So many factors affect the financial markets that it's often impossible to correctly predict where the prices will move next. Many traders lose their hard-earned money because of unexpected price swings. Some shift to smaller time frames and turn to scalp trading to reduce the risk of exposure to significant price fluctuations.
In this article, you'll learn what scalping is, what indicators scalpers use, and how to apply these indicators in a scalping trading strategy.
What is scalping?
Scalping is a very short-term day trading strategy that involves making profits from minuscule price changes. Traders that use this strategy are called scalpers, and their main goal is to earn money from a large number of small winning trades instead of relying on a few larger and longer-lasting ones. Each trade lasts between a couple of seconds to one hour, and the number of trades a scalper makes within one day can range from 10 to a few hundred, depending on whether a scalper trades manually or uses automated trading software.
The main thing that attracts traders to this strategy is that it is much easier to catch and profit from small price moves than larger ones. Minor price changes occur more frequently, and since each trade lasts for a short time, there's significantly less risk of encountering adverse events that can lead to undesirable price moves.
How does scalping work?
Even though scalping is considered less risky than longer-lasting trading strategies, it only works well if a trader has a solid trading plan and strict discipline, so it's more suitable for experienced traders.
Before entering a trade, scalpers must determine an entry point, a profit target, and a profit & loss level. Once this is done, sticking to this plan is crucial. If the price reaches the profit target, scalpers always exit the trade even if there is a chance for the price to go up even more. Similarly, if the price hits the profit & loss level, they leave the trade without waiting for the price to rebound. Doing this reduces the risk of exposure to unexpected and undesirable market moves and makes scalping less risky than other trading strategies.
To plan a successful trade, scalpers need to understand where the market is likely moving next, so they use a lot of technical analysis indicators, study short-term (1-5 minute) price charts, understand the psychology of traders and what their next moves may be depending on the current market conditions.
Advantages and disadvantages of scalping
Like any other trading style, scalping has a list of pros and cons that make it attractive for traders to use or prevent them from doing so.
The advantages of scalping include the following:
- Lower risk. Scalpers profit from small price moves that happen within a minimal time frame. Even if the price moves against a trader, it doesn't have enough time to move outside the predetermined profit & loss level, which puts a limit on any losses a scalper may suffer.
- Potential profitability. If scalpers stick to their detailed trading plans and trade a large volume of an asset at once, they can turn in a high profit at the end of the day.
- No need to follow fundamentals. Fundamental trading includes tracking the news, events, and economic statistics reports that affect an asset's value to determine the best time to buy or sell it. However, since scalpers profit off small price fluctuations, they do not need to follow fundamentals as they do not affect short time frames.
- Works for both directions. With scalping, it's possible to trade both bull and bear markets, so scalpers have more opportunities to profit from price changes.
- It can be automated. Scalping requires precision and good timing since even a one-second delay can affect the course of your trade. Fortunately, it is possible to use automated trading software to send out trade orders just as the price reaches one of the targets and make the most out of each trade.
That said, there are certain disadvantages that traders need to consider before deciding to integrate this strategy into their trading.
- Requires a lot of experience and time. Even though scalping might seem easy, it's still an advanced trading strategy that requires a good understanding of the market and how it moves. A beginner might find it challenging to stick to a strict trading plan and keep up with multiple trades for hours every single day. Experienced traders, on the other hand, have better discipline, more experience, and funds to keep up with the ever-changing movement of the market.
- Transaction costs. Like other traders, scalpers have to pay a commission or a spread for every trade they execute. Since scalpers make much more trades than other traders, the costs can build up and eat into the profit they make from those trades.
- Technical issues. As we've already mentioned, even a one-second delay can affect the outcome of a trade. However, not all delays are the fault of traders. Bad internet connection, platform issues, etc., can cause slippages and delays in execution, turning an overall promising trade into a failure. This can be mitigated by using automated trading software and VPS, but traders who don't have access to these tools should be cautious about scalping.
Eight most commonly used scalping indicators
Even though scalpers might not need to know the long-term direction of the market trend, they must understand where the price is likely to move to make informed decisions. This is when technical analysis indicators become particularly useful, as scalpers can use them to predict future price movements. And now, we will look at the eight most commonly used scalping indicators.
1. SMA indicator
The Simple Moving Average (SMA) indicator is one of the basic tools scalpers use to identify the trend and build a trading strategy. It gives information about the average price of a particular asset by adding up a range of closing prices and dividing the sum by the number of periods within that range. This helps scalpers understand whether the cost of an asset is moving up or down and if the current trend might reverse.
