Four popular scalping trading strategies

20 May 2020

     

    Which trading style do you fall into? Are you a swing trader or do you lean more towards the scalping trading kind of type? In a previous article, we analysed day trading and lightly touched on scalping, as it is one of the most popular strategies that day traders follow.

     

    By definition, scalping is a trading style that specialises in potentially making a profit from small price changes, once an order is placed and the trade becomes profitable. Scalping trading is very popular in the financial world, among forex traders, but it has also made its way into other markets, such as stocks, shares, energies and metals. Naturally being a high-risk style, hence why it is also being banned by many brokers, scalping trading needs to be accompanied by a strict exit strategy, along with confidence and discipline, given that it is not a long-term style, only taking place for a time frame of minutes or even seconds.

     

    So, our dear scalpers, which is the best scalping strategy for you? Many traders have created their own models, using a variety of indicators. It surely depends on your personal trading profile and the markets you trade, but we have rounded up the four most popular scalping strategies for you to go through and decide which one could potentially be the best for you.

     

    1. Scalping trading with the stochastic oscillator

    The stochastic oscillator is a momentum indicator, used to calculate a market’s closing price in comparison to its price range over a selected period of time. The indicator helps traders to decide when to buy or sell an asset, according to a very simple theory: when a market’s price increases, it will tend to close at its highest point for a specific time period. On the contrary, as a market’s price drops, it will potentially be closing at its lowest point. In general, along with other momentum indicators, it is looking at the rate at which a market’s price is changing.

     

    As we can see below, at the screenshot from Fondex cTrader, the stochastic oscillator ranges between 0 and 100. Readings over the limit of 80 are considered in the overbought range, whereas readings below 20 are in the oversold one. The stochastic oscillator appears at the bottom of the chart and is comprised of two lines, the %K and the %D line, which follow each other and occasionally cross one another.

     

     

    As already mentioned, when forming your scalping strategy, there are several ways to interpret a stochastic oscillator. The most popular ones are the following:

     

    -   When the oscillator falls below 20 and rises above that level right after, a potential buy signal occurs, and when it rises above 80 and falls right after, the trader usually interprets this as a sell signal.

    -   When the %K line crosses over the %D line, it calls for a potential buy trade. On the other hand, when the %K line falls below the %D line, traders normally sell their investment.  

     

    In terms of setting up your scalping strategy using the stochastic oscillator, we cannot say that we have found the best setting. There are millions of settings and combinations out there, which you can leverage and form your scalping strategy, but as a simple guideline that can get you going, when trading in short term time frames of M1 to M15, the stochastic 9,4,3 is normally used. For longer time frames, there are other combinations such as the 12,4,12 for M30 to 1H timeframes, as well as the 24,4,24 for the 1H to 1D time frames.

     

    To briefly summarise the stochastic oscillator, it is indeed a very famous one, especially for scalping strategies in stock and currency trading. It would be best though if it is not used alone, but in combination with another indicator in order to better validate the signal it’s giving out. And here comes our next scalping strategy, with an indicator that is widely used in combination with the stochastic oscillator.

     

    2. Trading with stochastics and Bollinger bands

    Bollinger bands is another widely-used indicator, created by the economic analyst John Bollinger. Created as an indicator for trading options, it has now moved its way to all sorts of markets including forex. In a scalping strategy, Bollinger bands are a very popular indicator, which scalpers often use in combination with other indicators to strengthen their predictions, since the Bollinger bands measure volatility.

     

    Let’s start by getting a feel of the Bollinger bands and how to interpret them. Looking at our platform below, the Bollinger bands consist of three lines, creating a price channel – an upper band, a lower band and a middle band. Bollinger bands are built from the simple moving average, hence why the middle band represents exactly that – the simple moving average! Many traders believe that the closer a price moves to the upper band, the more overbought the market is. Also, the closer the prices move to the lower band, the more oversold the market is.

     

    So how do the Bollinger bands and stochastic oscillator work together in a scalping strategy? When both indicators are used, the stochastic oscillator first triggers an overbought or oversold signal, and the Bollinger bands come in place to confirm or reject it.

