In the online trading world, there are unique styles and methodologies employed with the goal of achieving profitability. One of the most prominent forms of day trading used by both retail and institutional traders alike is known as "scalping."
How to use this guide:
What is Scalping
Scalping is a trading style in which the trader elects to take small profits quickly as they become available within the marketplace.
Often referred to as "picking up pennies in front of a steam roller", scalping focuses on identifying fluctuations in price during the extreme short-term. This trading philosophy is based on the idea that taking small profits repeatedly limits risk and creates an advantage for the trader. Scalping comes with the lost opportunity cost of bigger gains, so it requires discipline.
Traders who implement this strategy are known as scalpers. Many small profits can easily compound into large gains if a strict exit strategy is used to prevent large losses.
Scalping utilizes larger position sizes for smaller price gains in the smallest period of holding time. It is performed intraday. Scalpers get out of trades once their profit target has been hit, rather than waiting to see whether they can profit more. They also exit trades when their target loss level has been hit, rather than waiting to see whether the trade turns around.
Scalpers can be either discretionary or systematic traders. Discretionary scalpers quickly make each trading decision based on market conditions. It is up to the trader to decide the parameters of each trade (e.g., timing or profit targets).
Systematic scalpers rely little on their instincts. Instead, they use trading robots, which are computer programs that automate scalping with artificial intelligence to conduct trades based on the criteria set by the user. When the program sees a trading opportunity, it acts without waiting for the trader to assess that position or trade.
Discretionary scalping introduces bias into the online trading process that can pose a risk. Emotions may tempt you to make a bad trade or fail to act at the appropriate time. Systematic scalping takes human control away from trading decisions, making the trades unbiased.
Scalpers trade derivative products such as contracts for difference (CFDs) on the price movements of an underlying asset, whether this is a currency pair, share, or commodity, instead of owning the physical asset. This allows them to trade with leverage, which can provide huge profits if the trade is successful, although losses will be magnified if the markets move in an unfavorable direction.
- Scalping requires less market knowledge–helping newcomers.
- Scalping has low barriers to entry, making it good for retail traders.
- The liquid stock and forex market mean trades can be entered and exited easily.
- Since trades are held for a short period, losses from reversals can be reduced.
- Leverage with scalping can magnify gains but also magnify losses.
- The small profit-per-trade makes it challenging to reach a trader's financial goals.
- One large trading loss can wipe out the gains from many profitable trades.
- Cryptocurrency scalping can be risky due to market volatility.
Scalping Trading Methodology
Like in any other trading methodology, spotting positive-expectation opportunities is a primary aspect of scalping successfully. And, given the "instant gratification" philosophy of most scalpers, it is imperative that only the best trade setups are acted upon. If not, profits quickly dwindle as slippage and misaligned risk-to-reward payoffs compromise the trading operation's bottom line.
To optimize performance in the live market, developing a strong strategic foundation is of paramount importance. Focussing on ideal markets, sound analytics, and the proper order types are essential components of building a comprehensive scalping strategy.
#1 Choosing an ideal market
As covered earlier, a viable scalping market must feature both consistent volatility and depth. These characteristics promote efficiency as they ensure a multitude of trading opportunities.
Scalping strategies are not limited only to forex currency pairs; they are also frequently employed on futures, cryptocurrency, and equities products. With liquidity and volatility in mind, below are a few of the premier offerings from each security classification:
- Forex: In forex trading, the major currency pairings tend to be popular among scalpers due to their high liquidity. Specifically, the EUR/USD, GBP/USD, and other major currency pairs.
- Futures: Listed on the Chicago Mercantile Exchange (CME), equity index and commodity futures are renowned scalping markets. Leading products include the E-mini S&P 500, WTI crude oil, and gold.
- Equities: Shares of large, liquid companies such as Apple (AAPL), Tesla (TSLA), Boeing (BA) or Amazon (AMZN) are examples of scalp-friendly stocks. Additionally, equities-based exchange-traded funds (ETF) also draw significant attention.
