What is Price Action Trading?
Price action trading involves using price action setups or price action patterns that have been tested over time to predict future forex market moves.
The movement of a currency pair (e.g. USD/JPY) has proven to be repetitive. Traders observe these repetitive movements of the market. Knowledge of these market movements helps to predict future market moves.
An example of a powerful price action trading strategy is the candlestick patterns. Forex traders make use of a type of chart called candlestick charts. They show the open and close point of a period say 1hr, the highest point, and the lowest point of price during that 1hr interval.
Over time, forex traders observed certain patterns or formations in the candlesticks. They used these patterns to form efficient price action trading strategies.
For example, the bullish engulfing candlestick pattern shows that for the time range, the bulls were in control. Therefore, the bullish engulfing candlestick pattern signals an incoming uptrend.
A real chart example of the bullish engulfing candlestick
Most price action traders rely solely on price movements and do not include indicators on their charts. They make use of price action tools such as trendlines, support and resistance lines, candlestick patterns, and price action patterns.
What Does Price Action Mean?
Price action is the movement of the price of a currency pair or security which is plotted on a graph over a certain time. This movement is the change in the value of a pair over time.
Price action is a very important aspect of Forex trading and helps traders identify various setups or patterns.
Does price action really Work
A common question and argument among forex traders is whether price action trading strategies work or not.
Price action trading works as it involves the use of various setups that reoccur on the charts. The market has been around for years and rarely makes new moves which it hasn’t done before.
Let’s say Ben notices that the price usually reverses at an area where it has previously reversed (support or resistance). Trader Ben buys at a support zone when the price reaches it.
Say the support and resistance trading have a 60% accuracy.
Ben who trades support and resistance will have 6 wins out of 10 trades and as such will end up in profit. This example is to help answer the question of if price action really works.
As such a trader should see price action trading as a documentation of previous actions made by the market. Therefore, traders combine price action patterns to yield more profit.
How to become a successful price action trader
Time Needed : 00 days 00 hours 01 minutes
As you may have correctly guessed learning price action patterns and all the price action secrets isn’t enough to become a successful price action trader. To become a successful price action trader, you need to have the discipline required of a price action trader. They include
Patience
Every price action trading setup or strategy comes with its entry and exit rules. While watching the charts, one can become impatient and get into trades even when the entry rule has not been met. Patience is required of every price action trader to become successful. Forex trading is one of the cases where “The patient dog eats the fattest bone”.Spend less time on the charts to avoid temptation. Understand that following the rules of your trading strategy not rushed entries is the only way to become successful in trading price action.Avoid FOMO entries
FOMO means Fear of Missing Out. This secret is closely related to patience. A huge trend in any direction is enough to compel any trader to hop on to avoid missing out. The feeling is stronger when your strategy indicates an incoming trend, traders can be compelled to enter trades to avoid missing out.This is a recipe for failure as the Forex market is not a stranger to large wicks and fake-outs. Traders are encouraged to enter a trade only after their Trading setup rules have been fully met.Learn to deal with the Fear of getting in (FOGI).
Sometimes a trader may experience fear of getting into a trade even after it has met all entry rules. This is mostly due to a lack of confidence in one’s trading setup. We advise traders to back-test rigorously to establish confidence in their Forex trading setup. Perfect Execution
To become a successful Forex price action trader, a trader must enter trades perfectly. This doesn’t mean all trades must be a profit. It means that all entries must follow the trader’s Forex trading entry rules.Emotions should not cause traders to place trades. You have a defined input which is your strategy guides and rules. There is an output (open or closed trade) only when the input conditions are met.Always use a stop-loss
Most traders especially newbies tend to believe that they can get the perfect forex trading strategy or setup. The truth is there is no perfect Forex strategy. Keep this in mind while trading. Refusal to use stop loss mostly means that the trader doesn’t believe he will lose the trade. Or doesn’t have a clearly defined exit strategy in the case of a loss.
Tools
- Laptop or Mobile Phone
Materials
- forex-technics
2 Price Action Trading Strategies
There are various price action trading strategies. We advise traders to pick one of the best trading strategies that suit their trading style and master it through rigorous back-testing.
Some trading strategies for beginners include
- Trend following
- Confluence Trading
Trend-following Strategy
It is an instinct among traders to oppose the trend. Most traders wait to see the end of a trend so they can enter a reversal or new trend. Only a few traders understand the fact that the market continues on its current trend the majority of the time.
With trend trend-following strategy, traders enter positions in the direction of the current trend. It involves entering when a correction is about to end. The end of corrections can be predicted with various tools such as support levels, Fibonacci retracement, trend channels, etc. Traders enter as the correction ends and ride the next impulse wave.
In the example above, the initial downtrend begins with the first lower low. From there, we have multiple options to enter a sell position. Simple support zones serve as sell signals.
Confluence Trading
Confluence trading in forex involves combining multiple forex trading strategies to increase the probability of securing a winning trade. It is more common with indicators but is also possible with price action.
With confluence trading, you combine candlesticks, price action patterns, Fibonacci, and other tools to increase your chances of winning.
