreasing the profit target to 1-5 pips, and increasing the stop loss to a 5-10 multiple of the profit target.
Most re-configured systems turn into disasters because they are not accurate enough to begin in the first place. Usually, a good candidate for a scalping system is one that can correctly time the initial entry price and direction again and again, at least for a few pips. Very few systems can achieve this because of the difficult odds of repeatedly getting the initial entry direction and timing right within a constantly vacillating market.
Win size is small and consistent
The second most distinguishing characteristic of a scalper is the conjoining of high winning percentage with small win sizes of 1-15 pips. A scalper seeks small pip sizes because that is the only way of ensuring high winning probability. The intent is to accumulate many small wins, taking the profit off the table as soon as it is available. This method flies in the face of the “let your profits run” mindset, which attempts to be profitable via having larger winning trades, even if the percentage accuracy is less than 50%.
What about loss size? Usually, the absolute stop loss is greater than the profit target because the trade needs room to breathe through the currency’s microfluctuations. Since the profit target is so small (1-15 pips), the absolute stop loss needs to be at least 20 pips or higher. Otherwise, the system will be stopped out too often and too soon. No system can maintain high accuracy on a 1:1 win/loss ratio because the micro-fluctuations would flush out such small stops. Adaptive stops like trailing and breakeven are often used to limit the downside risk. The ability to let go of a bad trade quickly is an essential requirement.
Frequent Trading of Short Duration
Scalping trades that aim for accuracy of small pip sizes usually last a short period of time. The trades are in and out of the market within seconds or minutes. The trade setups are often taken on the shorter time frame bars (M1, M5 and M15) because the opportunity and duration of the trade reside on these smaller time frames. Because they are in and out of the market quickly on smaller time frames, they can thus enjoy more frequent trading opportunities. Scalpers and scalping strategies generally trade 1-20 times per day, sometimes much more.
Variable Defining Feature: High Leverage
A variable defining feature of scalping system is the use of high leverage. Because of the smaller number of pips gained per trade, larger than normal leverages can help in boosting the profits per trade, thus making the scalping system more appealing. It is often noted that leverage is a double-edged sword: the market can move against you on high leverage. However, a scalper justifies his use of leverage by referring to his winning accuracy: since the odds of winning are in his favor he will achieve more leveraged wins than losses.
High leverage is a variable, not defining, feature because a good scalping system does not need high leverage to be successful. A forex scalping system can use high leverage to achieve even greater returns, but higher leverage is not a must. A good scalping system can achieve modest and consistent results with small and frequent pip wins without much leverage. A reason to use less leverage for a scalping system would be the desire to maintain good results with very little drawdown.
Forex Scalping Pros
- High percentage win rate.
- Less exposure to the market limits risk: The trader has less of a chance of running into an adverse event when he is in and out of trades on a small time frame. Forex can be very frustrating because trends can reverse so suddenly. A scalper is able to close the trade and take profit before the trend reverses.
- A very effective method of using capital with minimal risk per trade: It requires a relatively insignificant amount of funds.
- More frequent trading opportunities: The small moves in the market that scalpers exploit happen with more frequency and frequent wins can more quickly build up the account.
- Possibility of using higher leverage to increase account: Because of the possibility of win rate, higher leverage can be used to increase winning dollar size, which builds account even faster
Forex Scalping Cons
- Gain to loss ratio is very low: Because the profit per trade objective is so much lower, it is easy for one bad trade to eliminate the profits of the day or week. Example: if you make 3 pips, 5 times in a row, you are up 15. If you have a stop loss of 20, just one loss wipes out all of your previous five wins.
- Hard to find a good (working) risk/reward ratio: The easiest way to increase accuracy is to increase stop loss relative to profit target, but then that means that the risk is much higher than the reward for each given trade. Higher stop loss per trade can be dangerous for scalper if win rate drops off and the system suffers repeated losing trades.
- Human Exhaustion/Stress Factor: scalping is intense, accuracy and timing are vital, and the physical and mental speeds of humans accurately deciphering the markets and entering/exiting trades in seconds can be too much. Thus, many scalpers look to automate their strategy.
- Requires a high degree of experience: the shorter time frames used require a good grasp of trading complimented with sound technical analysis skills not suitable for beginning traders.
- Spread costs: means more for scalping than for other strategies. Spreads can eat much more of the profits.
- High leverage: if employed, can greatly increase the risk by magnifying the dollar value of losing trades and losing streaks.
What is the best lot size for scalpers?
