What Is Scalping? 

Scalping is a trading strategy that involves placing numerous trades, each with the goal of making small profits over very short time frames. 

Understanding Scalping

As mentioned before, forex trading involves trading currency pairs over very short time frames, in large numbers. Many forex traders focus on highly volatile events surrounding economic data releases and breaking news, where large market moves are almost guaranteed. 

A standard forex lot is equivalent to 100,000 units of the base currency, but thanks to leverage, scalpers can take larger positions and profit from even small market moves. The average value of one pip is around $10, so holding a trade for a one-pip move ten times a day is worth $100. 

Forex traders typically have a target number of pips in mind and close their position once the currency pair has moved that amount in either direction. 

For example, a scalper might open a GBP/USD trade for just 30 seconds, aiming for a one- or two-pip move in the currency pair. On average, this could earn them a profit of $10-$20, but this process is repeated several times throughout the day. 

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Scalping Characteristics  

Scalping is distinguished from other trading strategies, such as options or swing trading, by its unique approach to taking advantage of market opportunities. Its defining characteristics are: 

• High trading frequency: 

 Scalping focuses on volume. Traders quickly open and close many positions, often executing hundreds of trades within a single day. It can be likened to the speed chess of the trading world. 

• Short holding periods: 

 Long-term investing is not the focus here. Scalpers aim to profit within minutes or even seconds. The focus is on getting out quickly before market conditions change. 

• Small profit margins: 

 Scalpers seek small, consistent gains. These modest gains accumulate over time, much like collecting coins from a fountain until a large sum is accumulated. 

Scalping Strategies 

• Scalping with the Stochastic Oscillator 

Scalping can be effectively executed using the Stochastic Oscillator. The term “stochastic” refers to the position of the current price relative to its range over a specific recent period. By comparing the price of a security to its recent range, the Stochastic Oscillator attempts to identify potential turning points in the market. 

When used for scalping, this oscillator aims to profit from movements within a trending market – that is, a market that is consistently moving up or down. Prices typically close near the extreme of their recent range before a turning point occurs. An example of this is shown below: 

In the chart above, which depicts Brent crude oil on a three-minute time frame, we observe an upward price movement. The dips in the stochastic indicator, marked by arrows, represent potential entry points for long trades. These entries are triggered when the black %K line crosses above the red dotted %D line. The trade is then exited when the stochastic indicator reaches the upper end of its range, above 80, or when a bearish crossover occurs, meaning the %K line crosses below the %D line.  

Conversely, short positions are used in a downward trending, as shown below. In this scenario, instead of “buying the dips,” we are “selling the rallies.” Therefore, we look for bearish crossovers that are consistent with the prevailing downtrend, as shown below: 

 Scalp trading using the moving average 

Scalp trading can also be done using moving averages. This approach typically involves two short-term moving averages and one long-term moving average to determine the prevailing trend. 

For example, consider a three-minute chart of the EUR/USD pair. We might use a five-period moving average and a twenty-period moving average for the short-term analysis, and a 200-period moving average for the longer-term trend. If the longer-term moving average (200-period) is trending upward, we look for instances where the five-period moving average crosses the 20-period moving average. These crossovers indicate potential buying opportunities in line with the overall uptrend. These entry points are usually marked with an arrow. 

In the second example, the long-term moving average is declining, so we look for short positions when the price crosses below the 5-period moving average, which has already crossed below the 20-period moving average. 

It is important to remember that these trades follow the prevailing trend, and we do not attempt to track every price fluctuation. As with all scalping strategies, proper risk management is crucial, and stop loss orders are essential to prevent large losses that can quickly cancel out many small gains. 

Scalp trading using the Parabolic SAR indicator 

The Parabolic SAR is an indicator that highlights the direction in which a market is moving and also attempts to provide entry and exit points. SAR stands for ‘stop and reversal’. The indicator is a series of dots placed above or below the price bars. A dot below the price is bullish, and one above is bearish. 

A change in the position of the dots suggests that a change in trend is underway. 

The chart below shows the DAX on a five-minute chart; short trades can be taken when the price moves below the SAR dots, and longs when the price is above them. As can be seen, some trends are quite extended, and at other times a trader will face many losing trades. 

 Scalp trading with the Relative Strength Index (RSI) 

Traders can use the RSI to identify entry points that are in line with the prevailing trend. In the first example, the price is trending steadily higher, with the three moving averages generally pointing higher. Dips in the trend are considered buying opportunities, so when the RSI drops to 30 and then crosses that level, a potential entry point is established. 

Conversely, when the RSI rises to 70 and then starts to decline within a downtrend, a “sell the rally” opportunity arises, as shown in the example below: 

Scalping in the Forex market: 

• Forex scalping is a trading style that aims to profit from small price fluctuations in the forex market.  

• Forex scalping involves buying or selling a currency pair, such as the EUR/USD, and holding the position for a short period of time, hoping to make a small profit. 

• Forex scalpers repeat this process repeatedly throughout the day, taking advantage of the price fluctuations of each currency pair.  

• These trades can last from seconds to minutes but are never held overnight.  

Pips and Scalping  

• In the forex market, the smallest price movement a currency can make is called a pip (percentage point), which traders use to measure profits and losses. 

• Forex scalpers typically aim to scalp between 5 and 10 pips from each position, seeking to accumulate a larger profit by the end of the day. 

• Effective forex scalping strategies often involve leveraged trading.  

• Forex leverage allows traders to borrow capital from a broker to gain greater exposure to the market, using only a small percentage of the total asset value as a deposit.  

