The Great Debate, Section 2

Nathan Tucci is a young trader . His trading techniques are based on Mathematics above all else. Though he understands technical analysis and fundamentals; his personal belief is that all trading success comes down to the Mathematical principles integrated into all trading. He loves to develop and improve strategies, and is constantly looking for ways to take advantage of the Forex Markets. Trained by Casey Stubbs, Nathan shares Casey’s belief that price is the truest of indicators, and a firm understanding of Price-action is vital to trading success. Nathan loves to share his lastest ideas, successes, failures and thoughts so that other people can benefit from his scientific approach to the market. Follow his latest thoughts on Twitter.

 

 

Section 2 of the Great Debate: Scalping vs Swing Trading

 

Hey everyone, this is Nathan again. I wrote an article a few days ago about scalping vs swing trading, where my thesis was that it was more mathematically sound, especially for beginning traders, to take a swing trading approach to the markets.

 

The article received a lot of interaction which I loved seeing!

 

The number one thing that I noticed in the comments was that people said, in scalping, you should not use a larger risk than reward. To be honest, I was quite surprised to see this, because I have never heard of a scalper targeting 10 or 15 pips and using a 1:1 ratio. However, that must not be the case, because I got a whole bunch of comments saying that they are scalpers and do not use a bigger risk than reward.

 

Here are some of the things folks said:

 

“As a professional scalper, I have an average win ratio of 70%, I target 12 pips and use a stoploss of 12 pips including spreads, I usually make 30 trades a week. I use 1 standard lot with the occasional 2 lots but in general 1 lot.. I make a living out of it.”

 

“Very entertaining Nathan. But, I don’t know of any scalper who would set a 50 pip stop on a 10 pip reward. So I think you fed the wrong numbers in your equation. BTW, I’m a swing trader”

 

“But simply put if we are after a 20 pip gain, we simply cannot let it go 50 pips against us and stop us out”

 

 

 

 

I was happy to see a common thread, because that means that I can respond to it, now.

 

To be honest, I am somewhat doubting the ability to trade with a 1:1 in scalping. I firmly believe that scalping can be a very profitable way to trade, but in my experience, you need to have a larger risk than reward and win an awesome percentage or use some type of martingaling to give the strategy an edge.

 

Let me explain my thoughts on this, and then all of you scalpers can tell me why I’m wrong 🙂

 

The main objective of scalping is to win small trades consistently. For this article, let us say that a scalper is always targeting ten pips.

 

So, with that in mind, I had many traders tell me that they would scalp with a 1:1 risk to reward ratio. Obviously, in this instance, that would be a 10 pip target and a 10 pip stop loss.

 

In my opinion (and you’ll have to prove me wrong), it is virtually impossible for a trader to use a 10 pip stop loss and a 10 pip target and win the majority of their trades.

 

The main reason? The Spread. Assume the average spread is 3 pips, let’s examine what a 1:1 ratio would look like.

 

You would enter your position with a stop of ten and target of ten. However, you would start out at -3, which means you are 7 pips away from your stop loss and 13 pips away from your target. That means you are almost TWICE as close to being stopped out as you are to hitting your target right off the bat.

 

This quickly drops your immediate chance of hitting your target from a coin flip to less than 30 percent.

 

With your percentage of hitting a target quickly diminished by this much, it puts you at a MASSIVE disadvantage to win a majority of your trades.

 

Another huge issue with attempting to use a 1:1 ratio in scalping is the volatility of the market. On the small time frames, it is simply too easy for trade set-ups to get rejected. In other words, even if you predicted the market correctly, it can still sway a few pips in the other direction on its way to your target. With over 4 trillion dollars exchanging hands each day, a bounce of 10 20 or even 50 pips is very easy for the market to do with no warning or indication.

 

One of the differences between taking a trade on a weekly bar compared to a 5 minute bar is this: If you take your time and make a good entry on a weekly set-up, the market cannot just bounce against you in a few minutes and knock you out of the trade and then continue on its way to where you predicted. If the market moves enough to change the weekly trend, there is serious market action telling you that things are changing. For a 5 minute bar to get rejected; however, it does not take much. A little bit of market fluctuation and you are stopped out of your 1:1 scalp, even if it was a good trade.

