Is Scalping Futures A Sustainable Trading Strategy?

Is Scalping Futures A Sustainable Trading Strategy?

 

The following article on futures trading scalping strategies is the opinion of Optimus Futures.

Scalping is a trading strategy that involves capturing profits from small price movements–as small as one to a few ticks. In order to make a profit, you often have to execute a substantial amount of trades a day. It isn’t uncommon for scalpers to make anywhere from ten to a hundred trades a day as each individual scalp trade typically generates a minuscule profit.

While scalping sounds good in theory, it comes with some caveats:

  • Since you must carry out a large number of trades, the transaction costs from fees and commissions can eat up a lot of your gains.
  • Considering that trading volume and liquidity may differ from minute to minute, you can never predict when price slippage will shave a tick or two from your entry points, reducing your profits or adding to your losses.
  • In fast-moving markets, you have to execute trades at lightning speed–an exceedingly stressful task if you don’t have the luxury to take regular breaks.
  • Last but not least, when you make a series of decisions in a context wherein real money is at stake, you may be prone to making more errors in thinking and execution.
On the bright side, with a solid future trading scalping strategy, you can potentially mitigate many of these risks. Before we delve into some of the strategies you can adopt to become a successful scalper, let’s dig a bit deeper and understand how scalping in the futures market works.

Taking a Look Under the Hood of Futures Scalping

If you are familiar with scalping in spot Forex, then you know that the only way to turn a profit is to buy or sell Forex pairs and hope that the asset’s price will go in your direction and you will end up bagging the difference in pips.

In the futures market, especially with E-Mini futures, you earn and lose points and ticks.

Each point in E-Mini futures is worth $50, and each point is made of four ticks, wherein each tick is worth 1/4 of a point or $12.50. Trading E-Mini futures is similar to trading stocks or spot Forex in one regard: your aim is to buy low and sell high (or sell high and buy low, if you’re going short the market).

But trading, let alone scalping which operates at a much higher speed, is never that easy. If it were, everyone would quit their day jobs to spend more time making an easy killing in the markets. Obviously, that’s not the case. One key to success in scalping is understanding the relationship between the empirical win rate and average reward to risk ratio of the futures scalping strategies you aim to implement.

Once you have found a strategy for futures scalping, you need to diligently back-test it over hundreds of trades in order to better understand the average win rate and average reward to risk ratio that it generates across different historical periods. Only then, can you devise the right money management strategy suitable for your technical trading strategy based on your risk tolerance and trading goals.

Keep in mind that having a certain percentage of win rate in a strategy does not guarantee that you will not lose five to ten trades in a row. Losing streaks are not predictable, and they can last much longer than you anticipate. Hence, having the emotional discipline and capital resources to stick to your futures trading scalping strategy might ultimately define your sustainability and long-term success as a scalper.

Now that you understand the importance of win rate and reward to risk in futures scalping strategies, let’s discuss how you can potentially gain from scalping the E-Mini Futures.

How You Can Scalp Trade E-Mini Futures

Let’s assume you are trading the S&P 500 E-Mini Futures December 2019 Contracts with a simple price action-based ES scalping strategy. As you can see, the chart ticket on TradingView is ESZ2019 and we can see a 3-minute chart.

Scalp Trading EMini Futures

Figure 1: A Simple Price Action Based ES Scalping Strategy

As per figure 1, let’s say you decided to buy ESZ2019 at 2946.75 upon a breakout above the high of the Bullish Pin Bar. Let’s assume you had set a stop-loss order a tick below the low of the pin bar, at 2944.25. You are effectively risking 2.5 points or 10 ticks. As each point is worth $50 in E-Mini Futures, you are risking a total capital of $125. Now, let’s say you are targeting the next major resistance, which is at 2952.00. So, your expected profit from the trade would be 5.25 points and you make a profit of $262.50. For this particular trade, your reward to risk ratio would be 2.1:1.

In this example trade, you aim to gain twice the amount of the capital you risked.

One common rule of thumb is to never risk more than 1% to 2% of your invested capital per trade. So if you were risking, say, 2% of your capital, then you would need an account balance of at least $6,250 to place the above trade–because 2% of that amount is $125.

For the sake of illustration, let’s assume you have $12,500 in your brokerage account. Let’s also assume that the win rate of this simple strategy is 50%, and the average reward to risk ratio is 2:1.