     

    When an instrument’s price crosses the middle, simple moving average band, the Bollinger bands confirm a signal, and traders tend to hold their positions until the price touches the opposite Bollinger band level. But Bollinger bands can also reject signals, especially when the stochastic oscillator predicts a bullish trade, but the price doesn’t cross the Bollinger band’s middle band.

     

    Generally, sell signals are generated when the price is moving upwards, towards the upper Bollinger band, going over the moving average line. In such cases, traders tend to hold their positions for as long as the price remains on the top price channel. As soon as it starts moving downwards, towards the lower band and touches it, breaking the moving average band, we get a buy signal.

     

    And this is how the Bollinger bands and stochastic oscillator work together in a scalping strategy. We can say that they indeed complement each other and can be used to make potentially strong predictions if you keep your eyes peeled and identify the false signals.

     

    Now, since we have mentioned the moving averages as part of the Bollinger bands, let’s have a look on how they can be incorporated in a scalping strategy by themselves.

     

    3. The moving average as a scalping strategy indicator

    The moving average is one of the most popular trend indicators, which helps traders determine price data by averaging an instrument’s closing prices over a period of time. Moving averages help in an uptrend, acting as a “support” point, while in downtrends, they provide a resistance point for traders. There are different types of moving averages, the simple and the exponential moving average, with their use depending on each one’s trading strategy.

     

    Simple Moving Average

     

    Exponential Moving Average

     

    The Simple Moving Average is showing a market’s average price over a period of time, allowing you to see if a price is moving up or down. Traders normally use more than one simple moving averages for their scalping strategy, and there are many popular and widely-used combinations of them.  

     

    The Exponential Moving Average is also calculating average prices, but in contrast to the simple moving average, it gives more weight to recent prices. In a scalping strategy, traders can use multiple exponential moving averages or a mix of simple and exponential moving averages. With exponential moving averages, when an asset’s current price is above the indicator’s line, it sends a sell signal. When the asset’s price is below the exponential moving average, we have a buy signal.

     

    Let’s have a look at one example - a combination of two short-term and one long-term moving average. The 5 and 20-period ones are used as short-term moving averages, and the 200-period one is used as a long-term one. When the long-term moving average is rising, we check if the 5-period is crossing the 20-period one, and we open positions according to the trend. On the other hand, when the 200-period moving average is declining, we sell once the 5-period moving average crosses below the 20-period one.

     

    And here comes our last scalping strategy, closely relating to the moving averages - trading at support and resistance.

     

    4. Scalping at support and resistance

    Important for almost every trading strategy, support and resistance levels are also widely used by scalpers.  

     

    Support and resistance levels are certain points in the market, where an instrument’s price has a high chance of reversing. Knowing when these levels are and why they exist, helps in predicting when the price will reverse and start moving in the opposite direction.

    The support and resistance levels are named after the effect they are having on a market’s price. Support levels are actually supporting the price and stop it from potentially moving lower, while resistance levels act as a “ceiling”, stopping the market from potentially moving higher.

     

    So how do we identify the support and resistance levels? There are many ways in doing so, but the three most common ways are price action, pivot points and moving averages.

     

    Price action is identified by first finding out swing highs and swing lows on your chart. Swing highs show as peaks and swing lows as a valleys. The channel which is created by connecting the swing highs and lows acts as your support and resistance range.

     

    Pivot points are the most favourable way among traders, in order to identify support and resistance levels. They are automatically calculated using a pre-set formula and can be added to any chart. Once added on a chart, they clearly display support levels with “S”, and resistance ones with “R”. On Fondex cTrader, pivot points are among the available indicators on the platform, ready for you to use instantly and fuss-free.

     

    Last, moving averages are another way of identifying support and resistance levels. If price peaks above the average line, traders potentially expect a dip, looking to buy an asset. If price is below the line, it is a potential short signal.

     

    Regarding scalpers’ action with support and resistance levels, they tend to sell a resistance, as they expect an asset’s price to fall, and buy a support, with the expectation that the asset’s price will rise.

     

    That was it on the top 4 scalping strategies. As already mentioned, scalping, along with any other trading style requires practice and patience. Always keep your eyes peeled for market events, stay on top of the news and keep developing your strategy!

     

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