 

So, just thinking about some of these basic ideas and the mathematical odds you will have to overcome in a scalping strategy like this, I do have some doubt about the idea of scalping with an even risk to reward ratio. If people are doing it and winning a high majority of their trades, they are going to be rich very quickly.

 

It is weird that I got so many comments from these scalpers who are raiding the market for pips, but hardly anyone has signed up for the Trading Competition that costs a lousy 25 bucks. If you are a scalper and you can do this successfully, I want to see you in the trading competition! It is a $2500 prize, by the way.

 

So, anyway, I wrote this in response to the idea of scalping without risking more than you target, and I am curious as to what everyone has to say, so please leave your thoughts!

 

 

And Follow me on Twitter for my latest thoughts.

 

 

P.S. Most of us probably think of scalping as a techincal system. Trading high-probability set-ups for small gains repeatedly… Well, I just read this article on Fundamental Scalping that was pretty interesting. He mentioned a 1:1 ratio in a scalp because of this system, and it seems like it could work in this scenario. 

 

 

 

 

 

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  • Anonymous

    Hey Dave, thanks for reading and leaving your thoughts.. I don’t know that I would consider it scalping. Probably more under just intra-day trading. but you are right that you need activity, so being on the right side of that activity is what makes you money. I would like to know more about how you implement the ATR into your trading.

  • Anonymous

    Hi Eric, thanks for the comment. And yes, you are very right.. There is different schools of thought that drive different methodologies. My goal was mainly to show what I believe to be an overall safer approach to the market, but you are correct in that my perspective is different than someone who might be a successful scalper. It is great to know that you are getting into Forex and I wish you the very best.

  • Anonymous

    Thanks for reading. That sounds like a REALLY solid strategy. It is wise of you to spread risk with two accounts like that, and I am not surprised that you are profitable with that kind of plan and discipline.. Thanks very much for the comment. Good luck to you as you continue your trading!

  • Anonymous

    Well Nathan…here is how I mix the two…I use a 15M scapling strategy in one account on one pair that is highly accurate an d rather than hard stop losses it employs a Martingale strategy to lessen greatly if not even eliminate any losses. I use a large account size here and extremely small lot sizes in order to be able to easily withstand equity drawdown during Martingaling. I have had this strategy automated and I run it on a VPS.

    Then in another account with just as much money I swing trade 3 different pairs on the 4H and Daily charts. These are the pairs I keep up with fundamentals, key levels, etc. I always shoot for at least a 1:4 (Risk:Reward) on these trades and have gone as high as 1:10 on some.

    I use the scalping strategy to hedge myself against losses on swing trading. Since the scalping wins are relatively small that is alright because I am looking at my combined account size to determine my profitability. While I may take a swing trade loss in one, my scalping strategy makes it up in a couple of days. Kind of like transferring it from one account to the other and my account grows even more on my swing trading winners.

    Enjoyed the posts…Thanks…

  • Eric Barnes

    Nathan – great articles and the video was a hoot!  I’m very new to forex trading community (about 7 months) and have been trying to absorb so much.  I love the fact that you are so into the math, but feel that the human psychology behind those numbers tends to make them fuzzy.  Every trade represents two individuals with 180 degree difference in respect to market direction, right?  I guess it follows that the methodologies they use to derive perspective could also be opposites. 

  • Anonymous

    Hey Michael, thanks for the comment! And good video with some good points. I do certainly understand what you are saying, and obviously you are one who knows what you are talking about, so I take the information you presented with a lot of faith in your thoughts. You made a great point about how a lot of times the time frame isn’t all that important anyway, and many traders can take a lot from that simple point alone. I would say that when you get to larger time frames, reversals and rejections become a little more clear and harder to achieve in the market.. But your point remains very accurate. I appreciate the video and the demonstration, and I took a lot from what you said about the truths of candles. Your comments and thoughts are much appreciated!

