What Does Hair Have to Do With Forex Trading? All About Scalping
During the warfare times of Native Americans and other tribes, fighters removed the skin off the top of their enemies’ heads and used these as trophies to affirm their battle prowess. Not long after, financial incentives came into the picture, where people began receiving payment for each scalp.
Hundreds of years later, the term ‘scalping’ gained popularity in railway travel. Here, men would sell unused rail tickets for a quick buck.
Coming into modern times, the idea of scalping transitioned to including any event like music and sports where tickets are resold quickly for an inflated price. Does any of this sound familiar in the world of trading forex?
Scalping in the context of currencies comes from the very same concept. Fortunately, forex scalping is legal and perhaps one of the first methods any newbie is introduced to when trading.
So, what exactly is scalping in forex, and what are the advantages and disadvantages? Let’s find out.
What exactly is scalping?
Scalping involves the practice of trading currency pairs by frequent execution throughout the day by holding orders for minutes or seconds to capture small and quick profits.
The theory is although the gains are almost always minimal, repeating this process with bigger positions results in a larger accumulation of money being made over a relatively short period.
Scalping sits at the low end of the pecking order when observing the other trading styles; day trading, swing trading, and position trading. Strategies utilizing scalping are manual and automated, though the vast majority tend to lean towards the former.
Another distinct characteristic with scalping is lower time-frames to spot trading opportunities, typically the 1-minute, 5-minutes, and 15-minutes.
What is required for scalping?
Below are some of the prerequisites for anyone considering scalping:
The right personality: Each prescribed trading style aligns with specific personality traits. Firstly, scalpers naturally have to be those with the ability to make decisions very quickly and possess intense concentration in the fast-paced environment of currency fluctuations.
Experts also consider scalpers as the traders with the least risk aversion. Scalping innately carries several more amplified dangers like monetary, volatility, and transactional risks. A skilled scalper needs to find methods to constantly deal with these drawbacks.
Trading the most liquid markets and periods: Unlike other methodologies in forex, scalping is easily the most time and effort-consuming.
To combat this challenge, the vast majority of scalpers will only operate during highly liquid trading sessions historically known for producing notable price movements like the New York and London sessions.
Moreover, the scalper tends to pick pairs with the cheapest spreads, most commonly EURUSD and other major currencies, all known as the most liquid because of their inherent trading volume and interest.
Of course, this distinction doesn’t dramatically reduce the time involved, but some above-average skill and experience are necessary to know the most optimal periods to scalp.
Unfortunately, not everyone has access to their computer or phone to make trades. Thus, a scalper needs to have far fewer daily commitments to position themselves when the time is right.
Using a fixed spread account: One of the biggest drawdowns is the accumulation of transaction costs in the form of spreads and sometimes commissions because of the high trading frequency.
All offer standard live accounts with competitive spreads across the board. To lower these, an increased number of brokerages now provide fixed spread accounts with cheaper spreads.
Advantages of scalping
Let’s briefly cover some of the attractive points about scalping which have continually resulted in the high interest of this trading style:
The constant flow of opportunities: Perhaps the most significant selling point for any scalper is the regular flow of trade setups. Unlike other approaches requiring long waiting times after each position, scalpers will always have several chances to trade throughout the day.
Still, the number of opportunities doesn’t numerically correlate to larger profits (quality over quantity).
Allows for the specialization on one or only a handful of markets: Another advantage is scalping enables traders to focus exclusively on a few pairs, with some even concentrating solely on one.
In a way, some might see this as a time-saving mechanism as the scalper will not need to analyze many markets every day.
No overnight risk: Scalpers never need to worry about negative swaps and spread widening experienced by those holding their orders overnight.
Disadvantages of scalping
Despite the understandable attraction of scalping, it is fair to assume the whole approach mostly has a bad rep in the industry for a few reasons:
‘Noise’: As previously mentioned, scalpers operate on lower charts that technical analysts call noise, meaning price movements appear far more erratic than they are on bigger charts.
This effect produces so-called whipsaws and lots of false signals for the trader. Another problem is lower time-frames often lead people to over-trading.
Traders need a higher win rate: The reason for needing a higher win percentage overall has to do with the smaller gains. By constantly taking smaller profits, a trader must be right more times to cover up their losses.
It becomes difficult to maintain this as any strategy is susceptible to a drawdown regardless of the timeframe. Scalpers don’t often capture ‘big moves’ in the markets as their philosophy leans more towards paltry, quick gains.
Transaction costs: Another massive drawback with scalping are the trading costs, despite that spreads in forex are pretty cheap for most pairs nowadays. The issue, however, is as the profit targets for scalpers are tiny, a large portion of the gains are reduced because of the spread.
While a small 1 or 2 pip spread seems insignificant on one position, it certainly adds up to a huge chunk over the long run.
Most industry experts have a negative connotation towards scalping, especially with how brokers push their marketing towards maximum leverage and the allure of quick profits.
Once a trader has a realistic view of the inner workings of forex, scalping is a technique with huge potential. Still, it is probably the hardest to excel consistently and requires a trader with years of experience who can implement sound risk management decisions.
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