Scalping in the forex market involves trading currencies based on a set of real-time analyses. The purpose of scalping is to make a profit by buying or selling currencies, holding the position for a very short time, and closing it for a small profit. Many trades are placed throughout the trading day, and the system used by traders is usually based on a set of signals derived from technical analysis charting tools. These tools rely on a multitude of signals that create a buy or sell decision when they point in the same direction. A forex scalper looks for a large number of trades for a small profit each time.

Key Takeaways

  • Forex scalping involves buying or selling currencies, holding the position for a very short time, and closing it for a small profit.
  • Forex scalping involves placing many trades throughout the trading day.
  • Trades are often automated based on a set of price signals derived from technical analysis charting tools.

Understanding Scalping as a Forex Trading Strategy

Forex scalping involves buying and selling foreign currencies with the goal of earning a profit on moves in exchange rates. The international currency market is the largest in the world with more than $6.5 trillion exchanged between currencies on a daily basis.  Traders and investors can take positions in currencies for a short period and book an offsetting trade. The difference between the exchange rate of the initial trade nets out with the exchange rate of the exit trade resulting in a gain or loss.

For example, if a U.S. trader initiated a buy position of euros at the euro-to-U.S. dollar exchange rate of $1.1050 and later sold the position at a rate of $1.1150, the profit would equal 0.0100 or 100 pips, which is approximately 1%.

A forex scalping trading strategy might involve a profit target of only 10 or 20 pips. However, the scalper would initiate many trades or add to the position size of each trade to maximize profits.

Popular Currency Exchange Rate Pairs

Although there are many exchange rate pairs available to trade, below are the major pairs that most traders use in their day-to-day trades.

Forex Scalping Tools

A forex scalping trading strategy can be either manual, where the trader looks for signals and interprets whether to buy or sell. However, many scalpers use automated trading systems when booking their trades with their brokers. The trader instructs the system what signals to look for and what action to take once a signal has been triggered.

Using the earlier example of the U.S. trader that initiated a buy position of euros at the euro-to-U.S. dollar rate of $1.1050 and sold for a profit at $1.1150, the trader could have automated the take-profit order. In other words, a trade could have automatically been triggered when the EUR/USD rate moved to $1.1150, closing the position for a profit.

The trader could have also automated a stop-loss order in case the rate moved against the position. So, if the stop-loss order was set at $1.10, a trade would be initiated automatically once the exchange rate triggered $1.10 to unwind the position. Stop-loss orders are critical for managing risk with scalping strategies since they limit trading losses.

The timely nature of technical analysis makes real-time charts the tool of choice for forex scalpers. Technical analysis uses volume, price momentum, and volatility to identify trading opportunities. Currency prices that break out of a recent range or break higher or lower than the previous day's close are also used in technical trading. Quite often, forex scalping trading strategies use a combination of automated trades that are triggered using signals from technical analysis and charting.

Pros
  • Scalping requires less market knowledge–helping newcomers.

  • Forex scalping has low barriers to entry, making it good for retail forex traders.

  • The liquid forex market means trades can be entered and exited easily.

  • Since trades are held for a short period, losses from reversals can be reduced.

Cons
  • Leverage with forex 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.

  • Forex scalping can be risky due to market volatility.

The Pros of Scalping

As a result of the low barriers to entry into the world of forex trading, scalping has become a viable strategy for the retail forex trader. Scalping is popular with newcomers since the strategy requires less knowledge of the market and established trading theories.

Since the forex market is large and liquid, traders can get in and out of trading positions easily.

Scalping is a good choice for those who hate waiting for a trade to close. Positions are generally held for a very brief timeframe, and that allows for a lower chance of reversals that can harm a trading position.

The Cons of Scalping

It's important to note that the forex scalper usually requires a larger deposit that can handle the amount of leverage the investor must take on to make the short and small trades worthwhile. Leverage is a form of margin in which the position is magnified since the trader borrows from the broker to expand the position size. However, just as leverage can magnify gains, it also can magnify losses.

The profits are smaller on each trade, which makes it challenging to reach a trader's financial goals. A “5-pip” yield on a trade might be insufficient for many traders.

As a result of the small amount of profit per trade, one trading loss can obliterate any gains from several successful trades. Good trades can yield a 1:1 risk to reward or less.

The volatility or wild swings in the currency market can add to scalping gains and profits, but also exacerbate losses. Forex scalping can be risky and wipe out a trader's brokerage account. For example, a trader might not have an exit strategy or a stop-loss trade in which the trade is automatically unwound. If the trade moves adversely, the forex trader can incur frequent and significant losses. As a result, newcomers to forex trading should understand the ins and outs of forex scalping before initiating their first trade.