The fuss about Forex scalping

Scalping is basically trading over very short horizons for small returns. The short holding periods limit the traders risk. While the return per trade is low - currencies can only move so far in the few minute horizons generally employed - so scalping opportunities will tend to occur frequently. That is the theory.

Scalping has been somewhat contentious in practice. Lets have a look at why.

For example, say a market is 20/21. You have the touch and pay the 21's and it always and immediately comes back 21 bid and never looks back. The seller has no window in which to close your trade at a profit. The seller will be sad and over time may suggest you might be happier trading somewhere else.

This is the equivalent of a casino concluding a player is counting cards at BlackJack - the gambling or trading pattern is just too good to be true. And that is right. Based on our analysis across millions of trades during our time in investment banking, the only people who exhibited this kind of touch were clients engaged in 'latency arbitrage', picking those occasions where our price stream was slow to update. There is a good argument that latency arbitrage is 'dirty pool' or ungentlemanly. It is certainly unsustainable if the trade never looks back.

Over time, the large bank liquidity providers have developed analytics to identify those clients engaged in latency arbitrage and implemented 'last look' pricing - holding the trade up for a period to determine how the market is going to come back before deciding whether to honour the previous rate. So in our previous 20/21, pay the 21's example the liquidity provider would decline the trade.

Your broker, who will generally be sourcing their pricing and liquidity from these liquidity providers, has to hold off confirming your trade until they get a response. That seriously degrades your experience, even when your trade is accepted. This is why many brokers discourage scalping, giving it a bad name, which is unfair and indiscriminate.

Generally scalpers are using charts and technical indicators to identify momentary over bought and over sold conditions at which they can achieve good entry prices, selling and buying respectively. They are not latency arbitraging. There will generally be a window in which another client may come the other way and neutralise the risk. That window will probably be short, but it exists. If your broker is happy to immediately confirm your trade and hold that risk there is a prospect of another client coming the other way and neutralising the risk at a profit to the broker.

So why shouldn't traders have the ability to exercise their skills and profit from the short term opportunities in FX?

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