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Using a scalping strategy in forex trading

Let’s begin by saying that a scalping forex strategy is not for everyone. This is a trading system for investors with adrenaline, who simply cannot live with the boredom of checking forex prices once a day, making small adjustments and allowing the market to take its course.

What it involves is trading in a very short timeframe, with the smallest possible Stop Loss. Scalpers often open and close trading positions within a matter of minutes, which is why they usually use one-minute charts to guide their trading decisions.

A word of warning, however, the reward/risk ratio is very low with scalping. Every trade comes with a built-in cost and commissions in the form of the spread, which can easily eat up a series of small wins.

With scalping it is often not viable to set up Take Profit levels, since your target price is simply too close to the entry price. It therefore requires a great deal of the investor’s time to personally monitor the trades, unless they have access to sophisticated computerised trading systems.

Scalping systems

The simplest scalping system is to wait for that time of the day when the US/European and US/Asian markets overlap, i.e. when they are both open. This is where you will often see a lot of action. Monitor the price of your chosen currency pair for 10-15 minutes and wait for a trend to emerge.

Although you can use moving averages, the Ichimoku Kinko Hyo or some other technical indicator, many scalpers simply try to ‘catch a trend’ through observation.

To give yourself at least a reasonable chance of success, set the target profit level to not less than 1.5 times the spread.

Breakouts

A simple scalping system is to trade on breakouts. See the one-minute chart of the USD/JDP below. One way of determining your entry point is to set it at just below the lowest level of the current candle.

Click to expand image

Let’s assume you open the chart when the market is at the thick green line, your ‘starting point’. You can, for example, set your entry point at point A, just below the low of the current candle, and then exit as soon as you have realised your target profit.

Another possibility is to use Bollinger Bands. In this case, set your entry point at point B, where the price breaks out of the band, and exit when the target profit has been realised.

EMA convergence

A third option is to use convergence of two or three moving averages.

Below we see the same chart with three moving averages added: 50-period (green), 21-period (blue) and 10-period (red).

Click to expand image

At point A, the red 10-period moving average dropped below both the longer-term averages, which would have been a good entry point in this situation. Once again, the exit level should be as soon as the trader has realised the target profit level.

Conclusion

What is clear from the above discussion is that the three systems give a fairly similar reading, at least in this particular example, but this will not always be the case. Using any one of these systems and waiting for confirmation from a second one might be a prudent option, if time allows.

High/low trend reversal strategy

If you have spent any time at all monitoring forex charts, you will undoubtedly be aware of spikes. They are those awful price surges, up or down, that can upset even the most sophisticated of trading systems.

You will also have noticed that often, after such a surge, the price gives up much of the former gain and settles at a level very close to where it started.

One way to make use of this behaviour is as follows. The moment the current High/Low/2 rises more than a certain number of pips above the previous High/Low/2, exit all long positions and go short. Exactly how many pips this should be depends on the particular market. Use the Maximum True Range to guide you in this regard.

The reverse also holds; the moment the current High/Low/2 drops the target number of pips below that of the previous candle, exit all short trades and go long.

Summary

Scalping only works in markets where the trading cost per transaction is very low. Some currency traders offer spreads as low as one pip per trade. This gives the investor a reasonable chance to succeed.

If scalping attracts you, stay away from markets where spreads are wide, which is often the case if you are involved in spread trading on the stock market.

Published: 13 March 2012

You should under no circumstances consider the information and comments provided as an offer or solicitation to invest. This is not investment advice. The information provided is believed to be accurate at the date the information is produced.

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