Price action is a popular trading concept used by both short-term and long-term traders to analyze the price of a security.
It is a simple and, yet, a very powerful way to spot tradable opportunities in the market, and experienced traders often prefer the simplicity in price action trading to analyzing charts that are cluttered with all forms of technical indicators.
If you know how to use price action the right way, you will not only enhance your ability to analyze price charts but also improve your trading results.
But with so many misunderstandings and half-truths about price action circulating on the internet, it’s easy to get confused.
This is especially true for beginner traders who may find reading the price action somewhat challenging.
So, we decide to share, in this post, 20 price action tips that can improve your chart analysis skills and overall trading outcome.
But, first, we will take a look at what price action trading really means.
What is price action trading?
Price action trading is not just about trading the candlestick patterns, instead, it encompasses everything — reading historical and current price movements, understanding the market structure, identifying key areas of value, and trading along the path of least resistance using candlestick patterns as trade triggers.
In essence, price action trading involves using historical and current price movements to understand the structure of the market — trending or ranging — and then, identify the important price levels and look for trade setups (candlestick patterns) in the path of least resistance, which could mean going with the trend or playing a ranging market accordingly.
So, there are three things you can get from the information on your price chart:
1. The market structure
Is the market trending or ranging? If the market is trending, which direction — up or down? An up-trending market is said to be in the advancing stage, while a down-trending market is said to be in the declining stage.
A ranging market could either be a consolidation before the continuation of a trend or accumulation/distribution stage preceding a trend reversal.
These different stages of the market structure can develop into a variety of identifiable chart patterns which are a very important aspect of price action trading.
Some of the most important chart patterns you should know include:
-Downward reversal chart patterns: head and shoulder, double top, triple top, and rising wedge.
-Upward reversal chart patterns: inverse head and shoulder, double bottom, triple bottom, and falling wedge
-Continuation chart patterns: rectangles, triangles, flags, and pennants
The downward reversal chart patterns form at the end of an uptrend (during the distribution stage of price movements), while the upward reversal chart patterns form at the end of a downtrend (during the accumulation stage of price movement).
A continuation chart pattern represents a price consolidation in a trend.
2. Key price levels
These are areas of value in the market, where you can look for trading opportunities.
A skilled trader knows that he can’t just trade at random and expect consistent results.
High probability setups are formed at important price levels, which represents area s of demand and supply in the market. Some of the levels to consider include :
-Previous swing highs and lows (horizontal support and resistance levels)
-Important round numbers
-Pivot lines
3. Candlestick trade setups at key price levels
After knowing where to enter a trade, you need to know when to enter a trade. This is where the candlestick patterns come in, and they can be reversal patterns like the pin bars, engulfing bars, and inside bars, or the continuation patterns like the rising three methods, falling three methods, Mat Hold pattern, and deliberation pattern.
While you can trade alone with the naked chart, you can complement price action with a few indicators like the long-period moving average (as stated above) or oscillator divergence.
What matters is to understand your trading tools and know how to effectively utilize them.
Having said that, let’s look at some 20 price action tips that can improve your trading.
20 tips that can improve your price action trading
Reading the price chart and identifying trading opportunities is something you learn from experience.
Nevertheless, there are many tips that can hasten your learning process.
Here are some of them:
1. Understand what candlestick patterns represent
The candlestick chart is the best chart for trading price action because candlesticks are more visually appealing and present more information about price movements during a trading session.
Additionally, individual or a group of candlesticks can form shapes and patterns that can tell who (buyers or sellers) is dominating in the market.
So, the first step to trading price action is to learn how to read candlesticks, identify the patterns, and understand what they represent.
As you know, a candlestick has a body with upper and lower wicks and shows the open, low, high, and close prices.
The position of the close price relative to the range of the candlesticks shows who dominated the trading session.
If the prices closed near the high of the range, the bulls controlled the session, while a close near the low of the range implies that the bears won the session.
You can extend this rule to multiple-candlestick patterns to easily understand those patterns without having to memorize them.
Here, the price closed near the high, so it has a bullish significance
Here, the price closed near the low, so it has a bearish significance
2. Choose the patterns to trade
There are over 40 candlestick patterns, and you can’t possibly trade all of them. Although you can learn to read the overall market movements without memorizing the individual candlestick patterns, it pays to have a few candlestick patterns that when occurring at the right level, defines a trade setup.
This holds true for every price action trader, but it’s especially important for beginner traders who don’t know how to read price movements.
Candlestick patterns can be grouped into reversal patterns and continuation patterns.
Reversal patterns indicate that a particular price swing is losing momentum and the price may be about to reverse.
Examples are pin bars, inside bars, engulfing bars, piercing and dark cloud, morning or evening star, tweezers, and many others.
They can have bullish or bearish reversal implications.
The continuation patterns include the separating lines, rising three methods, falling three methods, Mat Hold pattern, on-neck line, in-neck line, deliberation pattern, and many more.
