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What is scalping

Disclaimer: This article is an educational guide to CFD trading and the financial markets and should not be considered as advice. Trading CFDs is high risk. Always ensure you understand the potential risks and rewards associated with trading before you trade.

Introduction

Scalping is a day trading strategy that involves entering and exiting positions at great speed, profiting off very small price moves and using technical analysis to generate signals. Scalpers are active in all markets, and CFD traders are particularly well position to scalp due to the flexibility of opening long and short positions fast, without waiting for settlement. To scalp successfully, you need a few things: a functioning strategy with appropriate position sizing and win rate, the ability to trade quickly on small timescales, and strict risk management. Since markets can rise or fall unpredictably, scalpers like all traders need to be extremely cautious in how they take on risk. Done properly, scalping is an ideal strategy for CFD day traders because of the instant nature of transactions and flexibility in long or short positions.

 

Scalping: key characteristics and comparison

Scalping can involve either trend following or mean reversion strategies and is almost exclusively used by technical traders. Fundamental analysis has a much-reduced role for scalpers, since traders enter and exit positions too quickly for long-term economic considerations to take effect. The sole interest for scalpers is price action and finding small fast profits in markets. Finding a successful strategy will often involve backtesting or testing your scalping strategy in a demo account, as it needs to achieve a certain win rate to be potentially profitable. Scalpers need to have a good idea of the expected win rate of their scalping strategy before they begin trading in live markets.

 

Scalping strategies

Scalping strategies use technical analysis to exploit slight inefficiencies in the market, using leverage to magnify the opportunities (and risks) available. Scalping on forex or other CFD markets involves identifying the target market, developing a strategy through backtesting and demo trading, and then launching it on the live market. A scalping strategy should use multiple technical indicators to generate buy or sell signals, then quickly enter and exit these taking a small profit. Positions should not be held overnight and ideally are entered and exited as quickly as possible, with the one-minute scalping strategy popular with the fastest traders. Taken to extremes and executed algorithmically, scalping eventually falls into the domain of High Frequency Trading (HFT), a controversial market practice that executes trades in fractions of a second. For retail CFD traders, timeframes of one to five minutes are more common, with the only firm requirement that trading be fast and intraday.

 

Mean reversion

Mean reversion strategies look for failing trends and fluctuations towards the long-run average. Trends in financial markets never move in one direction smoothly without variation, and are made up of various smaller and smaller sub-trends, some following and some against the main direction.

Technical indicators used to identify a failing trend include oscillators such as the stochastic oscillator or relative strength index, which can both be used to identify over-extended trends that may soon reverse. Some candlestick patterns known as reversal patterns can also be used to confirm a pending reversal.

When scalping with mean reversion strategies, traders need to identify and quickly move on failing trends and should also set both take profit and stop losses close to the current market price. The idea in scalping is to set the take profit level somewhere where market noise will be enough to push it over, which makes positioning the stop loss a delicate point. If the stop loss is too close, the win ratio will be smaller since the quick fluctuations of the market push in both directions. Conversely, one big loss from a distant stop loss will be enough to wipe out the gains of many smaller successful trades, changing your target win ratio for the worse.

 

Trend following

Trend following strategies can be used in CFD day trading as well as for longer-term positions. In a trend following trade, you identify a prevailing trend and open a position in the same direction. In the context of scalping strategies, this trade should be brief, aiming to share in just a small part of the continuing trend’s price action.

There are many ways to identify trends, including moving averages and moving average convergence / divergence, as well as continuation candlestick patterns such as the doji star. When placing stop losses, it is important to preserve the ideal risk reward ratio, since the win rate is often the most difficult factor to get right in scalping.

A 1:1 risk reward ratio crosses into profitability at a 50% win rate; this is lower than the risk reward ratio favoured for longer term trades. Because scalping involves a high volume of small trades, marginal improvements on the 50% win rate can lead to big increases in profitability; conversely, falling below the demanded rate will render the strategy unprofitable.

 

One minute scalping

One minute scalping is a high speed variant of scalping (not to be confused with High Frequency Trading or HFT, which can use similar strategies but on even shorter timescales) where you enter and exit positions in less than one minute, with a maximum hold time of one minute.

Other variants exist such as five minute scalping, following the same principle. The target profit levels for a one minute scalping strategy is small, perhaps 5 to 10 pips, and traders need to be both consistent and quick in entering and closing positions. Popular technical indicators to use with a one minute scalping strategy include moving averages and the stochastic oscillator.

