Forex Scalping

What Is Forex Scalping?

Forex scalping is a day trading style used by forex traders that involves buying or selling currency pairs with only a brief holding time in an attempt to make a series of quick profits. A forex scalper looks to make a large number of trades, taking advantage of the small price movements, which are common throughout the day. While scalping attempts to capture small gains, such as 5 to 20 pips per trade, the profit on these trades can be magnified by increasing the position size.

Forex scalpers will typically hold trades for as little as seconds to minutes at a time, and open and close multiple positions within a single day.

Understanding Forex Scalping

Forex scalpers typically utilize leverage, which allows for larger position sizes, so that a small change in price equals a respectable profit. For example, a five pip profit in the EUR/USD on a $10,000 position (mini lot) is $5, while on a $100,000 position (standard lot) that five pip movement equates to $50.

Forex scalping strategies can be manual or automated. A manual system involves a trader sitting at the computer screen, looking for signals, and interpreting whether to buy or sell. In an automated trading system, programs are used to tell the trading software when to buy and sell based on inputted parameters. 

Scalping is popular in the moments after important data releases, such as the U.S. employment report and interest rate announcements. These types of high-impact news releases cause significant price moves in a short amount of time, which is ideal for the scalper who wants to get into and out of trades quickly.

Due to the increased volatility, position sizes may be scaled down to reduce risk. While a trader may attempt to usually make 10 pips on a trade, in the aftermath of a major news announcement they may be able to capture 20 pips or more, for example. 

Forex Scalping Risks

Like all styles of trading, forex scalping isn't without risk. While profits can accumulate quickly if lots of profitable trades are taken, losses can also mount quickly if the trader doesn't know what they are doing or is using a flawed system. Even if risking a small amount per trade, taking many trades could mean a significant drawdown if many of those trades end up being losers.

Leverage and scaled-up position sizes can also pose a risk. Assume a trader has $10,000 in their account but is using a $100,000 position size. This equates to 10:1 leverage. Assume the trader is willing to risk five pips on each trade, and tries to get out when they have a 10 pip profit.

This is a viable system, but sometimes the trader won't be able to get out for a five pip loss. The market may gap through their stop loss point, resulting in the trader getting out with a 20 pip loss and losing four times as much as expected.

This scenario, known as slippage, is common around major news announcements, and a few of these slippage scenarios can deplete an account quickly.

Special Considerations

Forex scalpers require a trading account with small spreads, low commissions, and the ability to post orders at any price. All these features are typically only offered in ECN forex accounts.

ECN forex accounts allow the trader to act like a market maker and choose to buy at the bid price and sell at the offer price. Typical forex trading accounts require retail clients to buy at the offer and sell at the bid. Typical forex accounts also discourage or do not allow scalping.

If the spread or commissions are too high, or the price at which a trader can trade is too restricted, the chances of the forex scalper succeeding are greatly diminished.

Forex Scalping Strategies

There are countless trading strategies, although they will typically fall into just a few broad categories:

An Example of Scalping the EUR/USD

Assume a forex scalper trades the EUR/USD using a trend trading strategy. They identify the recent trend, wait for a pullback, and then buy when the price starts moving back in the trending direction.

Depending on volatility, the trader typically risks four pips and takes profit at eight pips. The reward is twice the risk, which is a favorable risk/reward. If volatility is higher than usual, the trader will risk more pips and try to make a larger profit, but the position size will be smaller than with the four pip stop loss.

Assume the trader has a $10,000 account and is willing to risk 0.5% of their account per trade. That means they can lose $50 per trade. They are risking four pips. Each standard lot ($100,000) equates to $10 in profit or loss per pip. Since the trader is risking four pips, they can trade 1.25 standard lots ($50 / (4 pips x $10)). If they lose four pips on 1.25 standard lots, they will lose $50, which is their maximum risk per trade. Their profit is double, so if they make eight pips, they will earn $100.

The account has $10,000 in it, yet the trader is using a $100,000 position size. This is 10:1 leverage.

The following chart shows three trades, based on the recent trend direction. The first trade is a winner for eight pips, or $100. The second trade is a loss for four pips, or $50. The next two trades are winners for eight pips, or $100 each.

Image by Sabrina Jiang © Investopedia 2021

The overall profit for the day is three winners ($300) minus one loser ($50), or $250. On a $10,000 account, that is a 2.5% return for the day. This shows the compounding power of scalping.

On the flip side, finding winning trades isn't easy and, even with risking 0.5% of the account per trade, if the trader doesn't have a sound method, losses can mount quickly.

The above trades are for demonstration purposes only and are not meant to be advice or a recommendation.