- Cryptocurrency: The digital currencies Bitcoin, Ethereum, and Ripple are exceedingly popular in scalping circles.
When you create a CFD trading account with CAPEX, you will be able to:
- Trade over 2,000 international shares to speculate on their price rising or falling.
- Trade a host of global indices to go long or short on the performance of ana large chunk of the economy with a single trade.
- Take a position on our range of ETFs to get exposure to a basket of shares from an entire country, index, or sector that could be rising or falling in price.
- Speculate on the decreasing or increasing energy prices, grains, and metals.
- Trade the world's most powerful companies in simple pre-built portfolios based on specific industries and trends.
#2 Trading Time Frames
Scalping chart timeframes and the amount of time that each trade is active are the shortest of all the trading styles. For example, a day trader might use a five-minute chart or make four or five trades per trading day, with each trade being active for 30 minutes. These longer holding periods grant the day trader more generous profits resulting from larger market shifts that occur over the long run—but also greater risks because they subject holdings to long-term market volatility.
It is common for a scalper to use a five-second chart where each price bar represents only five seconds of trading. The trader may make anywhere from 10 to 100 or more trades per day, with each trade being active for a few seconds to a few minutes. Traders who practice scalping believe that the style is less risky since these shorter holding periods mean that they are only exposed to short-term market fluctuations, but the opportunity cost is that traders miss larger profits from ongoing market trends and shifts.
Scalping strategies come in a wide variety of forms, and they range from simple to ultra-complex. However, no matter the governing parameters, all scalping strategies are designed to repeatedly take small profits from the market. This involves the implementation of tight stop losses, modest profit targets, and compressed time horizons. Otherwise, the trade is not a true scalp.
Identifying positive expectation trade setups is the crux of any viable trading strategy. Accordingly, an analytical base is needed to place evolving price action into a useful context. For scalping strategies, analytics may be classified in one of three ways:
Technical Fundamental Hybrid Technical analysis is the most popular device integrated into scalping strategies. Indicators and tools are readily applied to price action itself, providing concrete market entry and exit points. Although typically used in longer-term trend-following or reversal strategies, fundamental analysis may be applied to scalping strategies as well. Among other tactics, scalpers utilize fundamentals by analyzing the impact of a scheduled economic data release or surprise event on market participation rates (liquidity, volatility). Hybrid analytics combine elements of both fundamental and technical analysis. An example of hybrid analysis would be to use fundamentals to identify optimal scalping conditions before implementing technical to fine-tune market entry/exit.
Finding solid opportunities in the live market is not a simple task. Nonetheless, through the application of fundamental, technical, or hybrid analysis, one can determine when conditions are suitable for potentially successful scalping.
#4 Securing Market share
After finding a viable product and strategy, it's time to secure market share. This involves entering and exiting the market with precision while reducing trade-related slippage as much as possible. To accomplish this goal, employing the proper order types is a key aspect of conducting day-to-day business.
In contrast to longer-term strategies such as day trading or swing trading, scalping emphasizes the need for precision. As a result, entering and exiting trades via simple market orders is frequently not enough, and an added degree of accuracy is required. Below are the primary order types used to execute scalping strategies:
Market Limit Stop After being placed, market orders are filled immediately at the best available price. Market orders often sustain significant slippage, contrary to most scalping strategies. Nonetheless, they are often used to scalp in conjunction with momentum-based, automated trading strategies. Limit orders are placed upon the market and are not filled (or partially filled) until the price reaches the designated price point. Buy-limit orders reside beneath the current price, while sell-limit orders are located above the current price. Limits furnish the trader with accuracy and an exact market exit. While the price is guaranteed, the order being filled is not. Stops limit the downside liability of any given trade. Stop orders are not filled until the price hits the designated price point, prompting the closure of the open position. Buy-stop orders are located above the price, while sell-stops reside below the price.