    Nathan

  • robin hood

    Hi Nathan.  The debate rages on, lol. I read both the articles and the comments shared by others on here as well.  I made a video response to it and am going to try and put the link here if it does not work anyone who wants to see and hear what I have to say about it can check it out on my youtube channel neo7613.  Here (hopefully) is the link:  http://www.youtube.com/watch?v=lrL0OxK-Qo0   Ok, now, I also just want to say, I can understand what your saying about the entry (3 pips against you right after you hit the button).  Tis true. Your right. On a one minute chart it may not make sense for many. But this is better on a 5 min and greatly increased probabilities on a 15 min chart.  If we all determine what form of CANDLE entry looks good to us (long or short), and put in whatever indicators anyone might use that one would like, couple this with other visual aids like support and resistance, waves, or channels, Fibs or what-have-you….. I believe it is the combination of all these things that give many traders their “cue” to short or long a particular currency. Now if we just focus on the price action and let it be a dictator of our entries and exits…  This is what I am getting at in the video. One merely can shorten that to whatever time frame is desired. All the way down to the tick charts if this is necessary or desired.  Last year when I won that stupid ipod thingy at the traders expo, when we were doing high speed trading (they sped the computers up to give 4 hours trading in like 10 minutes) there was not enough time to look at any thing but the ticks. So the others next to me blew their accounts out in 10 minutes and I ended up with 20% gain in that time based on  buying and selling on a tick chart on steroids, lol. I guess what I am trying to say, is everyone trades on the time frame. and/or frames that they feel comfortable on. So maybe we should get rid of the terms swing trader and scalper and just simply BE traders. Traders. Period. 

  • Anonymous

    Very true! … The contest is all about money, by the way. You made some good points, and I agree with you, but I do believe that Math is the overall declarer of winners and losers in trading.

  • Anonymous

    Oh come on, Roofus, you know that bragging rights is more than anything to a good trader… but you are right about the spread being smaller. That can be a major difference; however, it does not take the disadvantage completely away.

  • Anonymous

    Love the mathematical approach.. the problem is that the math is less than complete.

  • Anonymous

    some traders can get lower spreads than 3 pips though. sometimes even only 1 pip. then the author’s argument becomes mute. as far as the trading competition, why would a successful trader who is making a living trading forex need to pay $25 to enter a trading competition? they can make the money in the real live markets!

  • Anonymous

    Joe, thanks for continuing to read 🙂 … I agree with you and I know many people who use many different systems who are profitable. As you said, there are many different ways to be successful and you need to find a system that works for you and with you, then you need to be consistent in executing that strategy.. all of this I know, and have known. But I will repeat that the point of the article is not to say that you shouldn’t scalp, it is to get people thinking, communicating and interacting about a topic so that we can all benefit as traders.

    Thanks

  • Joe Zolin

    Ahah the debate continues…

    Heya Nathan this will be my last comment on this debate as i feel I am going round in circles… sooo here is my truth…

    There are so many strategies n methodologies out there for trading, but still the majority of traders will fail…
    I know (personally) successful traders who trade whilst incorporating the phases of the moon and planetary movements (AstroTrading) in their trade plans… I have been dismayed when these astro traders, despite showing their methodology and showing how it works get monstered by other traders who dont spend the time or dont have the mindset to comprehend what they are saying.

    they still make money doing what they do.

    I know fundamental traders who will argue til they are blue in the face that charts dont work and come up with statements like “Prove that charts work, you cant”

    I know technical traders who insist that you cant use any form of indicator and be successful, and other traders that insist that pure price action is just random noise.

    When you look at scalping (or any particular TRADING Strategy or
    methodology) as a viable method, and understand and accept that there
    are traders (RobinHood!!) out there who do it successfully, (whether
    they be in the majority or minority), then arguing whether the method is unsound or not is moot.

    While you look at a trading method and cant make it work for you, it wont work for you.

    so dont worry about it, stick with what you know, and if you get the
    time or desire to learn how to scalp profitably, grab the resources that
    are right here (Robin Hood!!) and learn.

    Joe