The price action trading strategy is one of the most commonly used methods in almost every financial market today. Whether you are trading in the short-term or the long-term, analyzing price action can often be considered one of the most powerful ways to gain an edge in the market. Simply put, price action allows a trader to make subjective trading decisions by just reading the market rather than relying solely on technical indicators. Let’s dive into the wild world of forex trading with Price Action!
What is Price Action Trading?
Price action trading is a strategy employed in financial markets, particularly in forex trading, that centers on examining the price movements on a chart without utilizing any technical indicators or other tools. Traders who utilize this strategy depend on their ability to interpret and analyze patterns and behavior in price movements, including trend lines, support and resistance levels, and chart patterns to make informed trading decisions.
Price action trading strategy is rooted in the notion that price encompasses all pertinent information in the market, and by studying price movements, traders can gain insights into the underlying supply and demand dynamics that steer market movements. Price Action Trading can be utilized across various time frames, ranging from short-term scalping to long-term position trading, and is a preferred strategy for both new and seasoned traders.
Understanding Price Action
Price Action is the study of a security’s price movement during a specified period. Traders who use price action strategies analyze historical price data to identify patterns, trends, and other relevant information that can help them predict potential market movements.
The primary objective of price action analysis is to comprehend the supply and demand dynamics that shape market behavior and make informed trading decisions based on this knowledge.
Typically, price action analysis involves examining price charts, trend lines, support and resistance levels, and chart patterns to identify favorable entry and exit points for trades. Traders appreciate the price action approach because it provides a straightforward and effective method of understanding market trends without relying on complicated technical indicators or other tools.
The image above displays the parts of a candlestick that represents valuable trade information. The top wicks present how high the price has reached while the bottom wicks show how low the price has fallen. In the middle of the wicks and in between the open and close is the body of the candlestick. According to a timeframe, if the candle’s open and close is above, it is bullish; if it is below, it is bearish.
Initially, in the Price Action strategy, a trading day is the time span a particular exchange market is open for trade actions. Situation-wise, a day may close bullishly but upon closer inspection of lower timeframes, a bearish candle pattern may still be apparent. In concept, the candle body closed positively with the timeframe showing bearish candles that took the course over the day.
A timeframe pertains to the period a trader decides to trade based on their strategic preferences and comfortabilities. AximTrade utilizes MT4 platform with the following timeframes:
Market noise is a term used in the Price Action strategy and it consists of all price data that distorts the visualization of an underlying trend because it includes small corrections and intraday volatility. Noise removal is valuable to traders in terms of avoiding false signals and making logical analysis and decisions. Below is an example of an H4 chart with less noise
Visually, it is much more convenient and efficient to identify tops and bottoms using higher timeframes to identify the possible market directions. Based on depicting each high as a “swing high” and each low as a “swing low” traders may create continued direction probabilities. As shown in the chart above, the swing high still retains as the candle is yet to close above the previous high. This may be interpreted as the price having further possibilities to fall.
How Price Action Trading Works?
Price Action Forex Trading is a strategy that involves analyzing the movement of prices on a chart to identify potential trading opportunities. The basic premise is that price reflects all the relevant information about a market, and by studying price movements, traders can gain insights into the underlying supply and demand dynamics that drive market movements.
Here’s how to perform price action trading with forex:
- Identify a currency pair: Choose a currency pair that you want to trade based on your strategy and analysis.
- Study the price movement: Analyze the price movement of the currency pair using candlestick charts. Look for patterns and formations, such as support and resistance levels, trendlines, and chart patterns.
- Identify key levels: Identify key levels on the chart, such as support and resistance levels, and trendlines, that are likely to influence the price movement of the currency pair.
- Determine entry and exit points: Based on your analysis, determine entry and exit points for the trade. Look for price action signals, such as pin bars, inside bars, and engulfing patterns, that can confirm your analysis and provide a signal to enter or exit a trade.
- Manage risk: Use appropriate risk management techniques, such as setting stop-loss and take-profit orders, to manage your risk and protect your trading capital.
- Monitor the trade: Monitor the trade to determine if it’s following your analysis and adjust your strategy as necessary.
Traders using Price Action Forex Trading also use stop-loss orders to manage risk. Stop-loss orders are placed at a predetermined price level, below the entry price for a long trade or above the entry price for a short trade. This helps limit losses if the trade does not move in the expected direction.