• While this strategy maximizes profits, it can also magnify losses if the market moves unfavorably.  

• Forex scalpers must constantly monitor the market for any changes. 

Scalping in the stock market: 

• Scalping assumes that most stocks will initially experience price fluctuations, but their subsequent direction is unpredictable.  

• Scalpers make profits by taking advantage of these small price movements, rather than anticipating large price swings.  

• This strategy contrasts with longer-term trading methodologies, which typically target larger gains but with less frequent trades. 

Scalping in indices: 

• Indices are statistical measures designed to track the performance of a group of stocks.  

• Indices cannot be purchased directly like individual stocks; instead, investors gain exposure to them by buying index funds or, rather, investing money with an underlying investment company that allocates capital to the individual stocks within the index.  

• Indices are particularly attractive to scalping because the sheer volume of activity within individual stocks virtually guarantees consistently decent volatility and liquidity.  

• This also means that the price movements of indices tend to be more stable and predictable, as no single stock can significantly impact the overall price of the underlying index. 

How Does Scalp Trading Work? 

• Speculators work on the principle of accumulating profits through many small price movements. 

• They prioritize reducing risk over the potential for large gains. To effectively manage risk, scalpers set strict trading parameters for both time frame and price volatility. 

• While scalping can indeed help mitigate losses, it can also cause traders to miss out on opportunities for larger profits. 

•  Scalpers do not hold positions in anticipation of larger gains. Instead, they typically exit the trade once their target profit is reached.  

• They do not wait for a potential market reversal once the stock reaches a predetermined loss level; rather, they exit the trade immediately. 

How Does Scalpers Analyse the Market Before Scalping? 

• Scalpers usually prefer technical analysis over fundamental analysis when examining a stock’s past price movements. 

• They use indicators and charts to identify trading events. Effective analysis helps them determine appropriate entry and exit points in the market. 

• Scalpers use real-time charts to monitor daily trading prices and stock price movements.  

• They then use established patterns and indicators to predict the stock’s movement in the coming minutes. Finally, they determine low and high trading points for entry and exit. 

• While scalpers may trade based on any event or news that affects a company’s value, including short-term changes in fundamental ratios, most focus on charts and trading indicators.  

• The time horizon, which refers to how long a position is held, affects its value. A longer time horizon usually corresponds to a lower value. 

•  Trading indicators and technical analysis are more suitable for the short-term nature of scalping. 

Day Trading vs. Scalp Trading 

Scalping and day trading are similar, both involve executing multiple trades within a single day. However, there are distinct differences between the two approaches. 

For example: 

• A day trader typically uses a time frame of 1 to 2 hours, while a scalper operates within a much shorter time frame, ranging from 5 seconds to 1 minute. 

• Scalping traders tend to have larger account sizes on average than day traders. 

• Scalping traders execute trades quickly. In contrast, day traders also trade in quick succession but at a more moderate pace. 

• Scalping traders rely primarily on their experience and understanding of market movements. Day traders, on the other hand, base their trading decisions primarily on technical analysis. 

Essential Tools for Scalping 

In scalping trading strategies, the use of technical analysis tools is paramount, with scalpers relying heavily on, 

• Charts  

• Indicators  

that provide real-time market data. This approach facilitates rapid, informed decision-making throughout the trading day, as scalp trading frequently involves swift entry and exit from positions, capitalizing on small price differences between the bid and ask price.    

Primary indicators employed in scalp trading: 

• Moving average convergence divergence (MACD): This indicator assists in identifying momentum and trend shifts by comparing two moving averages.   

• Relative strength index (RSI): Frequently used to detect overbought or oversold market conditions, signaling potential reversal points.    

• Exponential moving average (EMA): Places greater emphasis on recent price data and is used to identify short-term trend directions and dynamic support and resistance levels.    

• Bollinger bands indicator: This indicator comprises three lines that can indicate overbought or oversold market conditions.    

• Volume weighted average price (VWAP): Provides an average price at which a security has traded throughout the day, based on both volume and price. It is particularly important for traders seeking a true sense of where the majority of volume has transacted.    

• Parabolic stop and reverse (SAR): Helps to identify potential reversals in the market price direction of a traded asset. 

• Schaff trend cycle (STC): Combines the common concepts of cycles and trends to help identify market reversals and direction. 

Advantages of Scalp Trading 

Scalping relies more on technical indicators than fundamental analysis due to short-term price volatility. While news trading is generally not recommended for beginners, practicing on simulators can make scalping more accessible and attractive than fundamental analysis. It offers the potential for large profits, especially with high-frequency trading, by taking advantage of small price fluctuations in either direction, unlike intraday trading which can result in lost profits due to market corrections. Scalping allows for profits even in stable markets, avoids overnight swap fees, and most importantly, provides valuable market education. It also trains traders to better understand market dynamics and develop intuition, making longer-term strategies seem simpler by comparison. 

Disadvantages of Scalp Trading 

Spreads have a greater impact on scalping profits because they represent a larger percentage of the targeted small gains. Technical issues such as slippage, order delays, and platform failures can be particularly damaging when seconds matter. Market noise, which is insignificant over longer periods, can trigger stop-loss orders in short-term scalping.  

Scalping is limited to liquid currency pairs with moderate volatility; exotic pairs are not suitable. Restrictions imposed by brokers, including outright bans on scalping or minimum holding periods, can also be problematic. The intense concentration and rapid decision-making required can lead to mental stress and fatigue, although automated trading tools can mitigate this. Finally, the high leverage used in scalping often magnifies risks significantly. Despite these drawbacks, many traders are attracted to scalping because of its dynamic and attractive nature.