2. Exponential Moving Average (EMA)
The EMA is another indicator that utilizes moving averages. Like the SMA indicator, it analyzes the price of an asset. However, the EMA indicator focuses on the most recent price and can give scalpers more detailed information. Scalpers use the EMA to determine the current trend and identify potential entry points. If the price crosses above or below the EMA, it can signal potential buy or sell opportunities.
3. MACD Indicator
The next indicator on the list is the Moving Average Convergence Divergence (MACD). It is a trend-following indicator showing the relationship between two moving averages. The subsequent movement of two lines when they overlap, converge, or diverge from each other indicates the current momentum, giving traders buy or sell signals. Scalpers use this indicator to find potential entry or exit points and identify trend changes.
4. Parabolic SAR
The Parabolic Stop And Reversal (SAR) is an indicator commonly used by traders to get detailed information about price action trends. The Parabolic SAR appears on the charts as a series of dots above or below the price. If the beads are displayed below the price, the price is moving upwards, and vice versa. When the dots change their position, traders should expect a potential trend reversal. This indicator is particularly useful for scalpers as it can determine the short-term momentum of the price movement.
5. Stochastic Oscillator
The next technical analysis indicator used by scalpers is the Stochastic Oscillator. This is a momentum indicator, and it compares the closing price of an asset to a range of its prices over a specific period of time. As a result, it can identify overbought or oversold market conditions, which can signal a potential reversal of the trend.
6. Volume-Weighted Average Price (VWAP)
The Volume-Weighted Average Price (VWAP) is a technical analysis tool that helps traders determine the liquidity of an asset and identify support and resistance levels. This VWAP is used to calculate the average price of an asset based on the volume bought over a certain period of time. This indicator works best for short-term trades, so it's mainly used in scalping and other intraday strategies.
It’s better to follow volume-related trading strategies through services that provide aggregated volume data. Thus, the figure below shows VWAP indicator on the Trading View site.
7. Bollinger Bands
The Bollinger Bands is a scalping indicator that consists of three lines: a moving average (the middle line) and two standard deviations (the upper and lower bars). This indicator can help traders to determine overbought and oversold levels and identify trends and potential reversal, but scalpers mainly use it to find entry points and measure volatility. When the price reaches the upper or lower band, it can signal a potential reversal or trend continuation.
8. Relative Strength Index (RSI)
The Relative Strength Index (RSI) is an oscillator indicator that determines the strength of the price action by measuring price changes and the speed at which they occur. Scalpers use this indicator to identify potential overbought and oversold levels, which can signal a possible trend reversal.
Best scalping trading strategies
To master scalping, you need to develop a reliable trading strategy that can help you get the maximum profit out of all your trades. Here are three scalping trading strategies used by scalpers all around the world:
Moving Average Ribbon strategy
This scalping strategy involves the use of several EMAs with different time frames. For example, scalpers generally use 10 EMA, 20 EMA, 50 EMA, and 100 EMA. The EMAs are then plotted on the chart in a ribbon-like formation, running parallel. This ribbon can be used to identify the direction and momentum of the trend. A "smooth" ribbon indicates a strong trend, which means scalpers can open a buy or sell position.
The stop loss should be placed just below the last swing low (for a buy trade) or above the previous swing high (for a sell trade). Once the price touches the 200 EMA again, closing the trade and taking profits is time.
Bollinger Bands strategy
This strategy relies on the use of the Bollinger Bands indicator. As we already know, the hand consists of three lines: two standard deviations and an SMA in between them. If the price crosses one of the outer bands, it signals that there's a potential reversal or trend continuation coming next.
The stop loss should be placed just below the last swing low (for a buy trade) or above the previous swing high (for a sell trade). Scalpers can enter a trade once the price crosses one of the outer bands and exit when it returns to the SMA.
The MACD plus EMA strategy
In this strategy, scalpers use the MACD and EMA (e. g. 200 EMA) indicators to determine the direction and momentum of the trend. If the MACD line rises above zero level while the EMA is below the price, it gives a potential buy signal. At the same time, if the MACD line falls below zero level with the EMA being above the price, scalpers should prepare to open a sell position. When the MACD slides below the signal line, it's time to exit the trade.
Conclusion
Scalping requires a lot of patience, discipline, and time from a trader. If you want to start scalping, you need to be able to make swift decisions and know your way around various indicators. With the right strategy and mindset, you can become a successful scalper and make significant profits off the most liquid assets.