A Complete Guide to Forex Scalping

The early 1970s saw the collapse of the Bretton Woods System, which allowed floating rates for global currency exchange and laid the foundations of forex trading as we know it today. Yet, it wasn’t until 1996 that retail investors could participate in the markets. But it was only with the launch of online trading platforms in the 21st century that individual traders were able to access robust trading tools for decision-making, just like institutional traders. Today, traders can use automated trading, advanced trading algorithms, charting tools and access to institutional grade liquidity have popularised FX trading. Although there are many ways to participate in this market, forex scalping is a popular option for those with a short-term timeframe and enough time to monitor the markets constantly.

What is Forex Scalping

A form of day trading, forex scalpers attempt to make profits from even the tiniest pip changes in forex pairs. For this, they enter and exit trades very quickly, taking on numerous short-term positions through the day. The goal is to gain from micro-trends multiple times a day through ultra-short-term positions. The duration for such positions may range from less than a minute to 15 minutes, with an average of 3 to 5 minutes per position.

The FX market lends itself to scalping better than many other tradable assets because:

Volatility

The high volatility of currency pairs brings plentiful trading opportunities throughout the day.

Liquidity

This is known to be the most liquid market in the world, which means that traders are likely to find a counterparty to their trades quickly and easily. This prevents slippage and makes it easy to enter and exit the market multiple times throughout the day.

A 24/5 Market

The currency markets are open 24 hours a day, from when it opens with the Sydney session at 9:00 pm UTC on Sunday to the close of the New York session at 10:00 pm UTC on Friday. This makes forex the only market that truly allows trading at any time.

Yet forex scalping is considered a sophisticated form of trading due to the high concentration and discipline required from traders to leverage the currency price movements. If you wish to become a scalper, the first thing you need to do is familiarise yourself with technical analysis tools, such as indicators.

The Most Popular Forex Scalping Indicators

As forex scalping requires monitoring tiny movements and swiftly acting on them, scalpers trust technical indicators to identify entry and exit positions. The top indicators used by forex scalpers to devise their strategies are:

Bollinger Bands

Bollinger Bands plot the price trend line using two bands, each being two standard deviations away from the 21-day simple moving average(SMA). This means that the upper band is two standard deviations above the SMA line, while the lower band is two standard deviations below the SMA. When the distance between the bands widens, it indicates high volatility, while a narrowing of bands signals lower price volatility.

These bands are often used to determine support and resistance levels, as well as to identify trends. For instance, a widening of the bands, known as Bollinger Bounce, tends to signal an upcoming retracement. On the other hand, a Bollinger Squeeze or narrowing of the bands signals an impending price breakout.

Stochastic Oscillator

This simple momentum indicator is used by forex scalpers to predict when an existing trend is likely to end or reverse. It uses a scale from 0 to 100 to estimate the degree of change in prices by comparing the closing price of a forex pair to the trading range over your chosen timeframe. When the Stochastic lines rise above 80 on the 0-100 scale, it is considered a signal of an overbought market, while a reading below 30 indicates oversold conditions. The rule of thumb followed by traders is to go long when the market is oversold and go short or sell when it is overbought.

Parabolic Stop and Reverse

Apart from knowing when to enter a trade, experienced traders also determine their exit points right at the beginning. This is where the Parabolic SAR indicator helps. It helps spot the end of an ongoing trend. The indicator places dots along a candlestick chart to indicate potential trend reversals. A bearish reversal is depicted when red dots appear above the current price and is considered a signal to sell. A bullish run is imminent when green dots appear below the current price, which is taken as an indication to buy.

As forex scalpers gain from small movements, a red dot after a series of green ones or a green dot after a series of red ones indicates a bearish or a bearish reversal, respectively.

Relative Strength Index

The reversal of the current price direction is assessed using a range between 0 and 100. RSI is a momentum indicator that utilizes 30 and 70 on this scale as the levels of support and resistance, respectively, to predict a change in the direction of the market trend.

An overbought market is indicated when the RSI rises above 70. This is considered a signal to open a short position. When the RSI falls below the 30 mark, an oversold situation is indicated, signaling an opportunity to open a long position. Although RSI is preferred for trading with longer timeframes; forex scalpers use it to strengthen their strategies for short-duration trading.

However, remember not to rely too heavily on any single indicator without considering others, as it might give a false signal and lead to unsuccessful traders. Successful traders suggest using another indicator to confirm signals before making a trading decision.

Top Scalping Strategies

The above indicators can be used individually or in conjunction with others to build scalping strategies. These strategies are classified based on what time or movement in the market a trader finds best suited to their trading style and goals.

1.      The Breakout Strategy

Also known as trend trading, this strategy is used by traders to enter a trade as soon as the price of their chosen forex pair breaks out of a range. Traders using this strategy look for strong momentum before the actual breakout to open a position. Most often, a price break occurs after a period of compression in price action.