Example of Price Action Trading in Forex Market Let's say you want to perform price action trading with the EUR/USD currency pair. Here's an example of how you might approach it: 1. Look at the daily chart of EUR/USD and identify the trend. Let's assume the trend is bullish. 2. Identify key levels on the chart, such as support and resistance levels, and trendlines, that are likely to influence the price movement of the currency pair. Let's say you identify a resistance level at 1.2350. 3. Wait for a price action signal that confirms your analysis and provides a signal to enter a trade. Let's say you notice a bearish pin bar formation at the 1.2350 resistance level. 4. Enter a short position at the market price once the pin bar formation is confirmed. Set a stop-loss order above the pin bar and a take-profit order at a predetermined level, such as the next support level.
In this example, the trader used price action trading to identify a potential short opportunity in the EUR/USD currency pair. By waiting for a bearish pin bar formation at a key resistance level, the trader was able to enter the trade with a well-defined risk and reward ratio.
Price Action as a Trading Indicator
For a price action trader, the most important trade elements are price and time, and as such, price charts are the most essential trading tool. Candlestick charts are the most commonly used charts due to their graphical appeal and the detailed information they provide on asset prices. Typically, a candlestick displays the high, low, opening, and closing prices (HLOC) of an asset over a specified period. A candle with a higher closing price than its opening price is green and bullish, while a candle with a lower closing price than its opening price is red and bearish.
Price action traders rely on this detailed price information to understand the collective action of market participants. The positioning of HLOC price points determines the size and shape of the candle and the information it provides. Different candle types provide bullish signals, such as the hammer; bearish signals, such as the hanging man; and neutral signals, such as the Doji. As time goes on, multiple candlesticks are printed on a chart, which forms candlestick patterns that allow traders to track the ebb and flow of market waves.
Price action traders interpret candlesticks and chart patterns to identify lucrative price action opportunities in the market. Therefore, they prefer to trade with clean charts. Numerous chart patterns give traders three primary signals: continuation, reversal, or neutral.
- In trending markets, continuation patterns like directional wedges and flags form and indicate that the dominant trend will persist.
- On the other hand, reversal patterns such as head and shoulders or double bottoms signal that the momentum of the prevailing trend is losing steam, and a reversal is imminent.
- Neutral patterns, such as symmetrical triangles, can form in any market and suggest that a significant price movement is on the horizon, but they do not provide any directional cue
Analyzing and interpreting the information presented by candlesticks and chart patterns is crucial compared to memorizing their specific formations. By observing candlesticks, one can determine the price direction in the market. In addition to candlesticks and their patterns, trendlines can also aid price action traders in selecting the best entry and exit points in the market.
Popular Trading Strategies with Price Action Signals
Listed below are the top seven trading strategies forex traders can use with price action signals to make informed decisions.
1. Price action trend trading
If price action trading is the study of price movements, price action trend trading is the study of trends. Traders can make use of a number of trading techniques to spot and follow price action trends such as the head and shoulders trade reversal.
This is a great trading tool for new traders, as it allows them to effectively learn from their more experienced peers by chasing price action trends as they become visible. In the screengrab below, you’d open a ‘buy’ position to benefit from the green uptrends, or a ‘sell’ position to benefit from the red downtrends.
2. Pin bar Candlestick Pattern
Often called a candlestick pattern because of its distinctive shape, pin bar patterns are shaped like candles with long wicks. A wick represents a sharp reversal of a price, and the tail shows the range of prices that were rejected.
Traders assume that market prices will continue to move in opposite directions to the tail, and they will use that information to determine whether to buy or sell. An example would be a pin bar pattern with a long lower tail, which indicates a trend of lower prices being rejected, implying that the price could rise soon.
3. Inside bar Candlestick Pattern
A two-bar inside bar pattern consists of an inner bar that is smaller than the outer bar and falls within the range of the outer bar (or mother bar). In addition to forming during moments of consolidation, inside bars can also be a red herring, indicating a market turning point.
This trend can be seen at a glance by skilled traders, who can use their macro knowledge to determine whether the inside bar represents a consolidation or a shift in trend. Inside bars are a great indicator of whether a price will go up or down based on its size and position.
4. Trend following retracement entry
Essentially, this is a price action strategy in which the trader simply follows an existing trend.
Short positions might be taken if a price is on a clear downturn with low highs consistently being formed. It may be worthwhile for the trader to buy in when prices are steadily rising, and highs and lows are tending higher.
5. Trend following breakout entry
This trend tracks any major market movements, assuming a retracement will follow a price spike. When a market breaks out of a support or resistance line, it is called a breakout. If the asset is trending upwards or breaks above the resistance line, traders can take a long position, or if it moves below the support line, they can take a short position.
6. Head and shoulders reversal trade
Head and shoulders patterns are market movements that resemble a head and shoulders silhouette. The price rises, falls, rises again, falls, and rises to a lower high before a modest drop.
