In the world of Forex the term Scalping is most commonly used to refer to a legitimate trading method that focuses on making profit from short term market momentum. How scalpers derive their trading signals varies greatly, but what unites all true scalping strategies is that positions are only opened for a few minutes at a time. You may have noticed that some brokerages place limits on or outright stop clients from using scalping strategies. The majority of brokerages that ban or place limits on scalping are unregulated and slightly dubious entities based in offshore secrecy jurisdictions. There are a number of MiFID regulated brokerages that either prevent traders from scalping or place severe limitations on those who wish to engage in scalping. There are a number of reasons why brokerages might ban or limit scalping activities.
Why Do Brokerages Ban Scalping?
You will never find a true STP/ECN brokerage preventing their clients from using scalping strategies. These brokerages which operate using No Dealing Desk execution simply place their clients trades in the open market with their liquidity providers/electronic communication network, and make their profit by marking up spreads or by charging traders commission. Any brokerage which claims to be operate using a No Dealing Desk model but limits scalping activity is misleading their clients. STP/ECN brokerages are able to profit off any sort of volume and should welcome scalpers with open arms.
Brokerages that ban scalping will more than likely operate using some kind of Market Maker model. While STP/ECN brokerages place all of their customer’s trades with a liquidity provider or with another trader or institution, market Makers do not necessarily place customer’s trades in the underlying market. Instead these brokerages will either take on the risk themselves acting as a counterparty or alternatively hedge using a particular risk management model. Not all Market Makers ban scalping in fact there are a number of Market Makers that provide their clients with a high level of service.
Bucket shops are like market makers in the sense that they don’t necessarily place client trades in the underlying market. But unlike legitimate market makers, bucket shops will rarely if ever engage in any form hedging or risk management. In order to be profitable the customers of a bucket shop must lose more money overall. Banning or placing limits on the use of scalping strategies is just one way in which these brokerages can ensure they remain profitable. Rather than outright banning all scalping activity these brokerages place rules which make very difficult to profit from the use of scalping strategies. Forcing traders to keep positions open for a set period of time is one classic move which prevents a trader from closing a position if the market moves against them. Brokerages which place such limits should be avoided.
Brokerages that have a delayed or lagging price feed will often prevent traders from using scalping strategies. A delay of even a second could open the brokerage up to significant arbitrage opportunities. Traders could monitor a more up to date price feed and when an instrument moves significantly in one direction place a trade with a brokerage before their price feed had caught up, locking in guaranteed profits. Brokerages in such a position have no choice but to ban scalping as they could be taken to the cleaners. This is not to say that these brokerages should be excused in the day and age of fibre optic broadband there is no excuse for a brokerage to have a significantly delayed price feed.
Brokerages which ban or limit the scalping activity of their clients should be viewed with suspicion. There is no reason why a brokerage should ban or attempt to limit traders scalping activity, there are number of highly reputable market makers which allow traders to scalp. While you may not intend to scalp it is better to avoid brokerages that limit scalping as this could lead to you getting trapped in positions if the market moves significantly against you. Checking whether a brokerage allows traders to scalp should be on every traders check list when picking a brokerage to trade with.