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What Is Forex Scalping & Should You Be Using This Trading Strategy?

September 17
21:09 2012
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There is a great deal of confusion when it comes to the topic of scalping. The allure of fast paced trades, and even faster money is a great pull to new and experienced forex traders alike. To determine whether we should be scalping or not we must first define what scalping really means. Scalping is the action of taking many short term intra-day trades with the intention of only holding the trade for a few minutes. Those who scalp the forex market may only look for a very small take profit, capitalizing on moves smaller than 20 pips more often than not. While this forex trading strategy may present many viable trading opportunities, is it really in our best interest to scalp the forex market?

The Stress Of Forex Scalping Strategies

Often a traders mental ability is the determination between a successful forex trader and one that ends up never mastering the art of forex trading. With this in mind it is important to eradicate as much stress from your trading as possible. One very simple way to do this is to take less trades by using slightly longer time frames. Taking fewer trades will allow you more time to process fully your reason for entering the trade, your trade management and finally your exit strategy.

Forex scalping strategies at their very core rely on executing many trades per day. This fast paced trading style increases the level of stress a trader will experience exponentially. Not only are you forced to enter many trades per day, you are also in a position where these trades need to be closed quickly as well. For someone new to the forex market this is a recipe for disaster. This fast paced style leads to chasing markets, missing signals, and more often than not revenge trading.

The Effect Of Spread On The Forex Scalper

There is always a difference between the price you can buy a currency pair and the price at which you can sell it…this is called the spread. More often than not spread is never even a thought in the mind of aspiring forex traders. I use the word “aspiring”, as already profitable forex traders always take into account the effect spread has on their overall profit or loss. Let’s use an example to better illustrate the effect of spread.

5 Trades Per Day X 3 Pip Spread = 15 Pips Paid In Spread Per Day!

15 Pips Per Day X 5 Trading Days = 75 Pips Paid In Spread Per Week!

75 Pips Per Week X 50 Trading Weeks = 3,750 Pips Paid In Spread Per Year!

If we use 20 pip stops and risk 1% per trade that means every 20 pips we make or lose we will have gained or lost 1%.

3,750/20 = 187.5% Paid In Spread!!!

Is spread starting to become a little more important in your eyes? If you simply cut the amount of trades you take in half you will save yourself +93.75% or 1,875 pips! Now this is a very broad example of how spread can accumulate and cut into your overall profit but it illustrates a clear point of how spread can accumulate over the course of time. Spread is the cost of doing business as a forex trader, but like any other business we can cut costs and become a more streamlined business. Some companies use energy efficient light bulbs, as traders we “cut the light bill” by becoming more selective with the trades we take.

Controlling Your Risk

Our single job as a forex trader is to control risk. If you think about anything and everything we do it is done to control risk and eliminate it to the best of our ability. With that being said lets examine spread in relation to scalping. As an example lets say we bought the GBP/USD from 1.6000 with a 10 pip stop loss and a 7 pip take profit. If we are trading the Pound that means there is usually a 3 pip spread. Therefore in order for us to get filled at 1.6000 we would have had to have bought when the price (the bid) was at 1.5997 As a result the market would have had to only move 7 more pips down to hit our 10 pip stop loss. On the other side of the trade the market would have to move a full 10 pips to hit our 7 pip take profit!

This is a very important point to think about. With the example above we are risking 10 pips to make 7. Not only that but the market only has to move 7 pips to hit our stop loss, while it has to move a full 10 pips to hit our take profit! The spread works against you all the time, but as you can see the smaller your take profit and stop loss the more of an effect a pairs spread will tend to have. Another way to look at that is the spread is actually 30% of the entire profit target. That’s like running a business with a flat 30% fee on top of every sale! No one in their right mind would open a business that operated like this, but yet many jump into scalping without giving it a second thought.

One of the most simplistic ways of controlling risk is with a positive risk to reward ratio. Plain and simple, if you risk more than you look to receive on your trades you will eventually wipe out your account. There is no exception to this rule, it always comes true! A positive Risk/Reward ratio is something that is very difficult to achieve when scalping in the forex market because of spread.

Breaking Your Scalping Addiction

If you love to trade short term how can you still fill that desire but yet avoid the main pitfalls of scalping. First you need to understand that the satisfaction of turning a consistent profit far out weighs any rush you will ever experience from scalping. Our goal is to turn a profit and if the trading strategy we put to use is failing us, then its time to put it aside. I urge you to step back away from the charts and stop trading for a few days or a week. Give some consideration to the points brought forth here especially if you scalping is resulting in consistent loses. Understand that the main trend of the day is driven by the banks, and they use market manipulation to trap those trading short term intra-day strategies. For a week or two just try catching the stop run after the Asia market closes. For all you New York traders why not try sitting back and trading only stop run reversals around major levels in an extended market. The banks leave their footprint in the sand. Start following it and it will lead to success.


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