Taking advantage of the temporary peak (the head) is one of the most popular price action trading strategies with the head and shoulders reversal trade. You can choose your entry point (generally right after the first shoulder) and your stop loss (generally after the second shoulder).
7. The sequence of highs and lows
Highs and lows are the bedrock of price action trading. To map out emerging trends in their market, price action traders can follow the sequence of highs and lows strategy.
An upward trend is indicated, for example, by higher highs and lower lows. The trend is downward if the highs and lows are lower. When traders know the sequence of highs and lows, they can choose an entry point at the lower end of an upward trend, and set a stop just before the previous higher low.
Advantages of Price Action Trading Strategy:
There are several advantages to using a Price Action Trading Strategy:
- A simple approach: Price Action Trading is a straightforward approach that relies on examining price movements on a chart without the need for complicated technical indicators or other tools. This simplicity makes it easy for traders of all levels of experience to use.
- Adaptability: Price Action Trading can be used across various time frames, from short-term scalping to long-term position trading, making it a versatile strategy.
- More accurate signals: Price Action Trading is based on studying price movements and patterns, which many traders believe provide more reliable signals for potential market movements than traditional technical indicators.
- More clear analysis: Price Action Trading provides a clear analysis of market behavior, which can help traders understand supply and demand dynamics and make better-informed trading decisions.
- Risk management: Price Action Trading can help traders manage risk by identifying potential entry and exit points for trades based on support and resistance levels, trend lines, and other chart patterns.
- Time efficiency: Price Action Trading allows traders to focus on the most important information, namely price movements, which can save time and reduce the likelihood of getting bogged down in extraneous details.
Overall, the advantages of Price Action Trading make it a popular strategy among traders looking for a simple, reliable, and effective approach to analyzing financial markets.
Limitations of Price Action Trading Strategy:
While there are several advantages to using a Price Action Trading Strategy, there are also some limitations to consider:
- Market subjectivity: Price Action Trading relies on traders’ interpretation of price movements and patterns on a chart, which can lead to subjective analysis and differing opinions about potential market movements.
- Limited scope: Price Action Trading is focused solely on price movements and patterns, which may not capture all the relevant information about a particular security or market.
- Inadequate precision: Price Action Trading may not provide precise entry and exit points for trades, which can result in missed opportunities or suboptimal trading decisions.
- Limited historical data: Price Action Trading may not provide a comprehensive view of a security’s price movements and patterns, as it only considers historical price data for a given period.
- Time-consuming: Price Action Trading requires traders to spend time studying price charts and analyzing patterns, which may not be feasible for those with limited time or resources.
To achieve a comprehensive view of potential market movements, it is important to utilize a well-rounded approach to analyzing financial markets, incorporating a range of strategies and tools.
Trading with price action: Stop losses and Profit targets
Placing a stop-loss order on each trade is a way to manage risk. When buying and taking a long position, the stop loss is placed below the recent swing low. When shorting an asset, the stop loss can be placed above the recent swing high. This ensures that the risk of the price drops too low or rising too high is controlled. For Renko charts, one could exit the trade when the bricks reverse direction and change color.
Price action traders should secure profits, and there are various ways to accomplish this. One of the simplest methods is to use a risk-reward ratio. For instance, if you risk $0.05 per share on a scalp trade, you can exit at a $0.10 profit, resulting in a 2:1 risk-reward ratio. A ratio of 1.5:1 or 2:1 is typical for scalping, whereas a ratio of 3:1 or higher is common for swing trading. However, traders can determine their desired risk-reward ratio themselves.
Other methods of exiting a trade include relying on price action itself. If you enter a trade because a downtrend has begun, stay in the trade until the trend reverses. Price action indicates when to exit by providing evidence that the price is turning. When entering a trade near a supply area, consider exiting at demand, and when entering near a demand area, consider exiting near supply.
What makes price action so popular among forex traders?
Trading is based on price movements, such as those of shares, currencies, and commodities, as it is the shift in price that ultimately determines profits or losses. To determine when to enter and exit a position, traders must develop a price action strategy based solely on price charts.
There are several reasons why price action traders are particularly drawn to the forex market.
- As it is highly liquid, traders may have an easier time opening and closing their positions.
- Although the forex market moves constantly, it rarely experiences large highs and lows. Thus, it’s an ideal tool for new traders who want to start small before scaling up as they gain more expertise.
- It is easier to identify recurring patterns and trends in the market because of its maturity.
It is possible to be highly profitable if you are able to understand the mechanics of price action and develop a highly effective price action trading strategy.
Is price action forex trading profitable?
