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Forex Basics
Forex: Scalping Strategy
by InvestorGuide Staff (Write for us!)
(Click on the links within the article to get definition of that word)
There are a number of options that any investor has when trying to decide where to invest his/her money.
Forex (i.e. the foreign
exchangemarket) is one of these choices. Just as millions of travelers do every year
when they go abroad, Forex traders are merely exchanging one form of currency for another. But as most people
already know, one dollar of U.S. currency is not equal to one Euro - there is always a conversion rate involved
in any exchange between currencies.
Just as with stock prices, the exchange rate between currencies is constantly changing and reacting to market
conditions. One Euro might be worth 1.300 USD today, but only 1.2518 USD the following day. When dealing with
currency exchanges, the two currencies being traded are known as the currency pair. The base currency is the
first in the currency pair and it is used when the account is set up (USD/Euro). So, if an investor was looking
at the exchange rate of 1.312 USD when looking at the base pair of the Dollar/Euro - this means that it takes 1.312
USD to buy one Euro and that the dollar was used to set up this transaction.
At its simplest, scalping involves short-term movements in the exchange rates. In other words, Forex
traders who
use the scalping strategy are not in it for the long haul - in fact, this strategy may only involve investments
that last a few hours - or even minutes. Scalpers pay very special attention to market indicators that specifically
affect Forex rates.
The reason that most currency markets rely so heavily upon government statistics is because they are both accurate
and reliable indicators of economic strength or weakness. The statistics are compiled and analyzed using very
complexformulas that are nearly impossible to manipulate. These government figures are both transparent and generally
available to everyone at the same time - so there is a general sense that the currency market is an even playing
field for both large and small investors. These statistics are generally released around the same time every
month (with the exception of figures that are released quarterly, like the GDP) and distributed by all the major
players, such as Reuters, Bloomberg, CNBC, etc.
However, a good or bad report on unemployment will not necessarily mean a change in currency exchange rates.
For instance, assume an
investor is interested in the exchange rate between the USD and the Euro.
If the quarterly GDP figures showed a solid 5% increase for the U.S. economy but a lackluster 2% increase
for the euro zone, an inexperienced Forex trader might assume that the dollar would rise against the Euro.
Unfortunately, it is not that simple because the figures themselves are not truly what move the currency
exchange rates. In reality, it is the perception and expectations of the market that will move the rates.
So, even though the U.S. economy grew faster than the euro zone, the dollar may still lose ground to the Euro
on the exchange market. The U.S. economy may have been expected to grow at 7.5% while the euro zone had very
low expectations and was only expected to expand at a 1% rate. Thus, the U.S. economy grew at about half the rate
expected while the euro zone grew at double the anticipated amount - thus, it is more likely that the dollar would
lose ground to the Euro in such a situation.
Using the example above, a Forex trader using the scalping strategy would be eagerly awaiting the GDP figures
to be released by the respective governments. When they are released, the investor may indeed anticipate that
the dollar would lose ground against the Euro. Because smaller investors can organize and react quickly to
economic data, they actually have a slight advantage over the larger investors and hedge funds - especially when
using the scalping strategy.
The basic premise of any Forex investment is to purchase one currency while simultaneously selling another.
In truth, the GDP announcement may only cause a slight adjustment to the exchange rate between the USD and the
Euro - and yet the size and liquidity of the currency market may still make the transaction profitable if the
movement of the exchange rate can be accurately predicted.
The currency market is the most fluid and liquid in the world with roughly $2 trillion dollars changing
hands each day. While the standard size of a transaction in options is 100 shares of the underlying stock or
investment, the typical size (standard lot) of a Forex trade is 100,000 units of currency.
Therefore, for the scalper who predicted that the dollar would lose ground as a result of the economic data released
by the government earlier in the day, the movement of the Euro to 1.312 from 1.260 could be quite profitable.
While the position only moved .052, the fact that the standard lot is 100,000 units of currency means that
the gross
profit would be $5200!
It is quite possible that the scalper could buy in earlier than the larger investors and thus make a bigger profit
than when the market finished reacting to the economic data released earlier in the day. But, would a scalper
necessarily make all $5200 of the potential gross profit? Probably not, because the investor will typically have
trigger points already in mind when making an investment.
Investments using the scalping strategy are very short term and may indeed only be a few hours in duration.
Investors need to already have targets and stops in mind before investing in Forex if they intend to use the
scalping strategy. After all, it is impractical to follow the exchange rates on a minute-by-minute basis
for very long. The target is the projected price level that the currency will reach (verses the other currency
in the pair) as a result of the economic or political data recently released. Stops are determined by
the investor and they are specific points within the target range. When prices reach these stops, the stop order
becomes a market order and the currency is unloaded - with the investor presumably making a "reasonable" profit for
their troubles. Most successful scalpers use technical analysis (historical data) to determine the stop
points for the currency exchanges.
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