what-is-price-action

Today, price action trading is a commonly used method in financial markets.

Price analysis is one of the simplest yet powerful ways of gaining an edge in the market for both short-term and long-term traders.

Each trading indicator is derived from price, hence, it makes sense for you to study it, understand it, learn from it, and then use it in your trading.

During each trading day, you need to make sound trading decisions so as to become a successful trader.

This calls for you to review the historical prices of the forex pair in question.

This is possible through price action analysis.

In this article, I will help you know how to trade using price action.

Let’s start…

What is Price Action Trading?

Price action is simply the study of the price movement of a security.

So, the trader studies the historical price of the asset to get an idea about where the price will move next.

Most price action traders study the price bars to get details such as the open and closing price of a market as well as its low and high price levels during a particular period of time.

Analysis of such informations makes the core work of price action traders.

That’s why we can define the term “price action” as the study of the actions of all buyers and sellers who are actively involved in any particular market.

So, when a trader analyzes what other market participants are doing, he will be able to make sound trading decisions.

Price action traders rely on stripped down or “naked” price charts to make all their trading decisions.

This means that there is no use of lagging indicators other than a few moving averages to help them identify support and resistance areas and trends.

Each financial market generates data about the movement of the price of a market over different periods of time, and this data is displayed on price charts.

The price charts reflect the actions and believes of all market participants trading over a particular period of time.

These believes are portrayed on the price chart of the market in the form of “price action”.

Global news events and economic data trigger price movements in the market, but we don’t have to analyze them to be able to trade the market successfully.

The reason is that all world news and economic data that trigger price movement in the market are finally reflected via price action on the price chart of a market.

Since the market price action is a reflection of all the variables that affect the market for any particular period of time, the use of lagging price indicators such as MACD, Stochastics, RSI, and others is just a waste of time.

Price movement is all what you need to come up with a profitable and high-probability trading system.

Such strategies are collectively known as price action trading strategies and they provide traders with a way to make sense of price movements in the market.

Traders also use them to predict future movements of the market with a high degree of accuracy and come up with winning trading strategies.

By use of historical charts and real-time price information like offers, bids, volume, magnitude, and velocity, a price action trader can identify the most favorable entry point for a trade.

A favorable trade entry point is one that allows for risk control, offering potential profit at the same time.

What is a Price Action Indicator?

As you know, price action involves studying the actions of all buyers and sellers who are actively involved in a particular market.

The most popular price indicator is the candlestick, which gives traders useful information such as the opening and closing price of the market and the high and the low levels within a defined time period.

Consider the graphic given below…

price-action-trading

If you view a daily chart of a forex pair, the candles given above would represent a full day’s worth of trading.

Both candles given above provide very useful information to traders.

The high and the low price levels give traders the highest price and the lowest price made in a trading day.

The red candle is the seller candle.

It is sometimes drawn in black.

This candle tells traders that the sellers won the battle of the trading day.

The reason is that the level of the closing price is lower than the level of the opening price.

The buyer candle has been shown in green, although it is sometimes shown in white.

This candle tells traders that the buyers won the battle of the trading day.

The reason is that the level of the closing price is higher than the level of the opening price.

You can use the above simple candle setup as one of the first steps to coming up with a price action strategy.

For example…

If the next candle after the seller candle makes a new low, this sends the signal that the sellers are willing to keep on selling the market.

This is a weakness that will make most traders enter short positions or keep holding onto short positions that they already have.

If the next candle after the buyer candle makes a new high, this acts as an indication that buyers are ready to continue buying the market.

This is a strength that will make most traders initiate long positions or keep holding the long positions they already have.

Such type of price action analysis is just one of the ways to use candlesticks as a price action indicator.

The good thing is that the candles create patterns that traders can use to form a price action strategy.

Pure price action charts vs. Indicator-laden Charts

I want to show you the difference between a pure price action chart and another chart with technical indicators on it.

Consider the following chart…

price-action-versus-indicators

The above chart has no indicators on it other than the raw price action of the market.

Consider the next chart given below…

charts-with-technical-indicators

The above charts has three technical indicators on it namely the Bollinger Bands, MACD, and Stochastic indicators.

The above three are very popular technical indicators among traders.

