The Perils and Potential of Using High Leverage When Scalping: A Comprehensive Guide
Introduction
Scalping is a popular trading strategy, especially among forex traders, due to its potential for quick gains. However, one of the most debated aspects of scalping is whether or not to use high leverage.
This article will delve into the reasons traders consider using high leverage for scalping, the psychological and practical challenges it introduces, and why a more conservative approach might yield better long-term results.
The Attraction of High Leverage
The basic idea behind using high leverage when scalping is straightforward: if you are aiming to take small, quick profits from minor price movements, leveraging your positions can amplify those gains. For example, when trading a currency pair like the Aussie/US Dollar (AUD/USD), if the price moves into a support level and you’re looking to extract 8 to 10 points, using high leverage can significantly boost your returns from such small price movements. This sounds appealing in theory, but the reality can be quite different.
The Psychological Pitfalls
One of the major issues with using high leverage is its impact on trading psychology. Let’s consider a scenario: suppose you decide that the market conditions are ideal for buying at a certain support level. You note that risk sentiment is positive – oil prices are up, copper prices are up, bond yields are rising, and equity markets are buoyant. Moreover, there is strength in commodity currencies like the AUD, New Zealand Dollar (NZD), and Canadian Dollar (CAD), coupled with weakness in safe-haven currencies like the Japanese Yen (JPY), Swiss Franc (CHF), and the US Dollar (USD).
Based on these conditions, you enter a high-leverage position expecting the price to rise. However, if the price unexpectedly moves down to the next major support level, you could find yourself 30 to 40 points underwater very quickly. High leverage amplifies not only your potential gains but also your potential losses, leading to a significant drawdown.
The Cycle of Emotional Trading
This scenario often triggers a cycle of emotional trading. Faced with substantial unrealized losses, a trader might prematurely close out their position after a minor adverse movement, say 10 or 15 points. The fear of further loss can cloud judgment, prompting a reentry into the market based on the same initial analysis. This reentry incurs additional commissions and, if the market continues to move against the trader, results in further losses.
This vicious cycle of entering and reentering trades due to high leverage often leads to compounded losses. The stress and emotional toll of seeing significant portions of your account equity wiped out can lead to impulsive decision-making, further eroding both capital and confidence.
The Practical Approach: Matching Trade Size to Account Size
A more sustainable approach to scalping, especially for those new to the strategy, is to avoid high leverage altogether. Instead, align your trade size with your account size. For instance, if you have an account with 100,000 units of currency, a standard lot (100,000 units) is appropriate. For a smaller account, such as 10,000 units, using a mini lot (10,000 units) or 0.1 standard lot is advisable.
By trading without leverage, you mitigate the risk of large drawdowns. This approach allows for aiming toward double-digit returns with significantly less risk. It also helps in establishing disciplined trading habits, free from the emotional rollercoaster induced by high leverage.
Long-Term Benefits of Conservative Trading
The conservative approach to scalping involves finding key levels to enter and exit the market and setting stops well beyond these levels to avoid premature exits due to minor fluctuations. This strategy encourages patience and discipline, essential traits for successful long-term trading.
Moreover, by reducing reliance on leverage, traders can avoid the trap of trying to “make up” losses through even riskier trades, a behavior that often leads to a downward spiral of losses and emotional distress.
If you are interested in pursuing a leveraged scalping strategy for risk events read on.
Scalping Trading Strategy for Risk Events Using the NFP Report:
Step 1: Analyze Federal Reserve Priorities
Understanding the current focus of the Federal Reserve is crucial. If the Fed is closely monitoring employment data, the Non-Farm Payroll (NFP) report will have a heightened impact on market volatility. Use our Professional Economic Calendar, which includes a fundamental guide, to stay updated on the Fed’s priorities.
Step 2: Use High-Low Expectation Forecasts
Professional traders use high-low forecasts to gauge market expectations accurately. Here’s a more detailed look at why these forecasts are essential:
- Institutional Forecasts: Professional economic calendars include high and low estimates from top institutions, providing a comprehensive picture of potential outcomes.