They can be bullish continuation patterns in an uptrend and bearish continuation in a downtrend.
You may decide to trade only reversal patterns and select a few — say, pin bars, engulfing bars and inside bars — as your trade trigger.
Some may prefer to trade the continuation patterns and selects a few patterns they can easily identify.
3. Look for reversal pattern at key price levels
Since the reversal patterns show when the price is likely to end one swing and start a new one in the opposite direction, the best place to look for such patterns is the key market levels, which are usually seen as areas of value.
These levels are likely to have a huge amount of limit orders that can force the price in the opposite direction.
For example, a downswing is likely to reverse around a previous swing low or swing high because the price had already reversed at that level before since traders are already watching that level.
In addition to previous swing highs or lows, other important price levels are big round numbers (e.g. 1.20000), Fibonacci retracement levels, and pivot lines.
4. You may try continuation patterns at breakouts
Breakout trades often fail, so it pays to look for other supporting factors that favor your trade — continuation patterns might be of help here.
As you already know, continuation patterns indicate that the price will likely continue in the trend direction.
If, for example, a rising three pattern forms part of a breakout above a resistance level, the breakout is more likely to work.
Similarly, if a falling three pattern is a part of a breakout below a support level, the price is more likely to continue dropping.
5. A confluence of candlestick patterns may indicate
a stronger signal
It is not uncommon to see different candlestick patterns, especially the reversal patterns, clustered around the same place.
You mostly see this around a key price level, such as a support or resistance level.
When you see a cluster of reversal patterns at a level, there is a higher chance that the piece may actually reverse at that level.
That does not mean that a single reversal pattern at a suitable price level is not enough for entering a trade.
But the more the number of reversal signals, the stronger the price reversal will be and the higher the odds of a favorable outcome.
6. Understand market structures
To be able to correctly analyze your chart and trade price action well, you need to understand how the price has been moving in the past and know which stage the price is at the moment.
The price can be in the accumulation stage, advancing stage, distribution stage, or declining stage.
It could also be that the price is in consolidation within an advancing or a declining market.
Whatever is the case, understanding the stage of the market will help you know the best strategy that suits the market at that point.
For example, springs and upthrust are suitable in ranging markets that occur in the accumulation/distribution stage, while pullback reversals or breakouts are good for a trending market.
And even if you use only one strategy, you will know when to be in the market and when to be out of the market.
If your strategy is only for a trending market, it’s best to stay out of the market if it’s moving sideways.
7. There is money in chart patterns
Some price traders trade only chart patterns, and you too can make money trading chart patterns — identifiable price structures named after the objects they look like.
For instance, the head and shoulder pattern looks that way — a head with left and right shoulders.
Other chart patterns include triangles, wedges, double tops or bottoms, rectangles, flags, and pennants.
Some of them are reversal patterns, while others are continuation patterns.
You may not be able to trade all the chart patterns at once, so it may be better to start with only a few of the most common ones, like the head and shoulder, triangles, and wedges.
8. Combine candlestick patterns with chart patterns
It is possible to combine chart patterns and candlestick patterns, which can even increase the odds of your trade.
Depending on how you trade the head and shoulder pattern, for example, you may use a reversal candlestick pattern to enter a trade when the chart pattern is forming.
A bearish pin bar that forms at the right shoulder might be a good trigger to enter a trade even though the price hasn’t yet broken the neckline, which is the classical method of trading the pattern.
But it’s not all about reversal candlestick patterns — continuation patterns can also work with certain chart patterns.
A rising or falling three methods, for example, can be part of a flag or pennant chart pattern.
9. Be careful with ranging markets
You can make easy money from a ranging market — you know where to place your trades and where to get out.
But the party is only as good as it lasts. When a breakout occurs, the price can move very fast.
So, when trading a ranging market, you should be cautious about breakouts. This is especially true if the range is prolonged or narrowing.
To avoid taking a heavy loss when a breakout occurs, make sure you have a hard stop loss so that you can quickly get out of the market.
But even with a hard stop, slippages are likely. You may also trade the breakout.
10. False breakouts can create good opportunities
While breakout trades can give quick profits, false breakouts are common, and they may create potentially profitable trading opportunities in the opposite direction.
In a ranging market, a false breakout at the upper boundary can create the upthrust setup and lead to a profitable trade to the downside.
Similarly, a false downward breakout at the lower boundary of a ranging market can create the spring pattern and lead to a profitable trade to the upside.
11. Trade with the trend
If the market is trending, the best thing you can do is to only trade in the direction of the trend.
Whether your style is trend-following or you are a swing trader, it’s better to trade in the direction of a trending market.
And the reason is simple — price swings in the direction of the trend (impulse swings) are stronger and bigger, offering greater profit potentials.
In addition to the greater profit potentials, trading in the trend direction increases the chances of the trade going in your favor because the price is more likely to remain in a trend — as Dow’s Theory states, “A market in a trend remains in a trend until the trend is seen to have reversed.”
