Price action trading is one of the most useful things forex traders can learn. Some traders believe it’s the only thing you need to know.
In short, price action trading is trading market movements on market movements alone. Sound confusing?
Don’t worry, we’ll explain it all.
By learning price action trading, forex traders can put together better entry and exit strategies and predict with better accuracy in what direction the market is likely to move.
In this article, we’re going to explain what price action trading is and how forex traders can use it to their advantage.
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What is price action? Understanding cycles
Quite simply, price action is defined as market movements; every time the market makes a significant movement in any direction.
There are many definitions of what exactly price action trading is. But essentially, it is trading on these movements alone with no indicators.
Some traders would even recommend learning what price action is first before learning how to use indicators.
To understand price action trading, first traders need to understand that the market moves in cycles.
Typically, the market will go through four stages:
- Ranging low (accumulation). This is where the market is at a low point and is ranging.
- Uptrend (break out). This stage is characterised by higher highs and higher lows.
- Ranging high (distribution stage). This is where the market is a high point and is ranging.
- Downtrend (declining stage). This stage is characterised by lower highs and lower lows.
And then repeat the cycle.
This can take place over months or even years. To see such cycles, it usually depends on how zoomed in you are to your charts.
It should also be remembered that these cycles do not always work. It is still possible that during a distribution stage, the market can break out higher.
An important thing to remember about the market is that it every market situation is both unique and happened before.
Market cycles are important to understand for price action trading because by knowing what direction the market is heading, you can make better-informed trades.
Depending on the timeframes you look at, the market will be going through different cycles. Traders must have a frame of reference before jumping into the market.
How to trade price action
Many traders will trade price action alone and will not use any indicators. For some, this is a little too strict and it is a good idea to have some indicators to confirm movements.
But this doesn’t mean that you are trading without a plan. You still need to have a framework in place to follow. Never trade without a plan.
You should have set goals for how many pips you are looking to gain, know your risk-reward ratio and have a lot size in mind.
Price action trading at first requires traders to spot an ideal opportunity to get involved in the market.
With price action, you can find the right opportunities to get on board of trends. Only after you have seen where to buy and sell, start a plan and go through with it.
They first must spot at what stage the market is in which will then inform them what direction to trade in. Is it trending downwards or upwards or is it simply ranging?
A good way to do this is to mark support and resistance levels so you can find areas to buy and sell.
You should then access the speed of the market. Is it moving fast, slowly? How volatile is the market?
A volatile market can mean plenty of opportunities to get in involved in the market, a slow-moving market can mean the opposite. That said, too much volatility can be risky.
This is not just about how much the market is continuing a trend, but also when a trend is reversed.
This shows you how aggressive the buyers and sellers are.
Price action traders may also consider volume as well, though generally speaking, volume is not usually considered price action.
Picking the right market to trade
A good trader should be able to trade in any market.
Many traders struggle with this at first. They make a lot of money in bull markets, and then get a shock during a bear market or a ranging market when they start losing money.
That said, your trading strategy should be different in different markets.
When the market is in an uptrend, you don't want to sell, you want to look for buying opportunities.
You want to get on that ever-climbing train and get off when it can’t climb any further, and when it starts to reverse, sell and get out.
And in a downtrend, you don't want to be buying unless you are an investor. Here, you should be looking to sell the rips, when the market momentarily rises.
Look for confluence
Confluence is where two points of analysis meet.
Traders can find confluence by using a trendline and support and resistance levels. Where the two meet can be a good sign of where to buy or sell.
Bear in mind, sometimes old support levels become new resistance levels and vice versa.
Plus, as prices get closer to your trendline, the more likely the trend you are following will break. Be extra careful of this.
Channel patterns can also be used during uptrends or downtrends to look for consistent higher highs or lower lows to see where it is a good idea to buy or sell.
Remember, over time these points become dated and so you need to remove or update them. More recent movements are always more relevant.
Using volume can also show you the speed in which contracts are being traded. If there are many, it can symbolise a big movement price is about to take place.
However, it can sometimes be difficult to tell if the price will rise or fall. Typically, volume usually precedes price movements.
To trade price action, traders largely rely on candlestick patterns to show them how the market is moving.
Many traders look for price action by looking at candlestick patterns. Some, but not all, candlestick patterns can be used to signify price action
Bullish and bearish engulfing patterns are a particularly strong sign of price action. They show that a downtrend or uptrend is about to reverse.
But price action candlesticks can come in many forms.
The three line strike is another candlestick that is highly useful when determining price reversal. It contains three bearish candles and then a strong bullish candle.
What makes this candlestick pattern so useful and accurate is that it contains a strong candle of confirmation.
There are plenty more to use to your advantage. By learning what they mean, you can stay one step ahead of the game.
To use candlestick patterns for a price action trading strategy, they should be simple and easy to follow.
More complicated candlestick patterns can be harder to read and more likely to lead to error.
Another important thing to remember is that different people read candlestick patterns in different ways. You may see one pattern while someone else will see another.
Trading Education has a whole article on candlestick patterns that traders will find useful. You can find it here.
Dangers of relying solely on price action
Different traders interpret price action in different ways.
One trader may see a downtrend is emerging, another may believe that the market is about to turn bullish.
Therefore, it is a good idea to use multiple indicators - at max two - to confirm possible market movements.
If you use any more indicators you run the risk of getting confused. Trading should be simple, keep it that way.
You should also take into consideration fundamental analysis as well. Price movements never just happen by themselves.
Many of the biggest movements are related to events that have happened throughout the day. This is one of the important reasons why you need a forex economic calendar.
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If you remember anything from this article, make it these key points.
- Price action trading is trading market movements alone. Typically, price action traders will not use indicators.
- Traders should have framework in place before trading. Ideally, they should spot an opportunity and figure out when and where to enter and exit.
- Candlestick patterns are highly useful signs to predict market movements. Learn to recognise key candlestick patterns to make the most of price action trading.
- Traders shouldn’t rely solely on price action. Traders should also use some technical analysis and fundamental analysis.
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