The Bollinger Bands indicator has been added on top of the price action, while the other two indicators have been added on separate windows on the lower part of the chart.

There is a lot of clutter on the second chart.

On the indicator-laden chart, you must give some room on the bottom part of the chart for the addition of indicators,

This way, you will be forced to make the price action part smaller.

The price action part has also been obscured by the Bollinger Bands indicator.

This will draw your attention away from the price action to the indicators.

So, you have less screen space to view the price action and your focus is not completely on the price action as it should be.

But from the two charts, which one is easier to analyze and trade from?

Of course, it’s the first one.

All the indicators on the second chart, and indeed all technical indicators, are derived from the underlying price action.

So, when you add indicators on your chart, you are simply adding more variables but you don’t gain any insight or predictive clues that are not already provided by the raw price action in the market.

Price Action Trading Strategies

There are three different elements of a trading strategy, the why, the how, and the what.

The “why” gives you the reason as to why you should consider trading a particular market.

This is where you need to use price action patterns.

Through price action analysis, you will know what is most likely to happen next, whether the market will go up or down.

The “how” refers to the mechanics of your trade.

It is actually the manner in which you trade.

This type of analysis involves determining your price levels for entry as well as where to set your stop loss order and the profit target.

Always remember that trading is a game probabilities, hence, you have to remain protected because the market can move against you.

The “what” determines the outcome of the trade.

What do you want to achieve from your trade?

Is it a short-term or a long-term trade?

Normally, this will come down to how you manage your trade until you make profits or how you manage yourself in case you get an outcome that you did not desire.

Here are the various price action trading strategies…

#1: The Hammer

This price action pattern is a bullish signal that sends the signal that there is a high probability of the market moving higher rather than lower and is only used in up-trending markets.

The following graphic shows how a hammer candle looks like…

the-hammer-candlestick-pattern

A hammer candle is a signal that the sellers are pushing the market to a new low.

However, the seller aren’t strong enough to stay at the low, hence, they decide to bail on their positions.

This makes the market to rally back up, causing buyers to also step into the market.

The open and the close price levels should both be located in the upper half of the candle.

However, the close can still be below the open, but a stronger signal is generated when the close is above the opening price level.

Consider the chart given below…

how-to-trade-the-hammer

In the chart given above, there are two examples of the hammer pattern.

The two hammer candles have been pointed to by black arrows.

When you analyze the open, the close, the high, and the low price levels, the pattern sends a signal that an upward move is most likely to occur.

From the chart, it’s clear that the price moved higher after the formation of the two candles.

This means that any trader who had entered into a long position will benefit from the uptrend.

However, you should note that this should not be always the case.

The question is…

How should you have traded the pattern?

Let me show you…

The right time to enter the market was when the next candle finally managed to break the high of the second hammer candle.

This is what I am referring to…

hammer-as-price-action-pattern

The entry point has been shown on the chart by a black arrow marked as “Entry Point”.

The entry point is followed by a short consolidation period, but the price action resumed its bullish trend after the end of the consolidation period.

After entering the trade, you must ensure that you are protected.

The reason is that the market may move against you, with a possibility of wiping out your trading account.

To avoid this, you need to place a stop loss order in the market.

This will be triggered when the price action reverses and you will automatically exit the trade.

So, where should you place the stop loss?

The ideal place to set your stop loss is just at the low of the hammer candle.

See the chart given below…

price-action-entry-and-exit

The position of the stop loss has been shown using a red horizontal line marked as Stop Loss.

This is the position just below the hammer candle.

If the price reverses and begins to move in a bearish direction, this stop loss will be triggered.

This will help you exit the trade automatically to prevent you from incurring a loss.

So, the stop loss should be placed close to the entry.

You also need to set the profit target.

There are different ways to do this, such as exiting the trade on the close of the candle if the trade is in profit, targeting support and resistance levels, or using a trailing stop loss.

With a trailing stop loss, you can earn more profit as it will shift the position of the stop loss every time the price action moves in a direction that favors you.

The shifting will help you lock in profits that you have earned so far, and in case the price action reverses, your profits won’t be wiped out.

#2: Shooting Star

The shooting star price action pattern is a bearish signal that acts as an indication that there is a higher probability of the market moving lower than higher and it’s solely used in down trending markets.