- Market Shocks: When a report exceeds the high estimate or falls below the low estimate, it often results in sharp market movements due to the unexpected nature of the data.
- Lightning Bolt Feature: This tool signals deviations above the high or below the low of analyst expectations. Quick reaction to unexpected data can differentiate between a profitable trade and a missed opportunity.
Understanding High-Low Forecasts
Economic forecasts are based on surveys from credible institutions, providing their best estimates on upcoming data points. Professional economic calendars include both high and low estimates, showing the full range of expectations. Trading opportunities arise when data releases fall outside these estimates, causing significant market reactions.
Step 3: Choosing the Most Volatile Instrument to Trade
Using insights from institutional reports, traders can select the most responsive currency pairs or assets. For example, if the EUR/USD is particularly sensitive to economic data and the NFP report shows a significant deviation, this pair could be an ideal target for trading.
- City Economic Surprise Index: This report identifies currency pairs that react strongly to economic surprises, highlighting sensitive pairs.
- Risk-Reversal Report: Reveals market positioning and options build-up on certain currency pairs, helping traders choose responsive markets.
- CFTC Report: Details hedge funds' positions, indicating potential market movements based on fund activities.
Trade Execution Steps
- Confirm Fed Focus: Ensure the Federal Reserve is currently emphasizing employment data. If employment is a primary focus, the NFP report is more likely to move the market. Remember, if the central bank is focused on the data point, it’s because they are using that data point to make a decision on rates. This is the reason data points that are focused on cause volatility. In addition, sometimes the central bank is focused on a data point inside a data point. For example, the Federal Reserve has often called out average hourly earnings as the key metric they look for inside the Non-Farm Payroll report.
- Check Forecast Ranges: Review high and low forecast expectations before the data release. Plan to trade only if the actual data significantly exceeds the high estimate or falls below the low estimate, ensuring a response to genuinely surprising data.
- Monitor Revisions: Check for conflicting revisions in the data, as these can alter the initial market reaction. Ensure the primary release and any revisions align to support your trade.
- Enter Trade Promptly: Once you confirm the deviation, act quickly to enter your trade within the first 30 seconds. Speed is crucial, as market reactions to significant data surprises occur rapidly.
- Set Stop and Take Profit:
- Stop-Loss: Place your stop-loss below the low of the initial spike candle to protect against adverse movements.
- Take Profit: Aim for 15-30 pips for tier 2 events like NFP, adjusting based on market conditions and volatility.
Managing the Trade
- After the Initial Run: Look for a shallow pullback around a 23% Fibonacci retracement or near support/resistance levels. This initial pullback can provide an opportunity to enter the trade again after taking a few points off the table after your first entry.
- Break Even: Move your stop-loss to break even as soon as possible to protect your gains. The stronger the release, the shallower the pullback. If the market doesn’t buy off your support/resistance level and continue to the highs of the one-minute candle, consider reassessing the trade.
- Reentries: If your initial position is stopped out at break even, consider reentering at deeper retracements, such as the 38% or 50% Fibonacci levels. Use nearby support and resistance levels to guide your reentry points.
Conclusion
Trading the Non-Farm Payroll report can lead to significant market movements, and understanding its nuances is crucial. Using a professional trading strategy, including scalping techniques, can help you capitalize on unexpected deviations.
Scalping, with its focus on quick, small profits from short-term price movements, can be particularly effective during the high volatility following the NFP release. By quickly entering and exiting trades within seconds to minutes, scalpers can take advantage of the initial market reaction to surprising data.
If you don’t have the tools mentioned above, try out our Professional Economic Calendar Package and use institutional tools to level the playing field. By following these steps and incorporating scalping strategies, you’ll be well-prepared to trade the NFP report effectively, leveraging the same tactics that professional traders use to profit from this economic data release.