So, over 100 trades, you may win 50 trades and lose 50. (Caveat: this is pure theory, whereas in reality, the statistics are hardly that accurate. Plus, it doesn’t take into account your potential errors which can make your results significantly worse, and sometimes better).

So, theoretically, if you risked $125 or 10 ticks on each trade, with 2:1 reward to risk ratio, you may end up earning twice or $250 and your total profit will be ($250 x 50) $12,500 after executing a hundred trades. On the other hand, you will lose 50 trades and your total loss will be ($125 x 50) $6,250. And, your net profit will be ($12,500- $6,250) $6,250.

Remember that past performance is not indicative of future results. Examples are for illustration only. 

Some professional scalp traders execute up to 10-20 trades a day during the most volatile market hours to achieve their daily goals. Just remember a few things before you dive into the markets with a scalping strategy:

  • Historically, pit scalpers (yes, there used to be trading pits) may have had a significant advantage in that they were able to physically see and hear the big trades that were being placed–everyone knew who the “big” Goldman Sachs or Morgan Stanley traders were, where they stood, and what they were trading as soon as they started yelling their orders and throwing up hand signs. As an electronic trader, this historical advantage is more or less gone. Plus, many scalpers in the pit also faced failure despite this advantage; and
  • Institutional traders who occasionally scalp have the advantage of ample capital resources, high-performance computers, and a network of other traders and researchers who can help them monitor markets. In short, they have almost everything that retail traders don’t have, meaning that they can potentially generate a lot of their returns from retail traders’ losses.
So know what you’re up against before you engage in a trading environment that easily separates “the quick and the dead.”

Most Popular Futures Scalp Trading Indicators

Have you heard the saying that “the only difference between trading a 24-hour (daily) chart and a 1-minute or 3-minute chart is how fast you have to make decisions about a particular trade setup”? It’s pure BS. Here’s why:

You are trading the YM (E-Mini Dow Futures) using a 1-minute chart before the bell. The average true range over the last six hours stood at around 6 points.

A market moving jobs report gets released, and the YM jumps up 60 points in one second. That is a 1,000% move in a single bar!

On a daily chart, the 14-day average true range showed a reading of around 300 in late September (2019). If today’s range was still 300, and if it jumped 1,000% in a single (daily) bar, then that move would be equivalent to a 3,000-point jump.

Think:

  • A 1,000% move on an average range of 6 would be 60 points–this can occasionally happen on a 1-minute chart when volatility or headline risk spikes up.
  • A 1,000% move on an average range of 300 (daily chart) would be 3,000 points in one day–this cannot
Hence, scalping is NOT the same as trading a larger time frame. It is much more volatile, much noisier, and potentially riskier if you don’t have a solid money management strategy in place.

As a scalper, you are responsible for making a large number of trading and risk management decisions. After all, you may be trading pure market noise. Given the dynamic level of noise that occurs in smaller time frames, any change in the markets can disrupt your trading setup. Be prepared for this.

Nevertheless, a few different technical indicators may help. When you are scalping, you are basically ignoring all the market fundamentals, long-term trends, and relying solely on the momentum of the market. Just note that when an institutional trader scalps, that trader typically has all of the fundamental and technical data available to him courtesy of his operational setup. That trader is counting you to ignore everything that he is diligently monitoring. So there is a bit of a gamble here, and it may serve you well to be aware of this.

When it comes to indicators, you should only incorporate leading indicators that focus on only two things: 1) direction of the market and 2) how much volatility you should expect in the next few time periods that you are trading.

To get a sense of direction, you might want to use oscillators like Relative Strength Index (RSI) or Stochastics indicators that may clearly define the direction of the current momentum. It can provide you with valuable information regarding divergence in the market.

However, if there’s no volatility, it doesn’t matter if you know which way the market is going – you won’t be able to make a profit. So, using a standard deviation-based volatility indicator, such as Bollinger Bands might make for a wise choice.

You can either use Oscillator as a standalone option or combine it with moving averages. Or, you can combine both Oscillators and Volatility indicators. The mix is up to you–what you feel gives you the best information, and what provides you with just enough data to respond in time to place a trade.

It goes without saying that having too many parameters to watch on a chart might be counterintuitive. Therefore, think “lean and mean”; in other words, minimize and keep your setup simple.

