Scalping in Trading and How it Works – Forex scalping is a form of trade in currency pairs for very short periods but in large numbers. Many forex scalpers target high volatility events, such as economic data releases and breaking news, for opportunities when large market moves are likely.
The standard lot in forex represents 100,000 units of the base currency, but through leverage, it allows the scalpers to keep bigger positions and skim from the top of smaller movements. The value of an average pip is close to $10, so holding a trade for a one-pip move ten times a day would equate to $100.
With forex scalping, as a rule, a certain amount of pips is counted in one’s head, then the position is closed when a currency pair has moved that amount of pips either way.
For instance, a scalper may only enter a trade on GBP/USD, but that trade is only running for 30 seconds, with the aim of covering a one or two pip movement in the currency pair. Taking an average, that may only yield a profit of $10-$20, but it would be done a number of times throughout the day. Learn more in the article about scalping.
The Essential Elements Of Scalping Trading
As with any style of trading, there are always essential elements that traders might want to keep in mind, and scalping is no different. Below, you’ll find an in-depth overview of the essential elements involved.
Setting Up a Trading Plan
The first element of scalping is setting up a trading plan. Traders should select strategies that align with their goals and risk tolerance, considering the potential risks and losses of scalping.
It could also help traders develop a system for entering and exiting trades and determine which technical analysis factors they might want to incorporate with their strategy to assist with decision-making.
As mentioned, scalping requires discipline, focus, and the ability to make quick decisions when entering and exiting a position.
Risk management
The potential profits traders seek to make through scalping are generally smaller than other trading styles, which is why most scalpers use higher leverage with all their positions. Trading with leverage could increase potential profits. However, it could also magnify potential losses.
This is because the result of a trade using leverage is calculated based on the position’s entire value and not just the initial margin used to open the position.
One fundamental way to limit potential losses is by placing a strategic stop-loss order on every trade.
A stop-loss order is a predetermined level set up by the trader at a specific price point, depending on their risk-to-reward ratio. The way it works is when the price reaches this level; the position will close automatically, limiting any further potential losses.
Another form of risk management is the risk-to-reward ratio, which we just mentioned; this ratio is unique to each trader and states the amount a trader is willing to lose compared to how much they potentially want to make.
Many traders might stick to only risking 1-2% of their total account on a single trade.
Self-control
As previously mentioned, scalping is a fast-paced trading style involving opening and closing multiple positions to try and profit from the short-term price movements in the markets.
Because of this, traders might need to practice a certain level of self-control in order to stay focused and emotionally grounded while following their chosen strategy.
Lack of emotional grounding can lead to poor trading decisions, overtrading, or revenge trading, resulting in losses.
Market conditions
Scalpers generally look for volatile market conditions. When a market is volatile, it means price fluctuations happen more frequently, which is ideal for scalpers because they look to open and close multiple positions over a few seconds or a few minutes.
Apart from high volatility, scalpers also look at financial instruments that have a high trading volume and a high level of liquidity because they enter and exit positions much faster than other styles of trading; they are also looking to get in and out at the best possible price to try and secure any potential profits earned.
How Stock Scalping Works
Scalping is based on an assumption that most stocks will complete the first stage of a movement but where it goes from there is uncertain. Some stocks cease to advance after that initial stage. Others will continue advancing.
A discounter is trying to take as many little profits as possible. In contrast to the “let your profits run” mindset, which tries to optimize the positive trading results by increasing the size of the trades that are winners, this approach achieves its results through increasing the number of winners and sacrificing the size of the wins.
It is not uncommon that a trader with a longer time frame would yield positive results while winning only half or even less of the trades. The wins are just much bigger than the losses.
Advantages of scalping
Below is a list of some of the advantages of scalping.
- Scalping is traded through derivative products such as CFDs or spread betting, allowing traders to open positions on rising and falling markets.
- Scalpers are exposed to less risk because they only keep a position open for a very short time.
- There is potential for higher profits because scalpers only try to target small profits from short-term price movements.
- In certain market conditions, scalpers have the opportunity to take advantage of many trading opportunities in a single session.
- No overnight fees are payable because scalpers open and close their positions in a few seconds or minutes, never leaving a position open overnight.
Disadvantages of scalping
Below is a list of some of the disadvantages of scalping.
- Even though trading with leverage has the potential to magnify potential profits, it also magnifies any potential losses.
- Scalpers also tend to use bigger lot sizes, which could result in a significant loss of capital if a string of losses do occur.
- Due to the fast-paced nature of scalping can be time-consuming as it requires traders to look at the charts for potential trading opportunities constantly.
- Scalping is naturally a more challenging style to adopt because it requires a significant level of focus and patience and the ability to make quick decisions when an opportunity appears.
- Spread fees can quickly add up because scalpers open multiple trades during a trading session.
Tools and Indicators for Scalping
Moving Averages
Fast-moving averages, such as the 5 or 15minute, are essential for identifying short-term trends. Scalpers use them to spot potential buy or sell signals when price crosses or moves away from the averages.
Bollinger Bands
Bollinger Bands are used to gauge market volatility. Scalpers monitor the price as it moves towards the upper or lower band. Signaling potential entry or exit points in periods of high or low volatility.
RSI
The Relative Strength Index (RSI) is also classified as an oscillator, another momentum indicator that traders could use to identify overbought and oversold areas.
Within the indicator, there is a solid line moving between a range spanning from 0 to 100 with two horizontal lines, one at the 70 level and another at the 30 level.
Frequently Asked Questions (FAQs)
What is scalping in trading?
Scalping is a short-term trading strategy that aims to profit from small price movements by executing multiple trades in quick succession.
Is scalping illegal?
Scalping is not illegal, as it’s a legitimate style of trading used by retail traders and institutional investors. However, some brokers might impose restrictions on this trading activity due to its high risk.
Is scalping trading profitable?
A scalping trading strategy can be profitable, provided you have a higher ratio of winning trades versus losing ones. Traders with longer timeframes, such as day traders or position traders, might win less than half of their trades and still come out with a profit. Whereas scalpers could see all their hard work gone in the blink of an eye.
