Traders employ a variety of strategies in order to be able to consistently beat the markets and profit – however, there are few methods of trading as effective as scalping. Scalping refers to a form of trading that relies on making a series of small profitable trades, focussing on quantity rather than quality in order to boost profits. The primary focus of such strategies is to utilise trading volumes rather than performing a lot of complex technical analysis. There are several such trading strategies, and one of them has been discussed in this article. Read on to find out more.
There are 3 main indicators used in this trading setup, and each of these indicators has been explained below in detail.
The EMA is simply the exponential moving average of the stock’s closing price over a given number of trading sessions. It works in a very similar way to the SMA (Simple Moving Average), except it gives more priority to more recent data as this is considered to be more relevant than old data. The parameter that you have to enter for the EMA is the time period. Usually, traders only go long when the current price is above the EMA, and short when prices go below the EMA.
The Moving Average Convergence Divergence or the MACD is a momentum-based indicator that shows the relationship between two different EMAs. It is calculated by subtracting the EMA over the larger period from the EMA over the shorter period. This line can then be superimposed over another EMA line (called the signal line) in order to use as a buy or sell signal. Usually, traders go long when the MACD is above the EMA, and short when the MACD is below the EMA.
The RSI is a momentum indicator that is used to analyse the stock and identify if it is overbought or oversold at any point in time. It does this by monitoring the magnitude of recent price changes. The RSI is presented as a number between 0 and 100, wherein a number below 20 represents an oversold stock (ripe for a long position) and a number above 80 represents an overbought stock (ripe for a short).
For this particular trading setup, the following settings were used on the indicators:
- EMA: Three different EMAs were used in this setup, each with different time periods. They were all marked with different-coloured lines:
- EMA 1: Period = 9
- EMA 2: Period = 55
- EMA 3: Period = 200
- MACD: The signal line and the MACD line were disabled, and only the histogram was used. While the original chart was in 5-minute intervals, the MACD histogram was made on a 1-minute interval.
- RSI: The middle band is emphasized as opposed to the overbought (>80) and the oversold (<20) bands.
A long position was initiated whenever EMA 1 was above EMA 2, which was in turn above EMA 3. In addition to this, the RSI would have to be above 51 and there would have to be a red trend that is higher than the average (indicated through the MACD histogram).
A short position was initiated whenever EMA 1 was below EMa 2, which was in turn below EMA 3. The RSI chart would have to be below 49, and in addition to this, the MACDE histogram would have to show a larger-than-average green band.
These indicators were set to indicate pullbacks in trends. Larger-than-average bands can easily be identified by adding Bollinger bands to the MACD, and a higher-than-average or lower-than-average bar exists whenever a candle touches the Bollinger bands.
The risk-reward ratio was set as 1:2.
Results and Adjustments
After a 5-minute scalping session over the course of 3 months worth of past data, the overall results were:
Profitability: 112.62% net profit
Number of Trades: 151
% of trades profitable: 80.79%
Profit factor: 2.022
Some additional indicators and settings that could be added in order to increase the win rate and reduce the risk employed are:
- The RSI lines could be changed to 48 and 52 instead of 49 and 51 to ensure that the RSI has moved past the 50 line.
- The ADX indicator could be added to weed out bad trades that would’ve been made when the trend was about to end.
Scalping has been proven to be one of the most profitable trading strategies out there, however, even when you’re scalping, you need to ensure that you have a high win rate so that the strategy is fruitful and profitable. Using the strategy discussed above, you will be able to profit in both bull and bear markets consistently. You can even tweak the settings to suit your level of risk and trading style, finding the right balance between the win rate and the net profit.
- Exponential Moving Average – Investopedia
- Moving Average Convergence Divergence – Investopedia
- Relative Strength Index – Investopedia