At every point in the market, there are multiple reasons to enter a trade. Therefore, you should find the combination that gives you an edge in the market.
At every point in the market, there is at least one signal to buy or sell. when you see a bullish flag on a resistance, do you buy or do you sell?
The above image shows a real chart example of confluence trading. The support, bullish engulfing candlestick, Fibonacci retracement level, and the bullish flag pattern all give a buy signal. These tools can be used separately but were combined to increase winning chances.
Advantages of price action trading
Price action trading comes with numerous benefits. It is the language of the market. Price action shows the hidden secrets of the charts to the traders. It is a mighty arsenal for both the beginner and advanced trader. In this section we will list and explain the benefits of price action trading and why it is important.
The benefits include
- Price Action Trading is tested and proven to be profitable
- It generates entry and exit signals earlier than indicators
- All advanced technical analyses are rooted in price action
- Price Action is simple and easy to understand
These benefits are explained below
1. It is tested and proven to be profitable.
As has been explained earlier, price action trading involves the use of repetitive patterns that have been noticed over some time.
That is, most price action trading strategies have been tested. Every trading pattern or set-up has occurred previously and so comes with guides or rules on how to enter and exit.
This simplifies most of the work for beginners and makes it relatively easier to trade.
2. It generates entry and exit signals earlier than indicators.
It is much more reliable when compared to indicators. Most indicators lag and are merely a secondary effect or a reaction to price movements.
As such trading with indicators may lead to late entries and exits. With price action trading, a trader can choose to enter as early as he or she wants and exit the same. This is because the trader reacts directly to price movements and is not an indicator of price movements.
We call traders who enter early with little confirmation aggressive traders. The time of entry with price action depends on your price action setup. A price action setup should be tested to confirm if it allows for aggressive entry.
Taking early entries using setups that require a later entry or confirmation isn’t aggressive trading but a sign of impatience and FOMO (fear of missing out) which are terrible trading habits.
3. All advanced forms of technical analysis have their foundation in price action.
The basic price action setups with the right trading psychology and risk-reward ratio are enough to make any trader successful. This is because most of the complex analyses and setups you see on your expert’s charts have their base in price action.
Some popular advanced Forex trading strategies include
- Indicator Trading strategies. Indicators are tools used to provide better visual aids to the trader to assist in making trading decisions. For example, traders use the moving average to detect trend change. They also use the RSI to know when the market is overbought or oversold. A price action trader does not need all these as the candlesticks already show most of these services offered by indicators.
- Elliott Wave Analysis. Elliott wave analysis is an advanced form of price action analysis. It is a powerful tool for trading that gets its roots from the impulse-retracement-impulse movement of the market.
- ICT. ICT trading is a popular trading strategy among Forex traders where retail traders aim to trade with the mindset of the banks and big institutions. It makes use of new and complex terms which when carefully observed have lots of similarities with basic price action trading.
- Harmonic patterns. Harmonic patterns are a popular trading strategy that makes use of more complex and advanced price action patterns. These patterns are verified when they reach certain Fibonacci retracement and extension levels.
Advantages of price action over indicators
Some reasons why price action is advantageous over indicators include
- Price action trading signals are real-time and do not lag when compared to indicators.
- Using lots of indicators will mess up the charts and can cause the trader to miss out on important price action information.
- Indicator traders tend to look for the perfect combination of indicators to yield them maximum profits. This itself is also a weakness among all traders regardless of whatever trading strategy they use.
- With clean and clear charts, price action is relatively simpler and easier to understand than complex indicator combinations.
- Indicator trading may be complex and require the user to input certain values to achieve desired results for example the moving average comes in different types which have different functionality and may require different input values.
Indicators offer excellent visual aids to traders and provide entry and exit signals. But too much of indicators can ruin your charts. Let us use an example.
The Moving average is a popular Forex indicator. It can generate buy and sell signals and provide information about trend strength and direction.
It provides more functionality when combined with the RSI. An indicator trader can now also detect overbought and oversold regions together with the previous moving average functionality.
The trader can decide to add more indicators to increase his chances of landing a winning trade. Say he adds the Bollinger bands, the stochastic oscillator, and more! What happens then?
The trader’s charts become messy and they no longer show the main information required.
Frequently Asked Questions About Price Action Trading
Why is it called price action
It involves movement and changes in the value of price, hence the name Price Action. That is all the “actions” of the price displayed on the charts.
Which indicator is best for price action
The moving average is one of the best indicators for price action. This is because the moving average can serve as dynamic support and resistance. Also, most price action setups use the moving average as a confirmation for entry.
Which is better between Price Action Trading and Indicators
Price action is relatively better than indicators as indicators are mostly just a reaction to price action. This means indicators can only clearly show the trader what has already happened. For example, a trend has already started before the fast EMA crosses over.
Conclusion
In conclusion, traders can make use of price action to analyze the forex market. They should also ensure to use of stop loss to mitigate losses incurred during trading.
References
- The Candlestick Trading Bible by Munehisa Homma
- An Introduction to Price Action Trading Strategies – Investopedia
- What is Price Action – Priceaction.com
- Leading vs Lagging Indicators – BabyPips