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Scalping Trading Strategy: High Leverage, Little Time and Few PIPs at a Time

admin on August 25th, 2008

The technique of scalping is a very popular one among forex traders, one loved and encouraged by online brokers, and which is made possible by exploiting the high leverages that are typical of this market.

What Scalping Is and How to Scalp

Scalping consists in using very high leverages — typically 200:1 or 400:1 — to open trades on pairs with a low spread, aiming at a small target in terms of PIPs, usually compensating the higher risk exposure with tighter stop losses.

Because of its unique features, a typical scalping trade lasts a few seconds to a few hours, allowing traders to place more trades and invest more capital during the course of the day. Stop losses and take profits are usually quite tight, which makes it easy for the pair to reach one or another in a relatively short period of time.

This technique is quite easy to use and, when mastered, it certainly allows investors to earn (as well as lose) a very consistent percentage of their equity in a single day by placing multiple trades, but still controlling their risk exposure in a very precise way. For instance, it’s not uncommon to see traders earn or lose up to 15-20% of their equity in a single day by placing several trades of this kind, although professional traders don’t usually risk that much unless conditions appear particularly favorable.

Why Online Forex Brokers Love Scalpers

Online brokers love scalpers and encourage the use of this technique in their traders because, as you already know, forex brokers are being compensated with the difference between the bid and the ask price. This means that their earnings are proportionate to the product of spread and your current exposure and so, the more you trade, the more they earn.

However, it has to be said that not all online brokers have the ideal conditions for scalping, which are very high leverage (100:1 to 400:1) and reasonable spreads (no more than 2 PIPs on EUR/USD and other main pairs).

Moreover, not every broker allows you to place your stop and limit orders exactly where you want them, especially if you want to place them very close to the current pair price, say, at a distance of only 5 or 6 PIPs.

This partially limits your possibilities as a scalper, but it also has the very positive effect of protecting you against the high volatility of this market. Placing a stop/limit order at just 5 or 6 PIPs is typically not something you want to do, especially when you factor in the spread which can already be 2-3 PIPs: this would mean that, if the pair went just another 2 PIPs down, you’d trigger a stop loss and lose on a potentially profitable trade.

When you use scalping, you typically want to give the pair a little more room to swing back and forth a little before it has the possibility of reaching your take profit objective. Many investors use stops at limits from 10 to 20 PIPs each, which are still considered quite tight compared to other trading strategies, especially those in the long term.

Forex Definitions: Stop Loss, Take Profit and Trailing Stop Orders

admin on August 22nd, 2008

In the world of currency investing, the three terms “stop loss”, “take profit” and “trailing stop” are widely used, since they are the best known kind of limit orders that are used to close a trade under specific conditions, allowing the investor to greatly reduce its risk exposure and trade with more serenity.

A Few Initial Assumptions

For explanation purposes, let’s make the following assumptions:

• we went “long” on a standard 100,000 EUR/USD lot on a USD account, which means buying $100,000 worth of EUR;
• the current EUR/USD bid price is 1.500, which means we bought €66,666.67 (that is, $100,000 worth of EUR).

As we already explained, a PIP is defined as the minimum variation that can occur in a trade, which is 0.001 for EUR/USD as well as most of the other pairs. We can calculate the value of a PIP for any given trade by multiplying 0.001 to $100,000 and see that any minimum variation gives us a profit or a loss of exactly $10.

Since the forex market is extremely volatile, we want a way to protect our investment: luckily, we can do this with stop, limit and trailing stop orders.

Stop Loss Orders in Forex

A stop order is a way to protect ourselves in the worst-case scenario. Setting it at a distance of -20 PIPs, for instance, means (under the conditions explained above) that for this particular trade we won’t be losing more than $10 x 20 = $200. You’ll find it extremely useful to be able to precisely monitor the risk exposure of all your open trades.

Take Profit (or Limit) Orders in Forex

Conversely, a take profit (or limit) order is a way to somehow “save” your profits, meaning if you reach a certain ask price, you will automatically sell. If you for instance set a limit at a value of +40 PIPs, you’ll know the maximum you can profit from a trade is $10 x 40 = $400.

Placing a limit order is extremely important as it helps you keeping your trade objectives clear for all of its duration and avoids the (very realistic) possibility that greediness will take over and damage your trade. If you don’t have a clear objective from the very beginning, you’ll never want to close a trade since you’ll be constantly looking for more and more profits, but chances are you won’t want to close it even when the pair has made its peak and started to retrace, eventually leading you to lose on a potentially positive trade.

Trailing Stop Orders in Forex

A trailing stop order is another interesting possibility, very useful especially in volatile markets. Let’s suppose you placed a trailing stop at 1.510, and the pair initially goes at 1.515, then makes a swing back at 1.480, when your stop and limits are at 1.490 and 1.520 respectively. What happens here?

Without a trailing stop, you would exit the trade with a stop loss at 1.490, losing $100. But with a trailing stop, you would profit $100 under exactly the same conditions! A trailing stop is triggered when the pair price reaches a certain value, 1.510 in our example, and replaces the former stop loss.

That way, when the pair reaches 1.510, the trailing stop is triggered and somehow “saves” your profits, triggering a stop loss exit in case the pair starts going down from there, and of course the limit order otherwise.

As we hope you realized, using stop, limit and trailing stops often makes a difference between a good and a bad trade, and learning how to use them profitably is an essential part of your training as a forex investor.