Futures Scalping Strategy That Works

There is more than one way to skin a cat, and you can develop a few robust futures scalping strategies by combining different technical indicators. Let us help you get the ball rolling by showing you a few simple, but very effective, futures scalping strategies that you can immediately apply. You can also use one of these as an ES scalping strategy.

Example of Oscillator Based Futures Trading Scalping Strategy

As you may know, most oscillators are leading indicators. It means you will get a lot of early trading signals, but the reliability of the signals will be less than ideal.

Futures Scalping Indicators

Figure 2: Stochastics False Signals Can Decrease the Win Rate

In figure 2, we can see two false signals. In the first instance, the Stochastics sell signal came when the E-Mini Futures price closed at 2950.00 and the market turned bullish after dropping only eight ticks or 2 points to 2948.00. In the second instance, the Stochastics produced a buy signal after the price closed at 2948.75, but the market turned after only reaching 2952.25 or 3.5 points. If you only applied an Oscillator based futures trading scalping strategy, your reward to risk would have been too low. Both trades would have been turned out to be losers.

Volatility Based Futures Trading Scalping Strategy

Volatility based technical indicators like Standard Deviation and Bollinger Bands do not provide traders with directions. Hence, if you purely rely on price action and wait for the market to turn volatile, you will also get a lot of false signals.

Standard-Deviation-Failed-to-Predict-Direction

Figure 3: Volatility Indicators Do Not Provide Directions

In figure 3, we can see that in the first instance when the Standard Deviation went above 1.00, the market first went down, giving a bearish outlook. Nonetheless, it soon turned bullish and starred an uptrend. In the second instance, however, the price broke above and started a sustained uptrend.

There is really no reliable way to predict which way the market would go once volatility has gone up with this type of indicator.

Volatility and Oscillator Combination Based Futures Trading Scalping Strategy

As we discussed earlier, to improve your scalp trading strategy’s win rate, it is best to combine both oscillators and volatility-based indicators. In the following trade example, you can see how effective it is when you combine these two completely different types of technical indicators.

 

Oscillators-Volatility-Combination-Futures-Scalping-Strategy

Figure 4: Combining Oscillators and Volatility Indicators for Developing Futures Scalping Strategies

In figure 4, we can see that the Stochastics indicator reading was above 90, indicating an overbought condition. At the same time, the price of ESZ2019 closed above the upper Bollinger Band, indicating a potential retracement in the next few time period.

Here, you should have waited for the Stochastic indicator to cross and enter the market at the closing price of the tiny bearish bar we identified on the chart, at 2956.50. Then, set a stop loss above the high of the previous bar, at 2959.75, risking 3.25 points or ($50 x 3.25) $162.5. At the time of your entry, the lower Bollinger Band was at 2942.75, which would effectively have given you a profit target of 13.75 points or ($50 x 13.75) a profit of $687.5. Consequently, the reward to risk ratio for this particular trade would have been 4.23:1.

As you can see, within the next hour, the price fell to 2942.75, making the trade a winner.

Stop-loss Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.

Takeaway

Most of the financial trading market is controlled by High-Frequency Trading firms and according to some estimates, around one-third of the liquidity in the Futures market is controlled by around 15 of these companies. The rest is dominated by thousands of professional traders. To succeed in this market, you need rock-solid discipline and a futures scalping strategy that not only works but that works for you.

Sure, with the right strategy, you can have a sustainable method. But, if you are not psychologically disciplined to handle how to analyze the market with that given strategy, you will have a challenge in implementing to its fullest potential.

Most importantly, don’t forget the importance of having a top-level trading platform with low-latency order routing.

Without low latency routing speed, your prospects in the “scalping” market are pretty much doomed. Remember, success in futures scalping has a lot to do with speed–not only speed in identifying, analyzing, and executing trades, but also speed between the time of order placement and its arrival on the exchange.

Ultimately, picking a futures scalping strategy that works for your particular personality and availability of time during the day may be the key to your success as a futures scalp trader. Now that you know how you can sustainably scalp trade in the futures market, it’s time to develop your own futures trading scalping strategy.

Please be advised that trading futures and options involves substantial risk of loss and is not suitable for all investors.  Past performance is not necessarily indicative of future results.  This matter is intended as a solicitation to trade.

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