Forex scalping describes a technique for trading in forex where the trader enters and exits a trade position within the space of a few minutes. The principle behind this trade technique is to allow little drops of water to make a mighty ocean. In other words, opening and closing trade positions in a matter of minutes is done to allow the scalper pick off small number of pips in profit, which can be added up to get a substantial figure.
The Mindset of the Scalper
How does a scalper’s mind work? Anyone who has traded forex knows that price fluctuation is a very normal market occurrence. Even when price is in a defined trend, the movement of price action does not occur in a straight line. It bobs and weaves like the waves of an ocean. Moreover, a sudden economic or political announcement can cause price action to take a totally unexpected direction. Such was the case on January 22, 2008 when the Federal Reserve announced a change in US interest rates in an unprecedented unscheduled announcement. Worse still? The news hit the markets a few minutes before the New York open that fateful Monday, so no one could predict it or claim to have had some inkling that it would happen. Many currencies simply reversed their previous trends and not a few traders lost colossal amounts of money.
This scenario is the scalper’s worst nightmare. For a scalper, a bird in hand is always worth more than a million in the bush. The scalper does not want to subject trading capital to the vagaries of the market, so as soon as trades have entered into profit territory, the scalper cashes in, and repeats the process.
How Scalping Works
Practically speaking, scalping works best if the market has some sort of short-term market direction. A choppy market has no direction: how can you scalp effectively if you are trading blind? A choppy market is a risky market with endless whipsaws that will draw you in and end up dishing out losses.
Notice that what is mentioned is “short-term direction”, not trend. You can scalp against a prevailing trend, if that trend is in a retracement. You can also scalp along the main trend. A typical scalp aims to achieve a target of 10 pips. Some may aim for more, but at this point, the boundaries of a scalp are being crossed and this may no longer be considered a scalp trade.
Scalp trades usually broach the boundaries of risk management. Scalpers typically tend to adopt a high-volume, low pip-count approach to their trades. For instance, a scalper may decide to use a $2000 account to open trade positions of 0.2 lots per trade, aiming for $2 a pip. 5 successful daily trades of 10 pips each at $2 per trade will yield $100 a day. For some scalpers, this may be all they need.
What Brokerage Model Works Best for Scalping?
When scalping, is it best to use an ECN broker or a market-maker? Historically speaking, market makers loathe scalpers and hate them with a passion. There have been many reported cases of scalpers being banned from platforms and their funds seized for scalping. Some are warned to stay away ab initio. Why are market makers vehemently opposed to scalping?
It all boils down to conflict of interest. Market makers are counterparties to any forex trade. So a scalper is a direct competitor. Do you think market makers will enjoy it if you have making a killing by taking away profits little by little? They will not be amused one bit.
In contrast, ECN brokers not only collect a spread on trades, but they make the bulk of their money by charging commissions on both sides of the trade. So if you are a profitable scalper, you will actually be good business for the ECN broker in the long run. So it is actually in the interest of ECN brokers to allow scalpers do their thing. Moreover, ECN accounts usually demand more money for opening an account, so larger trade sizes will lead to larger commissions.
When is the Best Time to Scalp?
a) Scalp during times of maximum liquidity, which is between 8am and 12 noon EST. This is when the New York and London sessions overlap. You will have the best ability of entering and exiting trades with speed.
b) Some scalpers trade around high volatility news trades. Here is a demonstration of how it works.
A great danger in scalping around news trades is being taken out by the whipsawing price action. So a way to get around this is by allowing larger stop loss settings while maintaining a tight 10-15 profit target. This goes against risk management, but scalping in itself is risky business. All stops and profit targets are setup a few minutes before the news.
The news is watched on a 1-minute or 5-minute chart to see the full extent of the initial spike. Most retail traders try to catch the spike; you cannot do this effectively as you lack the tools. So maybe you can try catching the initial sell-off following the spike. At least, you will be following the institutional trade moves.
Once the news is released and a large initial spike forms, watch the price action to see where this spike starts to stall. If you are experienced, you can actually see this point. If you time the sell-off very well, you can take in 10-15 pips easily and then you get out of the market. Once out, stay out.
Tools to Help You Succeed in Scalping
Scalping will only succeed if the right tools and methods are used. Speaking of tools, you can access one right here. This Fix-API tool connects your MT4 EA directly to the pricing and execution from the interbank market and not from the in-house MT4 servers which are to slow to allow for quick entries and exits. Successful scalping depends on speed. If you do not have the tools to carry out speed trading, you will not make it as a scalper.
In addition, the trader must be wary of the broker he uses for his scalping activity. Many market makers will blacklist the trader and seize all funds if they notice a pattern of trading that suggests scalping. Scalps are better done on ECN platforms.
Is Scalping a Viable Way to Trade FX?
There will always be people arguing for and against scalping. However, if scalping were not a viable option, no one would do it. Scalping will only be viable if the rules are followed.
For instance, a scalper must possess a well-defined entry and exit strategy. Scalping will not work if a gambling approach is used. Scalping also may not work if you use a market-maker platform; you may even be kicked out by the broker.
Scalping is suited for ECN platforms, and it is actively supported by the ECN brokers. One such broker is Circle Markets.
When scalping, factor in the broker’s commissions so you know how many pips per trade you can realistically target. Also remember that commissions are charged on both trade entry and exit.