Scalping forex

Scalping can be performed in all markets, but is usually associated with forex trading. Scalping on forex price movements is popular because the FX market is highly liquid and trades round the clock, making it convenient for day traders in any time zone.

When scalping with forex CFDs, traders should take care to avoid days with relevant economic data announcements for either currency, as these will cause sharp moves and make strategies harder to execute. When trading on small price movements a sudden jump in price can be dangerous, potentially moving the market rate beyond your desired stop loss level and causing a larger loss than expected.

 

Scalping with CFDs

CFDs are the perfect tool for day traders interested in scalping. When scalping without CFDs, traders need to confirm liquidity and find the market with the smallest possible spread. ADSS CFD spreads start as low as 0.7 pips and leverage of up to 500:1 is available. Ultra-fine spreads allow for profitable strategies on the lowest possible win rate.

Scalping with CFDs also has the advantage of being instantaneous, with no need for settlement or trade confirmation since neither party takes ownership of the underlying asset. You can find out more about CFDs and how to trade them in our education section.

 

Risk management

Traders are familiar with the requirement for appropriate risk management strategies such as stop losses and position sizing. What is unique about scalping is the speed and number of trades, sometimes as many as hundreds a day.

As scalpers trade according to clearly defined rules for entering and exiting positions, it is important to constantly monitor strategy performance. The level of profit per successful trade must be sufficient to cover the inevitable losses when trading in high volumes. The risk reward ratio is the ratio between the strike price minus the stop loss and the take profit level minus the strike price. The greater the risk reward ratio (in favour of reward), the less often you need to be right for the strategy to be profitable. Generally, scalping strategies have a lower win rate than long term trading.

 

Summary: is scalping for me?

Scalping is a high-volume, high-speed trading strategy that is particularly well-suited for traders dealing with CFDs. The unique idea of scalping is swift entry and exit positions, aiming to profit from minimal price changes while leveraging technical analysis for signal generation. The analysis methods are the same as with any other strategy, as are the broad divisions of trend following and mean reversion, but only scalpers trade with such volume and frequency.

A high proportion of scalpers use CFDs, since forex, index or equity CFDs allow traders to go long or short without waiting for settlement. Not everyone can scalp profitably, and it is a strategy that takes time and perseverance to master. To succeed you will require a well-tested strategy, precise execution, and rigorous risk management. It’s often a good idea to test your strategy in a demo account before going live, or load historical data to run a backtest.

Most scalpers begin by using a simplified system, such as one-minute scalping and a simple technical signal system. Scalping on forex is the most common underlying asset class, but these strategies can also be applied to other markets such as equities or commodities.

Risk management takes a unique importance in scalping, given its high frequency of trades, and traders need to make sure their strategy consistently meets the minimum win rate for profitability. Do not be afraid to change a strategy or stop using it if it begins to fail, as often technical strategies work for a while until the market inefficiency they exploited disappears. Scalping, although it can work on lower win rate than long-term strategies such as buy and hold, can be stressful for new traders due to the speed and volume of transactions. Precision and discipline are key attributes of successful scalpers. And you must be prepared that if your strategy fails, you could lose more than you deposit.

FAQs

What is scalping in trading?

Scalping is a technical trading strategy that attempts to profit off small fluctuations in market prices on short timescales. Scalpers enter and exit trades quickly, profiting off very small moves in the market, and rely on having a win rate that matches the take profit levels. Scalpers are very vulnerable to high fees, slow settlement, or issues with market liquidity, which makes it an ideal candidate for a CFD trading strategy since you can then avoid dealing with the underlying market. Scalpers do not hold multi-day positions.

How does scalping differ from CFD day trading?

Scalping is a subtype of CFD day trading, and a very popular strategy for day traders in general. However, they are not equivalent, and some day trading strategies do not qualify as scalping. For example, strategies using fundamental analysis or news-based trading around economic announcements are not scalping, as they do not focus on price action and may wait for larger price moves than the small fluctuations preferred by scalping trading strategies.

What is the best scalping strategy?

Scalping trading strategies differ according to whether they are mean reversion or trend following, and by the indicators used. They still need to form part of a formalised, signals-based trading system. This means you need to define set rules that you then follow when trading, and monitor the strategy for its win rate. The win rate needs to meet the minimum requirement of your risk reward ratio (often 50% in scalping strategies) otherwise the strategy will start to lose money. CFDs allow for rapid entry and exit of positions, making them ideal for scalping strategies, but traders need to continually monitor performance as previously successful strategies can suddenly ‘fail’ and stop working. Whatever your scalping strategy, it is vital to only hold positions in the very short term, and never overnight.


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