Essentially, it is the opposite of the hammer pattern.

The following graphic shows how the shooting pattern looks like…

shooting-star-pattern

A shooting star signals that buyers are pushing the market to a new high.

However, these buyers are not strong enough to remain at the high and they choose to bail on their positions.

Due to this, the market falls lower, causing sellers to also enter into the market.

Both the open and the close price levels should be in the lower half of the candle.

It is possible for the close to be above the open but a strong signal is generated when the close is below opening price level.

Consider the following chart…

shooting-star

The above chart shows two examples of the shooting star pattern, all pointed to by black arrows.

After analyzing the open, the close, the high, and the low price levels, the patterns sends the signal that a move lower is most likely to occur.

This has been confirmed by the subsequent price action as the market continued to move lower.

However, this will not always be the case.

So, how should you trade this pattern?

A possible entry point is when the market manages to break the low of the shooting star candle.

So, you should enter the market at the point where the market breaks the low of the second shooting star candle.

This is shown below…

the-shooting-pattern-strategy

The above chart shows the point at which you should enter the market when trading the shooting star price action.

The entry point has been pointed to by a black arrow marked as “Entry Point”.

At this point, the market manages to break the low of the second shooting star candle.

After entering into the trade, you should ensure that you are protected.

This will protect your trading account in case the market reverses and begins to move against you.

You should set your stop loss above the high of the shooting star candle.

Consider the following chart…

shooting-star-entry-exit-strategies

The above chart shows the ideal place to set your stop loss when trading the shooting star pattern.

The stop loss should be placed at the red horizontal line marked as “stop Loss”.

If the market reverses and begins to move in a bullish direction, the stop loss will be triggered and you will exit the trade automatically.

This way, you will not incur a loss.

However, you need to set the stop loss at least one pip from the high of the shooting star candle.

This will ensure that the stop loss is not triggered in case of minor price consolidations in the market.

Such an occurrence can make you exit a trade when it’s too early, making you miss out on potential profits.

You also need to set the profit target.

There are different ways to approach this, including exiting the trade on the close of a candle if the trade is in profit, using trailing stop losses, or using support and resistance levels.

Choose the one that favors you and put it into action.

#3: The Harami

The harami price action pattern is made up of two candles that represent indecision in the market and is solely used for breakout trading.

It is also referred to as an “inside candle formation” since one of its candles is formed inside the range of the other candle, from high to low.

The graphic given below shows how a bearish and bullish harami pattern looks like…

harami-price-action-pattern

The bearish harami is formed when the high to low range of the seller’s candle develops within the high and low range of the previous buyer candle.

Since there has been no continuation to form a new high, the bearish harami is an indication that there is an indecision in the market which can cause a breakout to occur to the downside.

The bullish harami is formed when the high to low range of the buyer’s candle develops within the high and low range of the previous seller candle.

Since there has been no continuation to form a new low, the bullish harami is an indication that there is indecision in the market which can cause the occurrence of a breakout to the upside.

Consider the chart given below…

the-harami-pattern

The above chart shows the formation of the bearish and bullish harami patterns.

These two have been shown by small, black, horizontal lines that have been marked as Bearish Harami and Bullish Harami.

So, how can a trader trade these two patterns as a price action trading strategy?

Let’s begin with the bullish harami pattern…

First, you have to identify the bullish harami pattern, which is a buyer’s high and low range that is formed within the high and the low range of the previous seller candle.

You can then enter the market one pip above the high of the previous candle.

You can then protect your trade using a stop loss.

The ideal place to set your stop loss is one pip below the low of the previous candle.

This will help protect your profits from being wiped out in case the market makes a reversal.

Placing the stop loss one pip below the low of the last candle will also give your trade some room to breathe.

You can then target a one-to-one reward to risk, meaning that you should target the same amount of pips that you are risking from the entry price to the stop loss price.

If the trade is not triggered by the open of a new candle, just cancel the order.

If the trade is triggered, just leave it in the market until you reach your profit target or until the stop loss order is triggered by a market reversal.

Consider the chart given below…

harami-pattern

The above chart shows how to trade the bullish harami pattern using price action trading strategy.

The entry point has been shown in green and marked as “Entry Point”.

This is just above the high of the last candle.

