Forex scalping is a strategy that seeks consistent and steady equity growth from numerous small winning trades of short duration. It is very appealing because it requires a relatively insignificant amount of funds and provides numerous opportunities. There are those who criticize it but many who are greatly interested in it.
The defining characteristics of a scalping system are:
- High Winning Percentage
- Win size is small and consistent
- Frequent trading of short duration
High Winning Percentage
A high winning percentage accuracy of 70% or more is the single most important feature of a good scalping system. This is very difficult to achieve. One cannot turn any system into a scalper by just decreasing the profit target to 1-5 pips, and increasing the stop loss to a 5-10 multiple of the profit target. Most re-configured systems turn into disasters because they are not accurate enough to begin in the first place. Usually a good candidate for a scalping system is one that can correctly time the initial entry price and direction again and again, at least for a few pips. Very few systems can achieve this because of the difficult odds of repeatedly getting the initial entry direction and timing right within a constantly vacillating market.
Win size is small and consistent
The second most distinguishing characteristic of a scalper is the conjoining of high winning percentage with small win sizes of 1-15 pips. A scalper seeks small pip sizes because that is the only way of ensuring high winning probability. The intent is to accumulate many small wins, taking the profit off the table as soon as it is available. This method flies in the face of the “let your profits run” mindset, which attempts to be profitable via having larger winning trades, even if the percentage accuracy is less than 50%.
What about loss size? Usually, the absolute stop loss is greater than the profit target because the trade needs room to breathe through the currency’s micro fluctuations. Since the profit target is so small (1-15 pips), the absolute stop loss needs to be at least 20 pips or higher. Otherwise, the system will be stopped out too often and too soon. No system can maintain a high accuracy on a 1:1 win/loss ratio because the micro-fluctuations would flush out such small stops. Adaptive stops like trailing and breakeven are often used to limit the downside risk. The ability to let go of a bad trade quickly is an essential requirement.
Frequent Trading of Short Duration
Scalping trades that aim for accuracy of small pip sizes usually last a short period of time. The trades are in and out of the market within seconds or minutes. The trade setups are often taken on the shorter time frame bars (M1, M5 and M15) because the opportunity and duration of the trade resides on these smaller time frames. Because they are in and out of the market quickly on smaller time frames, they can thus enjoy more frequent trading opportunities. Scalpers and scalping strategies generally trade 1-20 times per day, sometimes much more.
Variable Defining Feature: High Leverage
A variable defining feature of scalping system is the use of high leverage. Because of the smaller number of pips gained per trade, larger than normal leverages can help in boosting the profits per trade, thus making the scalping system more appealing. It is often noted that leverage is a double edged sword: the market can move against you on a high leverage. However, a scalper justifies his use of leverage by referring to his winning accuracy: since the odds of winning are in his favor he will achieve more leveraged wins than losses.
High leverage is a variable, not defining, feature because a good scalping system does not need high leverage to be successful. A scalping system can use high leverage to achieve even greater returns, but higher leverage is not a must. A good scalping system can achieve modest and consistent results with small and frequent pip wins without much leverage. A reason to use less leverage for a scalping system would be the desire to maintain good results with very little draw down.
- High percentage win rate.
- Less exposure to the market limits risk: The trader has less of a chance of running into an adverse event when he is in and out of trades on a small time frame. Forex can be very frustrating because trends can reverse so suddenly. A scalper is able to close the trade and take profit before the trend reverses.
- Very effective method of using capital with minimal risk per trade: It requires a relatively insignificant amount of funds.
- More frequent trading opportunities: The small moves in the market that scalpers exploit happen with more frequency and frequent wins can more quickly build up the account.
- Possibility of using higher leverage to increase account: Because of the possibility of win rate, higher leverage can be used to increase winning dollar size, which builds account even faster
- Gain to loss ratio is very low: Because the profit per trade objective is so much lower, it is easy for one bad trade to eliminate the profits of the day or week. Example: if you make 3 pips, 5 times in a row, you are up 15. If you have a stop loss of 20, just one loss wipes out all of your previous five wins.
- Hard to find a good (working) risk/reward ratio: The easiest way to increase accuracy is to increase stop loss relative to profit target, but then that means that the risk is much higher than the reward for each given trade. Higher stop loss per trade can be dangerous for scalper if win rate drops off and system suffers repeated losing trades.
- Human Exhaustion/Stress Factor: scalping is intense, accuracy and timing is vital, and the physical and mental speeds of humans accurately deciphering the markets and entering/exiting trades in seconds can be too much. Thus, many scalpers look to automate their strategy.
- Requires a high degree of experience: the shorter time frames used require a good grasp of trading complimented with sound technical analysis skills not suitable for beginning traders.
- Spread costs: means more for scalping than for others strategies. Spreads can eat much more of the profits.
- High leverage: if employed, can greatly increase the risk by magnifying the dollar value of losing trades and losing streaks.