Your trading profitability depends on how a trading strategy or tool is employed. There have been many successful investors and traders who have proven that price action trading can be profitable. However, if traders rely exclusively on price charts and don’t take into account fundamental elements, such as economic indicators and news announcements, they could miss key events that have a significant impact on the price of their security.
Traders make profits and lose money based on their price movements. The purpose of price action trading is to profit from the price moving in a particular direction based on historical and current patterns. Despite price action trading has resulted in many successful traders, learning winning strategies and spotting promising patterns, trends, and reversals take time.
These are the Key Market Movers in Forex that you need to be aware of if you want to become a successful trader.
How Short-term traders benefit from Price Action Strategy?
Price action trading strategy works best for short- and medium-term limited profit trades, and not much for long-term holdings.
The majority of traders are of the opinion that the market follows a random pattern and that there is no clear method of defining a strategy that is always effective. However, by combining technical analysis tools and historical price data, price action trading has some serious support when it comes to identifying trade opportunities based on the trader’s interpretation.
The benefits include the freedom to define individual strategies, the possibility of using them with any trading platform, application, or trading portal, and the possibility of back testing any identified strategy on previous data. Furthermore, traders are able to make their own decisions, since the strategy allows them to choose their actions versus blindly following a predetermined plan.
Guide to Forex Trading Strategies
When you choose the best forex trading style it is important to know that every strategy has its benefits and drawbacks. There is no forex strategy that will work all the time and there is no certain level for profitability to generate. As you explore the different approaches, you will need to learn technical and fundamental analysis as well as mastering the MT4 platform. Copying a strategy without understanding the market movements and the ability to conduct trend analysis is risky.
Fundamentally, you will need to define your investment portfolio and find out your risk/reward ratios (R/R). Each forex investment should come with a solid plan and a good demonstration of trading basics. Avoid copying a forex strategy that doesn’t match your trading goals or strategies that you don’t fully understand and able to know what is the drawbacks of it. There is no perfect strategy in trading that can guarantee profit and in most cases, forex strategies can differ based on the market movements and news.
You will have to select the trading strategy based on what type of trader you are and your trading style. It should also depend on the currency pair or trading tool you wish to trade.
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Forex Price Action Trading Strategy – FAQ
Does price action trading work in forex?
Yes, Price Action Trading can be very effective in forex trading. Price Action Trading offers traders a simple way to understand market behavior by studying price movements, which helps traders gain insights into the supply and demand dynamics driving market movements, leading to informed trading decisions.
How do you read price action in forex?
Reading price action in forex involves analyzing the movement of price on a chart, identifying patterns, trends, support and resistance levels, and chart formations to gain insights into the underlying supply and demand dynamics that drive market movements, and make informed trading decisions based on that information.
Is price action the best way to trade forex?
There is no one-size-fits-all answer to this question as different trading strategies work better for different traders. However, price action trading can be an effective approach to forex trading for traders who have a solid understanding of market behavior and technical analysis concepts.
Is price action good for day trading?
Price action trading is a popular technique amongst day traders. Rather than relying solely on technical indicators, price action allows traders to read the market and make subjective trade decisions based on recent and actual price movements. For this reason, many day traders use price action trading strategies to generate profits quickly.
Is price action strategy profitable?
Price Action Trading can be profitable, but success depends on a trader’s ability to accurately analyze price movements and identify profitable opportunities. It offers a simple way to understand market behavior and gain insights into the supply and demand dynamics driving market movements, leading to informed trading decisions.
Do professional traders use price action?
Yes, professional traders use Price Action Trading. In fact, many professional traders prefer Price Action Trading over other trading strategies because it provides a simple and effective way to understand market behavior without relying on complex technical indicators or other tools.
Which indicator is best for price action?
Some price action traders prefer to use simple moving averages or exponential moving averages as indicators to identify trends and potential entry or exit points, while others may use Bollinger Bands, Relative Strength Index (RSI), or stochastic oscillators to help identify overbought or oversold conditions.
How can I master price action?
To master price action, you need to spend a significant amount of time observing and analyzing price movement on a chart, while keeping in mind the underlying fundamentals of the market. This involves understanding the behavior of price patterns, identifying support and resistance levels, and using technical indicators to confirm signals.
Why do price action traders fail?
Price action traders may fail for various reasons, including lack of proper risk management, over-trading, emotional trading, inadequate trading plan, insufficient trading knowledge and experience, and failure to adapt to changing market conditions. Additionally, some traders may struggle with discipline and consistency, leading to inconsistent trading results.
Which timeframe is best for price action trading?
The best timeframe for price action trading depends on a trader’s individual strategy, goals, and risk tolerance. Some traders may prefer short-term timeframes like the 5-minute or 15-minute charts, while others may prefer longer-term timeframes like the daily or weekly charts.