To achieve a consistently profitable edge over the market, price action trading involves developing a set of rules and systems. The key objective of price action trading is not centered around winning every single trade. Rather, the focus is on achieving profitability by implementing a strategy that generates a net positive return over time. There are various strategies available for price action trading, including candlestick patterns, broader price action patterns, trends, and combinations with indicators. We will explore these strategies in detail in this post.
Price action trading is a method of trading that focuses on the movement of prices on charts instead of relying on lagging indicators. Additionally, it disregards the fundamental factors of a security or forex pair and instead solely examines the price history. The charts reflect the collective beliefs and actions of all traders in the market. For instance, if the price suddenly spikes, the price action charts will demonstrate this, as the focus is purely on the movement of the price. The sudden movement could be due to various factors, but this does not alter the fact that the price has increased rapidly, indicating that the bulls (buyers) are in control over the bears (sellers).
By adopting a price action trading strategy, traders aim to create a clear system that generates profits after taking into account all their wins and losses over a series of trades. This method allows traders to develop a system that aligns with their personal style and preferences. It can be applied to various markets and timeframes, ranging from small to larger timeframes. Price action trading can even be used to scalp the markets.
While we examine the various price action strategies, systems, and patterns in this post, it is essential to bear in mind three key aspects.
Experts have criticized price action for not considering fundamental factors. As a price action trader, your sole focus is analyzing the chart that is presented before you. This includes examining the trend, patterns, and potential trade setups. Unlike fundamentals, which involve predicting what could happen, you are trading based on what you can observe in the current moment.
Once a trend is identified, it is more probable for the price movement to continue in the same direction. As long as the trend persists, it can be a reliable means of increasing the likelihood of successful trades.
It is a known fact that history tends to repeat itself. When engaged in price action trading, chart patterns are used to analyze market movements. Various forms of price action analysis have been in use for over 100 years, and they remain relevant today because they exhibit similar patterns in price movements. Price action charts are essentially a reflection of trader behavior, demonstrated through patterns. The recurrence of these patterns is attributed to the tendency of people and traders to repeat the same habits when confronted with comparable circumstances.
Price action trading is centered around the notion that past price history can serve as a predictor for the future of a market or the potential for a pattern to recur. Similarly, indicators operate under this principle. However, with price action trading, a trader analyzes the live price data as it appears on a chart, whereas indicators tend to lag. In other words, indicators utilize outdated price information to generate the signals presented on the chart. For instance, a 21-period moving average employs the last 21 periods of price action.
Although some traders may be opposed to using indicators, the most effective systems typically arise from the combination of both price action and indicators. This is because indicators can be useful in filtering out undesirable price action, identifying trends, detecting robust momentum, and even assisting with setting profit targets.
The Forex market is ideal for utilizing price action trading strategies due to its unique operational structure and several advantages offered by Forex brokers. With the Forex market being open 24 hours a day, five days a week, traders have access to numerous trading opportunities. Moreover, traders can trade anytime they want, regardless of their location in the world.
Most Forex brokers offer leverage, allowing traders to open larger trading positions with a small deposit. While leverage can be detrimental to an account if not used correctly, implementing smart money management controls can enhance the account’s performance. Furthermore, traders are attracted to the Forex market due to the large range of Forex pairs and market volatility.
Price action traders consider historical price movement to forecast future price behavior. In the Forex market, traders can analyze price patterns and chart formations to determine entry and exit points. Consequently, the Forex market is considered one of the most suitable markets for price action trading due to its dynamic nature and liquidity.
Increased volatility presents a favorable opportunity for traders. When the price is volatile, it implies that there is significant movement in the market, and this provides numerous opportunities to make profitable trades. In contrast, other markets that make small moves can leave you waiting for something to happen.
Intraday Forex markets are known for some of the fastest and most profitable moves. These markets are typically observed on time frames such as the 5-minute, 15-minute, 30-minute, and 1-hour charts. Trading on these charts comes with both advantages and disadvantages.