A sudden directional move can be identified using Bollinger Bands, which show market consolidation points and hence a breakout. Candlestick chart patterns are another tool used by scalpers following the breakout strategy. The chart patterns used most commonly for this are the Double Top/Bottom, Triple Top/Bottom, and Head and Shoulders.

2.      The Reversal Strategy

Predicting a pullback in the market requires more skill and experience. It needs the trader to know when and why a reversal in trend occurs. Countertrend trading is timed at the peaks and valleys of the price movements. There is no need to predict highs or lows, only short-term pullbacks to enter and exit trades. This technique needs strong risk management measures, since short-term reversals can be tricky.

Momentum-based indicators like the Stochastic Oscillators are leveraged here. They help in measuring the velocity of price movement. When the price action is exhausted, a reversal is likely.

3.      Mean Reversion Strategy

This strategy is based on the theory that asset prices will revert to their historical average after a period of volatility.  So, scalpers using this strategy aim to capture profits from the return of a forex pair to its average levels. To use this strategy, you need to first identify the average or mean. This can be done using a simple moving average (SMA), since it calculates the average price of an asset over a specific timeframe. So, while the price could fluctuate above or below this average price, it will eventually return close to it.

Other indicators, like Bollinger Bands, can be used to confirm entry and exit positions, since the upper and lower bands show how far the price has moved from its mean.

Before You Set Out

There is no perfect strategy to practice scalping. It requires more than an understanding of the markets and indicators. It needs discipline and patience to monitor the markets and identify viable trading opportunities. Trading psychology, therefore, plays a key role. Here are a few traits that usually characterise successful forex scalpers.

Emotional Control

Emotions can wreak havoc even on long-term positions. This is why scalpers work on identifying and controlling emotions that could come in the way of their trading decisions. For instance, being able to handle the stress of constant price fluctuations to find opportunities that offer earning potential.

Fear and greed are the most common emotions that impact trading. Fear could lead traders to pull out of positions too early or not enter a position at all, while greed tends to make traders hold on to positions much after they’ve stopped being profitable. Experts recommend keeping a trading journal and noting down your emotions and trading decisions regularly. This can help you identify helpful and unhelpful patterns, so that you can gain better control over emotions.

Trading Discipline

A proper trade set-up is indispensable. Use a demo account to backtest and fine-tune trading strategies. Once you have a plan, stick to it. The market conditions will change and tempt you to abandon your trading plan. These are the times when you need to exercise discipline to stay with the plan. Spontaneous decisions could lead to poor decisions, since you don’t have enough time to test them before applying them to the live markets.

Define Your Goals

Defining your financial goals before any investment is imperative. Know why you are trading, the timeframe of your trading goals, your risk appetite and the trading capital you can afford to lose on any single trade. This will help you set position sizes, apart from determining which trades to execute.

Practice Risk Management

Ben Franklin famously said, “By failing to prepare, you are preparing to fail.” This not only emphasises the need for a tried and tested trading plan but also the need for appropriate risk management to be a part of this plan. So, don’t forget to place stop loss and take profit levels for every single trade. Choose the capital you are willing to risk per trade. Experts recommend risking only 2% of your total trading capital on a single trade.

Continuously Test and Fine-Tune Your Strategies

As you gain familiarity with the forex market and trading tools, continue to work on refining your trading strategy. The way you trade as a beginner can be vastly different from the way you will trade as an experienced trader. Start with one currency pair, preferably the most liquid pair. Once you are confident of your strategy with this pair, you can go on to other forex pairs. But since you’re scalping, the higher the liquidity of the forex pair, the easier it will be to execute quick trades.

5 Tips to Help You Ace Forex Scalping

1. Two best times to trade in a day: These times are known for the highest liquidity and maximum volatility, which means more trading opportunities.
   1. Overlapping trading sessions. The period when the London and New York sessions overlap tends to see the highest trading volumes.
   2. The busiest time for your time zone.

• Keep your ears and eyes open: Announcements by central banks, economic releases, geopolitical developments and natural disasters can all impact forex rates. This makes it important for forex scalpers to follow the news closely.

• Pick more volatile pairs to access more opportunities for scalping throughout the day.

• Use stop loss generously. This is a powerful risk management technique to limit losses and prevent emotions from affecting trading decisions.

• Trading the news can be dangerous for beginners. Volatility rises exponentially when there are major news events. This not only affects trading volumes, but also liquidity. Keeping your eye on an economic calendar can be useful.

Bonus Tip

Scalping is not for everyone. It can be thrilling but needs hard work, patience and discipline. It is a trading style that relies on quantity as well as quality. Choose your broker carefully. Check for deep liquidity, ultra-fast trade executions and tight spreads. These aspects will impact your trading outcomes during scalping. Also, keep going back to your demo account to try out new trading tools and strategies before using them in live market conditions.

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