After entering the trade, a stop loss order was added to ensure that the trader’s account is protected.

The stop loss was added just below the low of the last candle.

It has been shown in red and marked as “Stop Loss”.

The profit target has been placed above the entry point and shown in black.

If the order is not triggered by the opening of the next bar, the trader can cancel the order and look for another trade.

However, in this case, the order was triggered because the price kept on moving in a bullish direction after the order was placed.

Even after reaching the profit target, the price kept on moving in a bullish direction.

Since the trader will exit the trade after hitting the profit target, he will miss out some profits.

That’s why it’s advisable for you to use a trailing stop loss instead of setting a profit target.

It shifts its position once the price moves in a direction that favors you.

This will lock in the profits that you have earned so far so that they are not wiped out in case the market reverses.

Also, the stop loss order was placed a pip below the low of the previous candle.

This will ensure that it is not triggered unnecessarily by price consolidations, which may cause you to exit the trade prematurely.

This can make you miss out on making profits.

 

So, that’s how to trade the bullish harami.

What about the bearish harami?

Here is how to…

First, you need to identify the bearish harami pattern, which is a seller’s candle high and low range formed within the high and low range of the previous buyer candle.

You should then enter your trade one pip below the low of the last candle.

Again, you must protect your profits against a market reversal using a stop loss order.

Place a stop loss order one pip above the high of the previous candle.

When setting your profit target, use a one-to-one reward to risk which means that you should target the same amount of pips that you are risking from the entry price to the stop loss price.

If the trade is not triggered by the open of a new candle, just cancel the order.

However, if the trade is triggered, just leave it in the market until you reach your profit target or until the stop loss order is triggered.

Consider the chart given below…

harami-candlestick-pattern

The above chart shows how you can trade the bearish harami using price action analysis.

The entry point has been shown in green and marked as “Entry Point”.

The entry point is located just 1 pip from the low of the previous candle.

After entering the trade, a stop loss was placed 1 pip above the high of the previous candle.

In case the price action makes a reversal and begins to move in a bullish direction, the stop loss will be triggered and you will automatically exit the trade.

This will save you from incurring a loss.

The position for setting the profit target has been shown in black and marked as “Profit Target”.

After hitting the profit target, the price action made a consolidation.

However, the bearish move resumed after some time.

#4: Forex Price Action Scalping

There are different forex price action scalping strategies that traders can use.

However, it’s worth noting that scalping requires taking very short term trades many times each day.

Due to this, many filters are required for one to trade a price action setup.

One of the important filters involves finding markets that are currently in a trend.

This way, the trader will be able to know who is currently controlling the market, whether the bulls or the bears.

The trader can use moving averages (MAs) for this.

Since any scalper looks for short term moves, faster moving averages such as 20 and 50 moving averages are recommended.

Let me give you an example that will guide you on how to create your own trading methodology.

Remember that each trading strategy has winning and losing trades, hence, you have to manage your risk sensibly.

Consider the chart given below…

moving-average-with-price-action

The above chart shows two moving averages added on the price chart of a forex pair.

We have the 20MA and 50MA as they have been marked on the chart.

Other than the moving averages, there are bearish and bullish harami patterns on the chart.

These have been shown by the two small, black, horizontal lines.

During the formation of the two harami patterns, the 50MA was moving above the 20MA.

A trader who entered a short position after spotting the bearish harami pattern made profit from the subsequent bearish move.

A trader who entered a long position after spotting the bullish harami pattern made a profit from the subsequent bullish move.

Conclusion:

This is what you’ve learned in this article…

  • Price action trading is a great tool for traders and it’s used all over the world.
  • It involves using price action to make trading decisions rather than using technical indicators.
  • Indicators occupy more space on the price chart as some are added on a separate window.
  • Other indicators are added on top of the price action, obscuring traders from having a clear view of the price action.
  • However, when a trader uses the price action alone on a chart, he has a clear view of what is happening in the market.
  • All technical indicators are derived from the underlying price action, meaning that a trader who uses technical indicators to make trading decisions just adds more variables to the system.
  • These variables don’t give the trader any insights about what is happening in the market.
  • There are different price action trading strategies.
  • It’s up to you as a trader to master them and adopt them in your trading strategies.
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