12. Countertrend trading works some times but it’s
more risky
Contrarian and mean-reversion traders do get profitable countertrend trades from time to time.
They often make their trades around strong resistance or support levels, with the hope that the level would hold and the price would reverse.
But the truth remains that going against the trend can be very risky.
The odds that the trade will move in your favor is far lower than that for a trade in the direction of the trend.
Also, when the trade fails, there is a greater chance for a higher loss, even with a hard stop loss, because of slippage.
13. Buy at demand levels and sell at supply levels
There is an old saying in the market — Buy low and sell high. It is still effective in the market today.
But how do you define low and high? To keep it simple, we say buy at demand levels and sell at supply levels.
Demand levels are areas of value in the market where there are lots of buy limit orders lying in wait, while supply levels are areas where there are plenty of sell limit orders.
These limit orders can push the price in the expected direction.
You can see these areas if you have access to level 2 market data, but it’s more useful for stocks where there are exchanges that keep the price book and order book with all price levels of quotes submitted to the exchange.
Since the forex market is decentralized, you can only get the data for the orders that pass through your broker or your broker’s liquidity provider.
In the absence of level 2 price data, support and resistance levels can do. So, look for buy setups (bullish reversal candlestick patterns) at support levels and look for sell setups (bearish reversal candlestick patterns) at resistance levels.
In an uptrend, it’s best to only look for buy setups. For a down-trending market, it’s best to look for only sell setups.
14. Observe what the price does around a trend line
It’s very helpful to make use of trend lines. Just like the horizontal support and resistance levels, they tend to correspond with levels where there are plenty of demand and supply.
As a matter of fact, a trend line is a rising support level in an uptrend and a declining resistance level in a downtrend.
Thus, look for bullish setups around the trend line in an uptrend. In a downtrend, look for bearish setups around the trend line.
15. A moving average can be a game-changer
Of course, you can also add an indicator to your price action strategy, and one of the most common indicators used by price action traders is the moving average.
Not only does this indicator help you identify the direction of the trend, but it can also serve as a dynamic support or resistance level, depending on the direction of the trend.
In other words, the price can reverse around a moving average — especially the long-period moving average.
In an uptrend, the indicator can serve as a support level, where you can look for bullish reversal candlestick setups.
On the other hand, in a downtrend, the indicator can serve as a resistance level, where a price rally can reverse — a bearish reversal candlestick pattern here can be a good trade signal.
16. Don’t overlook the Fibonacci retracement levels
and pivot lines
Other tools frequently used by price action traders are the Fibonacci retracement tool and the pivot lines.
The Fibonacci retracement levels show the percentage of the preceding impulse the price can retrace to before reversing.
The most important levels are 38.2%, 50%, and 61.8% levels.
Pivot lines are derived from the average of the high, low, and closing prices for the previous day, week, or month.
The pivot line and its derivatives — R1, R2, R3, S1, S2, and S3 — are important levels, where the price often reverses.
17. A confluence of supporting factors works better
When two or more of those indicators and tools that show important price levels coincide at one point, that level seems to hold better.
Trade setups that occur at such points have a greater chance of producing a successful outcome and are usually called high probability setups.
Examples include a 50% Fibonacci retracement level coinciding with a trend line, support/resistance level, or long-period moving average, the junction of a trend line and a support/resistance level, and the junction of a moving average and a support/resistance line.
18. Keep things simple
While you may want to have many factors align in the direction you intend to trade, it is much better to keep things simple.
Don’t overanalyze your chart to avoid analysis paralysis — where it becomes difficult to pull the trigger after seeing a trade setup.
That is why we advise that you minimize the number of tools and indicators you use to the absolutely necessary ones — the fewer indicators the better.
If you are using a long-period moving average, there’s no need for a trend line and vice versa.
19. Have a trade management strategy beforehand
You must have a trade management plan whenever you are trading — whether you are trading price action or not.
There are different ways to manage a trade once you are in it.
You can use a hands-off approach where your trade closes either by hitting your profit target or your stop loss.
Another approach may be to have multiple profit targets and take partial profits at different levels. You can also ride a trend with a trailing stop.
It’s also possible to take partial profits at multiple levels and trail the last portion until you are stopped out.
Choose a trade management option that suits your risk appetite and trading emotions.
20. Don’t use tight stop losses
The price doesn’t move in a straightforward fashion — it often gyrates to and fro. It is a good practice to give your trade enough room so that the usual price gyrations don’t knock off your trade before the price starts moving.
While using a tight stop loss may seem like you are risking fewer pips, getting frequently knocked off will still accumulate to huge losses, and you may end up missing several trades that could have moved in your favor.
Another reason to put your stop loss at a safe distance is to prevent stop hunting.
Institutional traders often try to capture retail traders stop loss orders as they search for opposite orders to fill theirs.
Final words
These tips are by no means exhaustive, but they can give you a head start in your journey to mastering price action trading.
If you understand them and apply them in your price action trading, you will shorten your learning curve.