(Newswire.net — April 13, 2019) — In the world of forex trading, there are generally two different approaches that you can use. You can either try to make a few major trades that each yield very high rates of return, or you can try to make many different trades with small returns that begin to add up over time.
The benefit of using the first approach is that it can be a little bit more “hands off” and it will also utilize more traditional approaches to the market. The benefit of using the second approach, on the other hand, is that opportunities for arbitrage may emerge over time. When taken advantage of correctly, arbitrage makes it possible for you to earn essentially risk-free returns.
One of the top arbitrage trading strategies is known as scalping. Scalping is an approach to forex trading (or any trading, for that matter) that involves exploiting differences in the bid-ask spread. Though scalping is something that will certainly need to be done quite carefully, it can be very profitable when done on a large scale.
Each “scalp” that you may make may only yield a few cents in profit, but this can really add up when done thousands, even millions, of times. In this article, we will discuss the essential things for you to know about developing a successful forex scalping strategy. By paying attention to the finer details, your approach to the market may become significantly more profitable.
What is forex scalping?
When trading any security or asset, the bid is a term used to describe the highest level the market is willing to sell at and the ask is a term used to describe the lowest level the market is willing to buy at. When markets are at equilibrium, the ask and the bid will theoretically be the same. However, markets are rarely actually “at equilibrium”—there will typically be a difference between the bid and the ask known as the bid-ask spread.
Scalpers attempt to “make the spread” by purchasing at the bid price and selling at the ask price, which consequently enables them to earn the difference between the too. In order to do this, they must operate using the shortest possible time frame and make trades before the market has had time to adjust. As a result, many scalpers will rely on software to automatically make these trades.
Earning the bid-ask spread is a consequence of being a quick buyer or quick seller. This means that they are willing to enter themselves into the “queue”, allowing them to trade independently of the general market. The profits from scalping will only be a few percentage points—in order for this trading strategy to be successful, you will need to commit a large amount of capital and be willing to make many trades within a day. Scalping will often take place in a matter of seconds or even less.
Scalping can be done while trading foreign currencies (forex), stocks, commodities, and most other tradable assets. Forex scalping will involve looking at a specific currency pair and trying to exploit the spread. By simultaneously looking at how many Euros someone is willing to pay for an American Dollar (USD) and how many American Dollars someone is willing to pay for a Euro, you will be able to identify the bid-ask spread and determine if any scalping opportunities actually exist.
What are the benefits of scalping?
As you would probably imagine, any opportunity to earn a “risk free” return on an investment will be exploited to the greatest extent that it possibly can. The many available benefits of scalping attracts forex traders from around the world.
- Limited level of exposure and risk: while scalping, your position is only “exposed” (subject to change) for a very brief amount of time. It is very unlikely that a scalping attempt will cause you to lose a large amount of money; instead, the “worst case scenario” will usually be that your wealth remains about the same.
- Small Steps: scalping is very easy to control because you are only pursuing very small gains at a time. This is very different from many institutional investing strategies that tend to put all of the eggs in one basket.
- Higher Volume, Higher Profits: even if you only make $.01 per scalp, earning a million pennies over time will still yield $10,000. Scalping is strictly a volume-driven trading strategy; the more you are willing and able to scalp, the more money that you will end up earning.
Scalping is an essential component of “making” the forex market. The spread that you are earning as a scalper is indirectly paid by individuals (such as momentum traders and stop limit users) who need market quotes more quickly than you do. In this way, scalpers and momentum traders create a sort of symbiotic relationship.
What are the risks of scalping?
If scalping were really such a perfect trading strategy, then there would likely be more institutional investors committing billions of dollars to exploiting the market. While scalping still has many risk prevention mechanisms built into it, there will still be a few notable risks involved.
- Risk of Volatility: highly volatile markets are not ideal for scalpers because these markets increase the risk of being exposed for even a short amount of time. Instead, scalpers prefer to trade using reliable currency pairs such as USD: GBP, GBP: EUR, and EUR: USD. While these pairs do experience some change over time, they are still among the most stable.
- Need for Accuracy: if being exposed during a period of high volatility causes you to hold a losing position, it will take many successful scalps in order to adequately make up for it.
- Low Profit Margins (Opportunity Cost): while the returns from scalping are somewhat guaranteed, the profit margins are still very low. If you are willing to assume an only slightly higher amount of risk, there are many day trading strategies that will be much more preferable.
- Risk of Fraudulent Use: due its “market making” nature, scalping is a strategy that is often used in a fraudulent way. Individuals who purchase and sell to themselves will be sending false signals to the market, which—according to the Supreme Court—is a violation of the Investment Advisers Act of 1940.
Scalping may not be the flashiest or preferred mechanism for exploiting forex markets, but many traders around the world still believe it gets the job done.
How can I develop a successful forex scalping strategy?
Scalping is a simple strategy that is somewhat immune to general market trends and instances of controlled volatility. If you hope to become a successful forex scalper, keep the following pieces of advice in mind:
- Scalp in high volumes: low volume scalping will not be worth the effort. If you want to make profits, you will need to scalp in large amounts and scalp as often as you possibly can.
- Use currency pairs with low volatility: contrary to some trading strategies, there is really nothing to be gained by scalping highly volatile securities.
- Implement other trading strategies: in order to maximize your daily ROI, you should commit some of your capital to scalping and the rest of your capital to day trading techniques with higher rates of return.
You will also want to make sure that your specific brand of scalping—which presents itself in several different forms—is one that is entirely legal.
Conclusion
Whenever there exists an opportunity for arbitrage, you may be able to earn an immediate return on your investment while assuming very little risk. Scalping is a forex trading strategy that yields low profit margins along with low degrees of risk. When done correctly and with the right level of volume, scalping can be a very productive approach to forex trading.