On the positive side, you will find many trading opportunities and have multiple chances to make profitable trades. Additionally, you can enter and exit your trades quickly without having to hold onto them overnight. However, trading on smaller time frames may pose more risks, especially for inexperienced traders. If things go wrong, they can go wrong quickly.
If you’re considering trading price action on the smaller intraday time frames, it is crucial to ensure that you use strict money management practices and always use a stop-loss order to protect your account.
Price action can be the foundation of simple yet effective trading strategies. This is because you are solely analyzing raw price action without the need for complex indicators. The benefit of this is that you can develop a system that fits your trading style. Often, the best trading systems are the ones that have clear rules and are easy to follow.
Examples of simple price action trading strategies include trend trading, candlestick trading, pattern trading, and combining price action with indicators.
One of the easiest ways to improve your chances of success in trading is by following the price action trend.
It is crucial to trade according to what we observe on the chart rather than relying on our assumptions about how the market should behave because the market tends to trend upwards or downwards for a longer duration than expected.
There are two uncomplicated methods of identifying trend trades using price action – trendlines and moving averages.
To detect a clear move in either direction, a trader can use a moving average. A combination of moving averages like the 50 and 200 EMA (exponential moving average) can signal a new trend formation or a strong trend in progress.
Another simple approach to spot and execute trades in the direction of the trend is by using trendlines.
Candlestick patterns are highly favored by traders due to their easy recognition and their ability to assist with determining entry and exit levels. This makes them one of the most popular price action strategies.
Professional traders mostly use the candlestick chart as it displays the price action clearly and provides an efficient way to identify candlestick signals.
Some of the most commonly used candlestick patterns include:
Pin bars can be identified on any “naked” bar chart or candlestick chart.
A pin bar typically features a lengthy upper or lower tail, shadow, or wick, as well as a relatively small real body.
If a pin bar is bullish, it indicates that the price is declining but ultimately bounces back to reject lower prices by the end of the session.
On the other hand, if a pin bar is bearish, it suggests that the price is rising but ultimately rejects higher prices.
By the end of the session, the price had retreated from its attempted upward movement and was pushed back down, indicating a rejection of higher prices.
These are reversal price action signals.
After the formation of the initial small candlestick, a second candlestick will follow that completely engulfs the first one.
This indicates a reversal in the flow of price action.
For instance, a bullish engulfing pattern is characterized by a small candle being followed by a second session where the price initially drops, but then reverses and breaks above the first candle completely.
Although a popular candlestick pattern, this formation carries certain risks.
The inside bar candlestick pattern consists of two candles, indicating a state of indecision.
The first candle is followed by a second candle that is completely contained within the range of the first candle. This reflects a lack of direction in which price couldn’t break out either higher or lower, signifying indecisiveness.
Although one and two candlestick patterns are widely used and may provide insight into short-term market potential, other patterns offer a more comprehensive view of overall market behavior.
Such patterns can assist in determining which side of the market to take.
This pattern is one of the most reliable trend reversal patterns.
Below is an example of head and shoulder pattern.
This pattern indicate that the price of Forex pair has reached its low point and the bearish trend has come to an end.
After a prolonged trend, the formation of this pattern is particularly effective in identifying the peak of a market.
The double top is a chart pattern that occurs when the price of a market experiences a drop, a recovery, and then another drop from the same level, creating two peaks at the top.
Traders prefer to use triangle patterns because they appear more frequently than other patterns, and they can be applied to various timeframes, lasting anywhere from a few weeks to several months.
The three primary types of triangle patterns are symmetrical, ascending, and descending triangles.
Symmetrical triangle pattern: This pattern is commonly known as the coil and typically indicates the continuation of a prevailing trend.
Ascending triangle pattern: During an uptrend, this pattern emerges and is generally viewed as a pattern of continuation.
Descending triangle pattern: The pattern is the opposite of the ascending triangle and signifies a bearish trend.