Forex Spreads: Low Spread Scalping Strategies
Forex scalping can be very exciting for traders. The promise of "free" cash with a good scalping strategy can make a trader's head spin and their fingers very trigger happy (by which traders start taking many trades). However, no Forex scalping strategy can be effective without understanding the size of the Forex spread and how to exploit the advantage of low spreads. This article will address questions such as 'What is a spread in Forex?', 'What is scalping in Forex?', and 'Why are low spreads important?'. We'll also cover two key strategies for scalping pairs that have their spreads lowered.
Table of Contents
What is the Trading Spread in Forex?
In Forex trading, the 'spread' refers to the difference between the Buy (or Bid) and Sell (or Ask) price of a currency pair. For instance, if the EUR/USD Bid price is 1.16909, and the Ask price is 1.16919, the spread is 1 pip. If the Bid price is 1.16909 and the Ask price is 1.16949, the spread would be 4 pips. When trading Forex, a trader makes a profit based on the movement of the currency pair. However, the trade only becomes profitable once the currency price has crossed the spread.
So, if the currency pair has a 1 pip spread, in a Long trade, the value of the currency would need to increase by at least 2 pips before the trader would profit (1 pip for the spread, and an extra pip for the profit). The wider the spread, the longer it will take for any trade to become profitable. So if we compare EUR/USD with a 0.6 pip spread to a high-spread pair like AUD/NZD (which is typically 6-10 pip, though the typical spread at Admirals is just 3.1 pips),* the EUR/USD currency pair wouldn't need to move as far as the AUD/NZD currency paid in order for a trade to become profitable.
What is Scalping in Forex?
Scalping in the Forex market involves taking advantage of minor price changes in the market, by making many small trades over very short time periods - usually between 1 and 15 minutes. For a 1 minute trade, a trader would look to make a 5 pip profit, while a 5 minute scalp would aim for a 10 pip profit.
Because these trades are so small, the importance of choosing low-spread currency pairs is clear - if a spread is too large, there will be no profit left over once the trade ends. Because the focus is on such small trades, this is a very popular trading style for many traders, as it creates many opportunities within a single day.
Top Low Spread Scalping Strategies
When it comes to taking advantage of low spreads, Forex scalping strategies provide many opportunities for traders. An FX currency pair may move 25 pips long or short for a minute, then pull back 10 pips the next minute, oscillate at this level for another 5 minutes, and make another strong 25 pip move over the next ten minutes.
This is usually a minor move in the Forex market, occurring over a matter of minutes, and this is what you, the scalper, are after. But first, let's discuss why it is so important to get educated on scalping. Of course, scalping wouldn't be nearly as popular if it didn't provide benefits, mainly:
- The possibility to achieve a greater level of profit than you can by merely making positional trades.
- No waiting around for a strong trend to develop.
- Many trading opportunities.
- No pressure to analyse the overall market.
On the other hand, scalping also has some disadvantages, including:
- A lower margin for mistakes.
- Too many 'good' trades leading to overconfidence.
- It can be exhausting at times.
- There is a risk of overtrading.
- A greater level of loss.
Strategy Number One – Extreme Scalping
- Bollinger Bands (20, 3).
- Exponential Moving Average (3), close
- MACD Histogram (6,17,8)
- Relative Strength Index (14) with 50 level.
Timeframe: 1 min
Pairs traded: EUR/USD, GBP/USD, USD/JPY, USD/CAD
- Wait for the 3 EMA to cross up through from the 18 Bollinger Bands middle line
- Wait for the Relative Strength Index and MACD Histogram to line up above 0 on the MACD, and above 50 on RSI.
- Wait for the 3 EMA to cross down through the 18 Bollinger Bands middle line
- Wait for the Relative Strength Index and MACD Histogram to line up below 0 on MACD and below 50 on RSI.
- Place the stop-loss for long trade a few pips below lower band
- Place the stop-loss for sell a few pips above upper band.
- Place profit target on opposite band
- Average target is 5-15 pips.
Strategy Number Two – Gold CFD Trading Strategy
- Exponential Moving Average (5), close
- Exponential Moving Average (10), close
- Stochastic Oscillator (8,3,3)
- Relative Strength Index (14) with 50 level.
Commodity CFD trading: GOLD
- The price should be at or very close to the Admiral Pivot support (S1, S2, S3) or slightly above the Pivot Point (PP)
- Wait for the 5 EMA to cross above 10 EMA
- The Stochastic should have recently crossed 20 from below
- The RSI should be above 50.
- The price should be at or very close to the Admiral Pivot resistance (R1,R2,R3) or slightly below the Pivot Point (PP)
- Wait for the 5 EMA to cross below 10 EMA
- Stochastic should have recently crossed 80 from above
- The RSI should be below 50.
- Place the stop-loss for long trade below previous support
- Place the stop-loss for sell trade above previous resistance.
