Scalping - Getting Your Strategy Right
When it comes to scalping, the term either serves to excite or strike fear in a trader. Many are scared off by the speed in which this style of trading is executed. While it is true that scalping in general is a technical approach to forex trading, in which market participants try to realise an overall profit by taking advantage of small changes in price movement, there is indeed more to it than that. If you look a little deeper, you can see that there are in fact, several different strategies that fall under the umbrella of scalping, each with its own set of pros and cons. We are going to look at these below to shed a little light on the ins and outs of these strategies and why it’s important to get it right.
A breakout is essentially defined where price moves outside a defined support or resistance level. As such, a breakout trader is required to identify these areas of support and resistance in order to establish where to place their trades. A breakout trader will enter a long position after the price breaks above resistance or enter a short position after the price breaks below support. The greater the frequency in which the price has touched these areas, the more valid these S and R levels are. Also, the longer these support and resistance levels have been in play, the better the outcome when the price finally breaks out. This sounds simple enough right? Well unfortunately there are some spanners flying around the works that you need to be aware of.
One of the major challenges in trading the breakout strategy successfully is the ability for the market to produce “false breakouts”. This is where the price advances only a short distance in the direction of the breakout before reversing course, handing the trader a loss instead of the anticipated gain.
As with any scalping strategy, you need to keep your eye on the ball in this regards. If you are using automated systems, your EA needs to have a very disciplined set of rules to manage your potential losses due to reversals and false breakouts.
The Range/ Mean Reversion
Scalping strategies centre on finding predictable movements in price and this can often involve trading narrow intraday ranges. Like the breakout, the range strategy also depends on identifying levels of support and resistance. However, here the levels are seen as forming a sort of channel between which the price remains “trapped.” The upper boundary of the channel is marked by a trend line connecting the highs while the lower boundary is defined by a trend line connecting the lows.
Instead of entering a position when price breaks support or resistance, the idea is to repeatedly buy the asset when it is at a low point in the channel, and repeatedly sell it when it is near the top. Alternatively, as with Mean Reversion, it can sometimes be profitable to bet on the currency retracing sudden moves. Either way, traders assume price will invariably bounce off support (or resistance) to deliver multiple profits. This can allow for the opportunistic scalper to enter in and out of some quick fire trades within the range to accumulate a good profit. However, caution does need to be exercised with timing and execution. The range doesn’t last forever and when the price eventually does break free, it often does so in dramatic fashion, which can result in hefty losses if you’re not paying attention. The price of the spread is also very significant in range trading. As a range by its nature is particularly limiting in the potential profit that can be taken from any given trade, it is important to ensure that your spread is as low as possible.
The Umbrella Concept
While scalping is a strategy employed on short time frames, sometimes those that are traditionally longer-term traders utilise this strategy to maximise or supplement a profit. To utilise this “umbrella concept”, a trader firstly initiates a position for a longer time-frame trade. While the main trade develops, they identify new setups in a shorter time frame in the direction of the main trade, entering and exiting them by the principles of scalping.
Not On The Trend?
Trend trading and Scalping are essentially two different sides of the Forex coin. Both are essential and present, but never the twain shall meet. They are like polar opposites by their very nature. The trend requires decisions to be made on sustained movements whereas scalping doesn’t have time to wait for these movements to develop and become clear. Trend trading is done on longer time scales, over at the very least, hours and days if not weeks months and years. There are those that pioneer, that look to marry the two and to use the trend with scalping but all this serves to do is create a type of hybrid day trading strategy. The trend by its very nature requires analysis, this takes time and in the short game, trend analysis, while good to know is not so relevant.
There are other styles and strategies for scalping in Forex, but most are variations of breakout and range trading. In essence, the style requires short fast moves for small but multiple profits. Scalping is not everyone’s cup of tea but if you get your strategy right and you have the time to commit to your computer and the market, it could just be the winning strategy for you. For more on Scalping, why not check out our Forex Scalping Guide.
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