One valuable tool in the scalper's arsenal is the bracket order. A bracket order is a fully automated trade management device. Bracket functionality dictates that both profit target and stop-loss orders are placed instantly following market entry. Brackets take the guesswork out of order location, a feature that scalpers find especially useful in rapidly moving, volatile markets.
With CAPEX WebTrader you can pre-set Stop Loss and Take Profit orders in 4 ways (Rate, Pips, USD, and Percentage).
1-Minute Scalping Strategy
In the following lines, we’ll cover a simple yet effective forex scalping strategy in the 1-minute timeframe. This technique is based on both trend-following and mean-reversing, which lowers the number of false signals to a minimum. Still, you need to apply strict risk management rules and only risk a small part of your account if you want to become successful overall.
You can use this scalping strategy around the clock, but the best results are usually generated during volatile market conditions when the New York-London session overlap.
These few Forex hours (from 8:00 AM to 12:00 PM EST) offer the lowest trading costs and highest liquidity which is particularly important to scalpers. Also, most US market reports are released early in the New York session, creating market volatility and scalping opportunities.
The scalping technique uses two moving averages and one oscillator. Here are the indicators and their setting that you need to apply to your trading platform:
- 50-Period exponential moving average
- 100-Period exponential moving average
- Stochastic indicator with a setting of (5,3,3)
1-Minute Scalping Strategy Step-by-Step
Let us look at the 3 main steps of our 1-minute scalping strategy.
Step 1: Identify the short-term trend
The two moving averages are used to identify the current trend in the 1-minute timeframe. The 50-period EMA calculates the average price of the past 50 minutes, while the 100-period EMA calculates the average price of the past 100 minutes. The 50-period EMA is faster than the 100-period EMA, which means that it reacts to price changes more quickly.
If the faster 50-period EMA crosses above the slower 100-period EMA, this reflects those average prices are starting to rise and that an uptrend is likely to establish. Similarly, a cross of the 50-period EMA below the 100-period EMA signals that average prices start to drop and that a short-term downtrend is about to form. We’ll only take trades in the direction of the short-term trend.
We’re using the exponential moving average (EMA) and not the simple moving average (SMA). EMAs react more quickly to recent price changes than simple moving averages because they add more weight to the newest prices.
Step 2: Wait for a pullback
Once we determine the short-term trend in the 1-minute chart based on the location of the slow and fast EMAs, it’s time to wait for a pullback to the moving averages. This step is important because prices tend to return to their mean value after a strong up- or down-move. Waiting for pullbacks prevents us from entering long and short positions immediately after a strong price change. Profit-taking activities often cause the price to reverse after a sustained move, which can lead to fake signals and losses.
Step 3: Wait for the stochastics indicator to move above/below oversold/overbought conditions
Finally, our stochastics indicator serves as the last filter and helps us take only high-probability trades. The Stochastics indicator is an oscillator that oscillates between 0 and 100, depending on the strength of recent price moves. A reading above 80 usually signals that the recent up-move was too strong and that a down-move can be expected. This market condition is usually referred to as overbought.
Similarly, a reading below 20 signals that the recent down-move was too strong and that an up-move may be ahead. This market condition is usually flagged as oversold. After the price completes a pullback to the EMAs, Stochastics will usually become overbought/oversold because of the recent price action.
Buy Setup Example
The following chart shows a buy setup generated by our 1-minute scalping strategy. Let’s look at what happened in the chart, step by step.
- The 50-period EMA crossed above the 100-period EMA – The first arrow from the left shows a cross of the faster 50-period EMA above the slower 100-period EMA, signaling that the EUR/USD pair is entering into an uptrend in the 1-minute chart. If the faster EMA remains above the slower EMA, we’ll only look for buy opportunities in this chart, to only trade in the direction of the trend.
- Price returns to EMA and Stochastics move below 80 – The next two red arrows show the pullback to the moving averages. After the 50-period EMA moved above the 100-period EMA, Stochastics became overbought, and the price started to make a pullback to the MAs (Moving Averages).
