Forex Scalping

In Forex and similar markets, scalping refers to a trading style that could be well described with the following characteristics:

• Short-time horizon; positions are to be liquidated in minutes or even seconds
• Large number of trades; often up to hundreds a day
• Highly leveraged positions to magnify small price changes
• Tight stops to limit the risk of unwanted market moves

Scalpers' Goal

Traders who use this method are known as scalpers. In scalping, the goal is to take profit from "small price changes" when the profit is magnified by leveraging positions and maximizing the number of trades.

It is often said that the role of scalpers is similar to the market-makers. However, there is at least one significant difference between them: market-makers have exclusive access to inside-information about where the clients' orders are accumulated, helping them to place their orders accordingly, and it is an advantage to them.

Assumptions behind Scalping

The basic assumption in scalping is that it is easier to catch the small moves in the market than finding the main trends which result from underlying changes in supply and demand forces; though it looks very subjective and may be difficult to proof.

Another assumption is that by leveraging the positions traders could make the profit large enough to compensate the time and effort used in collecting small pips from hundreds of trades. However, it seems to be true regardless of the trading style when the other side of the coin may be even more important: leverage could magnify not only profits but also losses.

The most challenging part of scalping may be about the way that scalpers set their positions. Scalpers try to collect 2 or 3 pips profit from positions that have relatively very tight stop-loss, usually up to 10 pips. It is based on this assumption: "The price is more likely to hit the take-profit first because it is nearer to the take-profit than the stop-loss".

While it could be true in a single trade, the result may be different in the long term. Generally and in a long term, the "expected profit" and "expected loss" should be determined to give a picture of the most probable outcome of any trading style.

Expected profit (loss) is always the probability of making profit (loss) times the amount of that profit (loss). In the case of scalping, probability theories could show that the expected profit and expected loss tend to offset each other. In simple words, a large number of small profits would be probably wiped out by a small number of large losses.

Regarding this possibility, some traders believe that scalpers need to be equipped with some sorts of technical or fundamental analysis. By incorporating such methods, one may also conclude that it is no longer scalping but a different form of trading.

Factors that Affect Scalping

The performance of scalpers could be affected by the following factors:

Spread: Obviously, low spread is always better for all traders, especially when it is about a large number of trades and when the profit and loss are comparable with the spread.

Liquidity: In scalping it is important to be able to liquid the positions immediately. Any delay could result in changes in price, raising the chance of losing a profitable trade.

Fast Execution: Along with the liquidity, scalper's orders should be executed very fast and without slippage. Slippage refers to the difference between the order price and the executed price which may result from high volatility or manual execution by some brokers.

Volatility: Scalpers prefer a less volatile market, where the price rises and falls in a limited range giving them the opportunity to put their orders frequently in that range. The problem is that a scalper may never be aware that a calm market is going to be volatile.

Brokers: Finally, a broker with the so-called dealing desk may be not an option, since they hold the other side of the trader's position, like a market maker, and there would be conditions in the market which results in conflict of interests that may eventually force them to do against their clients. Such a broker often sees the scalper as a competitor.

To solve this problem, scalpers prefer brokers with the Electronic Communication Network (ECN) dealing system as they have no dealing desk, instead offer their clients the best bid and ask price available from the market makers.