Scalping is one of the most common trend strategies in Day Trading
As we have explained in our previous articles, the success of any trader – or investor – lies in having a good strategy.
The strategy one adopts will help him identify an entry and exit position. It will also help him manage his risks to stay psychologically fit.
For this reason, the worst mistake one can make when trading is to do it without a strategy (other mistakes to avoid).
There are thousands of strategies out there and the secret is not to master all of them but to understand one. Two of the most common trading strategies are diversification and hedging.
In diversification, a trader will open a couple of trades at the same time. For instance, a trader can open the following trades: buy EUR/USD, sell GBP/JPY, and buy GBP/USD.
The idea is that if the first pair goes down and the second goes up, there are chances that the third pair will go up and then cover the losses. The problem comes when all the pairs go in the opposite directions.
On the other hand, scalping is a strategy where a trader opens and closes trades within a very short duration of time. For instance, a trader can place a trade and exit in the next minute.
In this article, we will focus on this strategy and how you can maximize the gains.
→ Use Scalping techniques to get alpha
Identifying the trend
In scalping, the most important detail is the trend. If a trend is bullish, the scalpers will place buy positions and if the trend is going south, they will open a short position.
For this reason, these traders don’t waste their time doing deep macro analysis.
Rather, they spend most of their time identifying the trend.
After identifying the trend, they will have a close look at the support and resistance points. They will therefore place a buy position at the support, and close the trade at the resistance point. At the resistance point, they will place a sell position.
On paper, this might seem as a very easy thing to do. In reality, identifying a trend is the most challenging thing that a trader can battle with.
→ More about Parabolic Sar Indicator
Timing the entry
After identifying the trend, the next most important thing is to decide on the entry position. Ideally, in an upward trend, a trader will want to identify a pullback and place a buy position. By buying in a pullback, the trader will make a profit once the chart goes high.
Other traders prefer to use a breakout mechanism. This comes from having a good understanding of the support and resistance levels.
Again, in a bull market, the trader will make a buy position when a key level of resistance is broken and the market forms other support and resistance levels.
A number of tools have been developed to help a trader know his entry and exit positions. The Fibonacci sequence is the most important.
Another strategy to time the entry position is on the data. Economic data which is released on a daily basis is one of the key drivers of price movements.
In scalping, a trader will enter a trade minutes before crucial data is released. For instance, minutes before the non-farm pay rolls data is released, a trader will use the past data to predict whether the new number will beat the analyst estimates.
If it will, then he will sell EUR/USD on the hopes that the dollar will continue to rise. Then, if his prediction is correct, he will make an exit a second after the data has been released. However, this is usually very risky especially when the market goes against his thesis.
While scalping can make one a lot of money, the fact is that it exposes traders at great risks. For this reason, scalpers must exercise a lot of caution when making trades.
There are a number of techniques that this can be achieved. One, the trader needs not risk more than 2% of his portfolio in a trade. This can be achieved by setting the right lot size and having proper stop losses. A stop loss is an important tool that can help you mitigate the outflow.
Second, a trader can come up with a strategy of trading a single currency pair. In this, experience has shown that the more pairs a trader trades, the more he exposes himself to risk. By focusing on only one currency pair, the trader will have in-depth knowledge about it.
He will also be at a good position to understand the positions to place.