- Buy signal – The pullback lowered the reading of the Stochastics indicator to below 20, signaling an oversold market environment. Once the Stochastics indicator moves above 20 again, our system triggers a buy signal.
Sell Setup Example
The following chart shows an example of a sell signal generated by our 1-minute Forex scalping system. Again, let’s cover the main points of this sell setup example.
- The 50-period EMA moved below the 100-period EMA – This signals that the Gold price is entering into a downtrend as the average price of the last 50 minutes is sharply dropping. From now on, we’ll look only for short opportunities if the 50-period EMA stays below the 100-period EMA.
- Pullback – After the price finished its strong down-move, moving the Stochastics indicator to below 20 (oversold conditions), the price started to form a pullback to the moving averages. Simultaneously, the Stochastics oscillator crossed above 20, heading to overbought market conditions.
- Sell signal – After the price finishes its pullback and the Stochastics indicator moves below 80, indicating that the market isn’t overbought anymore, we can enter a short position.
Just like any other trading strategy, this scalping technique is not bulletproof. Once we identify a trend based on the EMA crossover rule, it’s important to note that the Stochastics oscillator may stay in overbought or oversold market conditions for considerable periods of time. This is especially true during strong trends.
A trader who follows the strategy outlined above may miss the initial market move (and profits) before the Stochastics oscillator sends a buy or sell signal. However, while we will miss some of the profits, the filter based on the Stochastics oscillator will reduce the number of fake signals significantly.
Scalping Trading Tips
There is a saying that says, "You can try to scalp the markets, but eventually it will scalp you." Scalping seems fun when you're winning, but as soon as you start losing, it's not fun anymore.
There are several well-known traders making huge profits from scalping but still, there are people losing their money just like in the other trading strategies. Here are 10 trading tips to help you master the essentials of scalping:
1. Try scalping with a demo account first
You should not jump into scalping and assume that you know everything. To be a scalper, you need to learn and exercise your scalping skills with a demo account. This is particularly for beginners who have not done scalping before. The demo account will help you get an insight into what to expect once you get started.
2. Use lower risks
If you consider what a scalper makes in a day, it is critical to lower the gap devoted to a single trade and reduce risk. You should NEVER risk over 2% of your initial deposit. For instance, if you deposit $1,000 in your trading account, you should avoid placing any trade above $20 in the margin.
This is the limit that your account can take if the trade does not go in your favor. A trader can place multiple trades without violating the margin requirements. Low stakes ensure that you can continue trading for a long time without receiving a margin call that can lead to blowing the account.
3. Minimizing scalping indicators usage
Trading indicators are mostly used by advisors and technical analysts and can be especially useful to you as a trader since they inform you of any opportunities that may arise soon. Among the most common indicators are:
You will notice that every trading app will have very many technical indicators (50 plus) and you (trader) will always be tempted to add as many of these indicators as possible and this will make you end up with a cluttered workspace full of indicators.
This would, in turn, cause an overload of information that would consume too much time to interpret. By the time you interpret them, you will have lost the trend you were looking for. Pick 1 to 3 indicators and have faith in them.
4. Master specific scalping strategies
Unlike other trading strategies whereby you can switch up from one trading strategy to another, you should NEVER try that when scalping. Just imagine having ten trades in a day without any strategy. That would be suicidal, right? You’d never tell which strategy worked and which one didn’t. You will never understand what went wrong.
This is the reason scalping isn’t for amateur traders. It is only for seasonal traders who have mastered a certain strategy that has worked out the best. It is fundamental to test any strategy on a demo account before scalping into any market.
A scalper should have 2 or 3 strategies that they use throughout the day. Some of the strategies used by scalpers involve mastery in the following:
- Technical trading indicators
- Western Chart patterns
- Japanese candlestick chart patterns
- Fibonacci retracements
- Price action
5. Select the right timeframe
Regardless of the charts that you will be using, you will discover that there are options that will let you choose your preferred trading timeframe. This timeframe can be a minute, day(s) week(s), month(s)or even years. This option is provided by all the online brokers so that you can choose the best timeframe that suits your particular needs.
