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Jun 22

Forex Trading Strategies Guide: Scalping 101

Posted by bo at 17:46 | Others | Comments(5) | Reads(41424)

The first step in any guide on scalping is understanding how scalpers actually make money. What does a scalping strategy look like in daily practice?

We already mentioned that scalping involves entering and exiting the market in short time spans. But what guides the choice to enter or exit? Actually, this strategy works on the basis of careful analysis and timing. What makes scalping different from other strategies is that it takes advantage of volatility rather than trending, ranging, or fundamental analysis. Recognizing that the market moves erratically in the short term, scalpers try to identify small patterns and exploit them.

The strategy works when traders can find short-term disruptions in liquidity, or other temporary abnormalities. For instance, a news shock or some other factor might suddenly increase demand for the yen. During that time, there will be a need for liquidity as too many people demand the yen with insufficient supply. The spread between bid and asking price will temporarily widen. A scalper might recognize that the liquidity has to return eventually and the price will eventually settle back into normal levels. Based on this, he can go long or short, as appropriate, and collect on the difference.

This means that scalpers actually benefit from volatility by trading on the assumption that prices will stabilize again. It’s not hard to see that after a major event, prices routinely zigzag for several minutes before settling again. Since this is an emotional over-reaction, a scalper maintains a realistic, stable viewpoint and profits from those who don’t.

It’s also easy to see that if trading wisely, scalpers act as “brakes” on the micro-volatility of the market. They actually profit by dragging irrational price-spikes back to meaningful levels. One other implication is that the most important time for a scalper is just after a market shock. Scalpers pay careful attention to announcements of economic data or news shocks and the disruption that follows.

But these observations lead to the other major topic of this article—leverage. The inherent limitation of trading on micro-volatility is that it will never be very significant. Therefore, scalpers use surprising amounts of leverage to make their trading more potent. Their leverage might range from 5:1, all the way up to 50:1. These kinds of leverage would be simply intolerable for other traders, but the important thing to remember is the short duration that scalpers use. During this time, there is little opportunity for wide swings in the market that would risk massive losses. It is also crucial to always use a good stop-loss mechanism and not adjust it for individual trades. If these measures are maintained and a trade turns out badly, it will be closed in a matter of minutes or even less when the stop-loss level is reached.

There are still a few cases when scalpers might still suffer significant losses. Significant news shocks might cause very wide spreads in a short time. Even the best brokers may not be able to complete stop-loss orders quickly enough, and losses can multiply exponentially. Therefore, traders should always be conscious of whether new economic data or another type of event has the potential to cause significant disruptions. In such cases, it is always wise to use caution and trade with lower amounts of leverage.

Scalping is an interesting strategy because it takes advantage of phenomena that might otherwise seem random. It is a simple testimony to the fact that on every level of the forex market, the same principle applies—profit belongs to the traders that use their heads and who are not carried away by short-term emotion. The scalpers that succeed are the ones that have mastered that art.
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Scalping is very good type of Forex trading I'm using it and day trading.  Thanks for this article.
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