It is wise to decide on the size of the trading lot and exposed risk in advance. Calculate the worst case scenario (e.g. 10 consecutive losses in a row), and see if your account would survive such a drawdown and you would still be comfortable moving forward. Generally, scalping EAs want you to trade 10:1 leverage relative to account size, meaning that you would trade 0.1 lots (10,000) per 1K account size, risking $1 per pip, but perhaps half that lot size would be more appropriate. Definitely, test different lot size scenarios in a demo account to feel more comfortable about which size to use.
Why are automated scalping optimization systems preferable to manual scalping?
A human scalper must have some super human traits: he must have a savant-like knowledge of the market, lightning fast pattern recognition abilities and fast reflexes, iron discipline and steely courage, and be immune to stress and sleep. Oh yeah, and be possessed of an abnormal level of excellent timing and luck. Quite simply, scalping is very intense and only suitable for the most advanced level of trader. Scalping can be very draining and demand lots of screen time. Accurate timing is vital, and the physical and mental speeds of humans accurately deciphering the markets and entering/exiting trades in seconds can be too much.
Consequently, when most people look at scalping, it is to develop, borrow or buy an automated scalping EA. A scalping EA would have none of the aforementioned disadvantages: it could read, decipher and react to the rapidly changing markets with a sophisticated arsenal of built-in strategies at lightning-fast speeds around the clock, 24/7.
What types of market conditions are most suitable for scalpers?
There are many different market scenarios that scalpers can exploit. The two most obvious market conditions are when the overall market is trending or not:
1. When a larger time frame market is trending, scalpers can pinpoint setups in a shorter time frame that are in the direction of the main trade. For example, scalpers can enter two kinds of orders: one long term order and one short term scalping order in direction of market tendency. The short term scalping order would be picking up orders on rebound points. This method allows traders to work without time limitation, 24 hours, and it is not as dependent on spreads.
2. When the larger time frame market is not trending (channeling, choppy, or locked in a narrow range), scalpers can go to a shorter time frame that can reveal scalping opportunities. For example, scalpers can scalp the inter-session range or channel borders, buying at the bottom and selling at the top, with the idea that the channel with hold together and the moment of breakout is improbable, at least for the short-term.
What is the best time of the day to scalp?
Although Forex is active 24/7, not every hour is suitable for scalping. If scalping takes place on rebound points of the larger trend, then it is perhaps ok to find these opportunities throughout the day. However, most scalping systems work on the counter-trend principle, trading the channel borders or trading off of support and resistance levels, and consequently, it has been found that the quieter Asian session works better for these models.
The Asian session has less large time frame directional movements and thus less likely chance of breakouts through channels and support/resistance areas. Support and resistance levels seem to hold together better. The Asian session has more small time frame, seemingly “non-directional” moves (“mini” trends, counter-trends, and reversals) that can be exploited. Thus, applying a time filter to a strategy that only limits trades to the Asian session is a definite enhancement: though the time filter limits the number of trades in the day, it ensures that the more limited set of trades is much more profitable, which is the bigger advantage.
What types of currencies are most suitable for scalpers?
The currency selected for scalping often works best with the preferred market condition for scalping.
Those scalpers seeking to trade the range prefer the cross currencies like EUR/CHF and EUR/GBP for their greater range-bound tendencies. They have been the most attractive to date because they are the cross currencies with the best spreads. Both have had long periods of ranginess, making them ideal for scalping, particularly during the Asian Session, when these two pairs are quieter. Many brokers have caught on to their attractiveness as scalping currencies during the Asian session and have accordingly increased the spreads on these two pairs during that session. Some brokers have not, particularly the fixed spread brokers and ECN brokers. Other cross currencies selected for scalping are GBP/CHF, GBP/CAD, GBP/AUD, EUR/CAD (also best traded during the Asian session when they are more quiet). The difficulty with these pairs is their higher spreads.
Those scalpers seeking to trade off the dips and micro-trends in the direction of the trend prefer to trade with the currencies with more trendiness, movement, volatility and low spreads, such as the EUR/USD and GBP/USD (and EUR/JPY and GBP/JPY). The EUR/USD is the most popular because of its highest volume and lowest spread. This method is not session dependent.
Why are the spread costs so important for scalping?
With scalping, you need to overcome the spread much more often. Since you are aiming for a small profit of a few pips, you are more likely to find yourself giving back 40% or more due to spread.
Thus, scalpers tend to select their broker on the basis of which one has the tightest spreads.