As already said above, scalpers need to make very many trades per day, and therefore choosing longer timeframes is not advisable. The recommended timeframe for scalpers is the 1-hour chart; however, you will be making use of the 1-minute, 5-minutes, and 15-minutes charts.
6. Use markets with the lowest spreads
Spread is defined as the difference between the bid and the ask price (Spread = Bid Price – Ask Price) and this explains why all the trades begin with a negative return. The main aim of a scalper is to make numerous small profits from tens/hundreds of trades. It will, however, be particularly challenging to make profits within a very short timeframe when the spread is very wide. High-liquid markets are more suitable for scalping.
7. Focus on the financial announcements
If you can compare technical analysis and fundamentals, you will realize that scalpers are normally technical analysts. However, this doesn’t make you disregard economic indicators or any other data. As a scalper, you should be aware of any major news announcements.
The only variance between a pure fundamental analyst and a scalper is that, as a scalper, you can start trading even without waiting for news to break. The financial news knowledge will only help you understand the right currency pairs, futures, or stocks to trade, but this will not affect your trading day directly.
8. Control the number of trades
The sweetest thing about scalping is placing several trades with low stakes. This leaves you with a huge free margin to place other trades.
You should do it depending on your trading equity. If you have big equity in your account, you can place as many trades as possible provided that the margin level is logical. Avoid over-exposure and over-trading.
Note that it is not advisable to place more than three trades containing one asset. For instance, avoid trading on more than three trades containing USD as the base currency. If you try it and the USD does not perform to your expectations, then it means that you will lose all your trades. Always have different assets if you think of placing several simultaneous trades.
9. Trading sides
Beginners are normally contented with trading on the buy-side. They should stick to that before trying to handle it on the short side. A scalper should try as much as possible to balance the long and short positions for positive results.
10. Avoid distractions
It is advisable to avoid distractions when scalping. The only thing you should focus on when scalping is the markets and chart conditions. You should shut any form of distraction that might make you lose your attention. By avoiding distractions, you will be able to maximize the use of your small scalping time frame. Remember that the charts move fast!
Is Scalping Trading Viable?
The viability of scalping as a trading approach depends on several contributing factors and inputs:
- Low transaction costs: Commissions and fees need to be minimized to facilitate a high-volume approach to trading in each financial market.
- Efficient market entry and exit: Adequate computer hardware and software technology is required to minimize latency-related slippage and interact within the marketplace efficiently. Slippage on entry and exit can play a key role in the overall profitability of a scalping approach and is magnified when the realized profit per trade is small.
- High volume trade identification: A major part of the scalping methodology is to repeat small profits over and over. It is crucial that the adopted trade recognition philosophy can produce a high volume of trades.
- High market liquidity: The ability to enter and exit the market quickly and efficiently is dependent upon the number of potential buyers and sellers available at the trader's desired price. Markets that exhibit a high degree of liquidity, in addition to tight bid/ask spreads, are prime candidates for scalping.
Scalping is most suitable for a specific type of trading personality. Specifically, traders must be highly disciplined, especially in the case of systematic scalpers, as they must be comfortable handing over trade decisions to a computer and be capable of following their trading system no matter what impulses might arise.
In addition, scalpers must be able to make quick decisions without hesitation and without questioning their decisions once they have been made. They also need to be flexible enough to recognize when a trade is not proceeding as expected or hoped and take action to rectify the situation by exiting the trade.
Before you start scalping the markets, you should consider using the educational resources we offer like CAPEX Academy or a demo trading account. CAPEX Academy has lots of free trading courses for you to choose from, and they all tackle a different financial concept or process – like the basics of analyses – to help you to become a better trader or make more-informed investment decisions.
Our demo account is a suitable place for you to get an intimate understanding of how trading and investing work – as well as what it’s like to trade with leverage – before risking real capital. For this reason, a demo account with us is a great tool for investors who are looking to make a transition to leveraged securities.