Introduction to price action trading
Price action refers to the pattern of price changes over time. For instance, a chart of a currency pair will show a number of consistent patterns that a skilled trader can use to their advantage. Trading only off of price charts, as opposed to using lagging technical indicators like the Relative Strength Index (RSI), Moving Average Convergence/Contraction (MACD), or Bollinger Bands, is known as “price action trading.” A price action trader relies solely on price charts for all of their analysis and makes trading decisions based on the patterns of price action they observe.
Technical analysis’s four tenets—that markets favor trends, that trends tend to endure, that fundamental data is neglected, and that certain chart formations can predict future price action—form the basis of price action trading.
Trading on price action involves focusing on where buying and selling pressure are likely to be strongest for a given security or currency pair. A price action trader’s primary technical tools are trend lines, horizontal support and resistance lines, channels, Fibonacci retracements and extensions, and a firm grasp of the various phases and significant chart patterns that characterize a given trend. Additionally, candlestick patterns can be employed as entry confirmation signals, and moving averages can be used to locate shifting support and resistance levels. A price action trader just needs to be familiar with moving averages as a technical indicator.
Clean VS messy chart
A price action trader simply requires a blank chart (with the exception of moving averages) to do their work. By removing distracting indications, a trader can better analyze price movement. Technical indicators not only take up valuable real estate on your screen but also distract you from the chart. A price action trader’s chart is shown on top, while a chart cluttered with technical indicators is shown on the bottom.
How to determine the market trend
One of the fundamental tenets of technical analysis is that market trends exist and are relatively stable over time. In fact, a price action trader’s whole arsenal of technical indicators is geared toward one goal: spotting developing trends and the points in time and territory when those trends are most likely to reverse. The foundation of profitable price action trading is the ability to recognize a trending market.
Markets can be classified as either upwardly or downwardly trending, or even as sideways going. Successfully trading in a wide variety of market conditions calls for a wide variety of trading tools.
Markets that are trending up create higher highs and lower lows, and markets that are trending down create lower lows and higher highs. Below is an illustration of what upward and downward trends look like.
When an uptrend fails to produce a new high and a downtrend fails to produce a new low, it is a sign that the underlying trend is losing momentum and that a reversal to the opposite direction is possible. There are two primary ways trends can change direction, called failure swings and non-failure swings, respectively. The following image illustrates this point.
You may identify a failure swing by the fact that the higher low at (B) does not drop below the earlier higher low (X). The fact that (C) creates a lower high rather than breaking above (A) is suggestive of a possible trend reversal. Point (S) represents a sell indication.
D forms a lower low and declines below B in a successful swing. Breaking the lower low (D) represents a more conservative sell entry than the more aggressive sell entry illustrated at point (S1) above. The difference between a successful and unsuccessful swing is dramatic.
It’s also worthwhile remembering that there are three broad types of trends: major, intermediate, and small. Primary trends can be observed on wide timescales, such as weekly or monthly charts, and span anywhere from six months to many years. Short- to medium-term intermediate trends typically represent reversals, or corrections, of the prevailing primary trend. Market noise causes short-lived but observable trends that can be leveraged to trade a wide range of breakouts and chart patterns.
How to trade Forex with price action trading strategy
To enter high-probability trades, price action traders analyze the price action using trend-following strategies, support and resistance lines, chart patterns, and candlestick patterns.
Support and resistance analysis and trend-following
To succeed as a trader, you must identify emerging trends and ride them until they fizzle out. The following graph displays an upward trend in the EUR/JPY exchange rate that began in April 2017. At point 1, after the price has broken through the prior resistance, price action traders may consider taking a long position in the market. The pair actually made a significant non-failure swing, with subsequent weeks seeing higher highs (HH) and lower lows (HL).
It’s worth noting that price action traders try to use a variety of analysis methods to boost their chances of making profitable bets. The preceding figure illustrates this as well, with the beginning of a rectangular pattern at point 2.
Patterns and convergent areas in charts
The above chart features a rectangle layout, which we have already discussed. Rectangles are continuation chart patterns, meaning that once the price breaks above the rectangle, the underlying trend is likely to continue. First of all, though, what exactly are chart patterns?
A chart pattern, in its most basic definition, is a recognizable price formation that may be utilized to make a prediction about the direction of prices in the future. Price action traders frequently make use of these patterns because of the predictive power they have shown in the past.
There are two main types of chart patterns: those that indicate a continuation of an existing trend, and those that indicate a reversal. Reversal patterns, as contrast to continuation patterns, indicate that the underlying trend is poised to change direction.
Major reversal patterns include head and shoulders, inverse head and shoulders, double tops and bottoms, falling wedges (during downtrends) and rising wedges (during uptrends), and rectangles and flags (during uptrends).
The scope of this text does not permit us to cover all possible chart patterns. Because of its widespread use, we will concentrate on the wedge and head and shoulders layout.
A rising wedge during an upswing indicates a reversal, as seen in the preceding chart. In falling and rising wedges, unlike triangles, each line slopes in the same direction. At (1), a buy-in signal is sent.
Keep in mind that traders who focus on price action frequently employ a wide range of research methods. If you put in the time and effort, you can identify a head and shoulders pattern right where the rising wedge is. Another reversal pattern is the head and shoulders formation, which consists of a left shoulder, head (swing high), and right shoulder. The pattern’s “neckline” occurs when the head’s lows are connected, and its break indicates a selling opportunity. The green arrows in the following chart represent the target price of an H&S pattern, which is the vertical distance from the pattern’s neckline to its head.
As an added bonus, the target price of the head and shoulders pattern in the aforementioned chart coincided with the intersection of a support area (yellow) and a long-term trend line (red). The overlap and intersection of two or more significant levels defines a confluence zone. The market analysis tools might be anything from support and resistance lines to trend lines to chart patterns to channels to Fibonacci retracements and beyond. When comparing confluence zones to non-confluent zones, it is clear that a confluence zone has considerably greater relevance and works as a stronger support or resistance zone for the price.
Conclusion
When compared to other trading systems, price action trading has a relatively high success rate. For good reason, too; price action trading is founded on the actual supply and demand for particular currency pairings, as shown by discernible trends, support and resistance levels, and robust chart patterns. Technical analysis tools are used largely to evaluate the development of a trend and probable turning points. The formation of a candlestick is commonly used as a confirmation signal by price action traders before they enter a transaction.
A simple, uncluttered chart is all that’s required for profitable price action trading, as opposed to the jumble of technical indicators that might slow you down. Profits should increase noticeably after using the strategies discussed in this article.