- Place the profit target close to the next pivot.
Source: MetaTrader 4 Gold. Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
- When taking long trades, it is always best to see that stochastics have just crossed above 20 from below.
- When taking short trades, it is always best to see that stochastics have just crossed below 80 from above.
- Using 'Profit Stop' is advised after a trade has gone into profits.
- Download MT4 Supreme edition
- Use 'VPS' (Volatility Protection Settings)
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Key Considerations for Low Spread Trading
When using low spreads as a part of their trading strategy, it's important for traders to keep the following factors in mind:
ATR is the indicator that measures the volatility of a financial instrument. It also projects high and low range based on its calculation. The higher the ATR, the higher the volatility. For instance, if the AUD/NZD moved 60 pips a day while the EUR/USD moved 90-120 pips a day, the EUR/USD would have a higher ATR.
When it comes to low-spread trading, while higher volatility can compensate for a wide spread, the ideal scenario is one where the volatility is high while the spread is low. To go back to the previous example, if the AUD/NZD moved 60 pips a day, and you paid a 6-pip spread, the total trading profit would be based on 54 pips. By contrast, if the EUR/USD moved 100 pips and had a one pip spread, the profit would be calculated based on 99 pips.
Stop-loss vs. stop grab
Source: MetaTrader 4 GBP/USD. Charts for financial instruments in this article are for illustrative purposes and does not constitute trading advice or a solicitation to buy or sell any financial instrument provided by Admirals (CFDs, ETFs, Shares). Past performance is not necessarily an indication of future performance.
You also need to consider what happens when your stop-loss gets hit on those high spread pairs. You are paying a huge spread when your 'market order' stop-loss order hits the market. That might create a pattern that collects all stops above or below it. The more stops that are hit, the stronger the move of the price is going to be. This might even push the price to the next support or resistance level, creating a fake out, caused by a stop grabber.
Source: MetaTrader Supreme Edition - Correlation Matrix
In financial terms, correlation is the numerical measure of the relationship between two variables. The range of the correlation coefficient is between -1 and +1. A correlation of +1 denotes that the two currency pairs will flow in the same direction. A correlation of -1 indicates that the two currency pairs will move in the opposite directions, 100% of the time. Meanwhile, a correlation of zero denotes that the relationship between the currency pairs is completely arbitrary.
So in the chart above, you can see that EUR/GBP and GBP/USD are negatively correlated (-98). This means that they move in a completely opposite direction. If you compare the current ATR of EUR/GBP(70) to ATR of GBP/USD(128), it is very easy to see which pair to trade. Moreover, the spread on EUR/GBP is 2.5 pips, while GBP/USD has a spread of 1.4 pips. Occasionally you'll see that brokers change the spread and allow you to trade with extremely low costs, so make sure to look out for them!
The trader's account should be in a better position to handle setups with larger drawdowns before problems with margins hit the radar. Traders are, therefore, less limited in terms of the number of trades. This can be particularly useful when the market accelerates in its price action, and it suddenly offers the trader more opportunities to trade.
The spread fluctuation might also depend on market factor, namely, liquidity. A market that is liquid means that it has many trades on a daily basis, and is composed of many active traders. The Forex market is extremely liquid because hundreds of banks and millions of individuals trade currencies on it every day. The spread is then divided by the average daily range of a currency pair. This gives us a percentage which tells us more precisely how much the spread costs. The lower the number, the better it is.
The spread can be considered an opportunity cost in the sense that it might reduce the amount of profit gained from the daily range calculated by ATR. The higher this opportunity cost, the more likely it is to convert to losing trades and, subsequently, real financial losses. In the table below are some examples using current average spreads* and ATR (the lower, the better).
* MT4 average spreads as of January 26 2017
ATR (14): 87
Typical Spread Value : 1.0 pips
Spread as a percentage of ATR: 1.0/87 = 1.14 %
Typical Spread Value: 1.4 pips
Spread as a percentage of ATR: 0.85 %
Typical Spread Value: 1.1pips
Spread as a percentage of ATR: 0.72 %
Typical Spread Value: 1.0 pips
Spread as a percentage of ATR: 0.8 %
Typical Spread Value: 18 pips
Spread as a percentage of ATR: 1.23 %
Typical Spread Value: 6.5 pips
Spread as a percentage of ATR: 3.11 %
Source: An example of a MetaTrader 4 account.
If we compare the first five instruments with the GBP/NZD currency pair at the bottom of the table further up, we can see a clear difference in the numbers, and therefore, it is easy to understand the effect of low spreads on opportunity costs, their benefits, and why they should be considered by professional traders.
The example in the screenshot above clearly shows that highly profitable gains are possible when using low spread scalping strategies. If you would like to attempt these strategies yourself, we would recommend that you use a Demo account first, in order to test them in a risk free environment, before transitioning to a live account and testing them in the real-life markets.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.