Scalping is a tricky technique to pin down: for every trader who says he or she is scalping, there are usually ten more traders who’ll cry “that’s not scalping!” And give a completely different definition.
So what is ‘Scalping’ and how do you know if you’re scalping or simply short-term trading?
Scalping involves getting in and out of the market very quickly, sometimes for just a few minutes, sometimes for just a few seconds. And the scalper will do this again and again, often dozens or hundreds of times in a day.
The scalper isn’t looking for a big movement on each of these trades. Instead, he or she is “scalping” just a few (perhaps 5-10) pips each time.
Seems pretty modest, doesn’t it?
So how are they making big bucks?
Many scalpers will be staking high on those pips, so that each pip is making them £hundreds. But even with very modest staking – because you’re in and out of that trade in such a short period of time – you could have made yourself £50 in just a couple of minutes.
And the best bit … your funds are now released to do the same thing all over again.
Sounds less modest now, doesn’t it?
The enemy of the scalper
The two factors that a scalper must constantly battle against are: the spread, and the win/loss ratio.
If you’re only looking to gain 10 pips, you could easily find yourself giving back 40% of that in the cost of the spread.
If you’re a swing trader, and you’re looking for 100 pips profit, it won’t be too painful to give 4 of those back to your broker.
Likewise, if you’re a swing trader, you’ll probably have a risk profile that’s similar to your reward objective – i.e. the distance to your profit target will be around the same as the distance to your stop limit.
Scalpers, on the other hand, will often have a far wider stop loss than profit target. A “tight” stop at 6 pips sounds very risk-averse, but if you’re aiming for just 3 pips, you need a high winning percentage to make this work…
Let’s say you win 4 times in a row – you’ve scored 12 pips. But just two losses will wipe out those winnings.
Any scalper must have a firm handle on their success rate and their risk/reward profile.
I often hear scalping described as “high risk”, and I often hear it described as “low risk” – so which is it?
By reducing the time that your capital is in the market, you are inherently reducing your risk. And scalping can enable you to get the most from a small trading fund – as your money isn’t tied up in any one position for long.
In essence, scalping is no more risky than other forms of leveraged trading – but it does require an immense degree of discipline.
Unfortunately, discipline is an area where many traders fall short.
Plus, the scalper must repeatedly overcome the “hurdle” of the spread cost, every time they place a trade (something other traders do just once, or perhaps a handful of times, a day).
Why do scalpers love Forex?
You’ll probably have noticed that I’ve been talking “pips” rather than “points” throughout this email.
That’s because the scalpers favourite trading is to be found in the Forex markets. The currency markets are the largest, most liquid and most volatile markets in the world – and that’s why they offer the most opportunities for a scalper to find profits.
The short time frames that scalpers use also add to the potential opportunities available to them. If you’re looking at a daily price chart – you’ll have to wait a while for a candlestick pattern to emerge. However, if you’re a scalper following a 1-minute and a 5-minute chart – candlestick patterns will be unfolding in front of your eyes.
What indicators do scalpers use?
Most don’t care about trends or fundamentals, or lagging indicators – just whether or not the buying or selling position is good at that moment. Some will look at whether the market is overbought or oversold for the short term, and leave it at that.
Candlesticks, pivot points, the Stochastic oscillator… I’d like to talk more about indicators and their relative strengths and weaknesses in further emails. I’d be interested to hear what your
favourites are – and what have been bringing Maven readers the best results for scalping. Drop me a line and let me know your thoughts…