Most price formations used by price action traders to enter the market are formed regularly on all forex pair charts and time frames.
Examples of such price formations include Pin Bars, Engulfing Bars, Inside Bars, and Two Bar Reversals.
Traders who are new to this trading technique tend to get excited immediately they spot these formations on their charts.
Due to this, they end up entering trades and risking their money on trades they should not have even entered.
Most mentors and educators of this trading technique only focus on the correct setups that a trader should consider to enter the market.
However, they forget to teach traders which setups they should avoid.
Of course, there are some price signals that are not worth risking your money on.
As a trader, you should just watch such price signals go by without entering the market since their location on the chart is not a place where you can get a clearly defined edge.
That’s why you need to know the price formations that trick traders into entering the market.
Other than that, even the most popular price formations do fail.
Maybe you are used to trading the PinBar and Engulfing chart patterns at key support resistance area.
Sometimes, you wait for a pullback that never comes, and the price keeps on trading higher without you.
In this article, I will help you know the reasons as to why price action traders fail.
What is Price Action Trading?
It is a type of trade that relies on the study of the historical price movement of a security.
The trader studies the historical price movements of the asset to get an idea about where the price will move next.
Most traders study the price bars to get information such as the open and the closing price of a market as well as its low and high price levels during a particular period of time.
This forms the core work of traders who use this trading strategy.
Due to this, see “price action” as the study of the actions of all buyers and sellers who are participating in a given market.
After a trader has analyzed what other market participants are doing, he will be able to make sound trading decisions.
These traders use stripped down or “naked” price charts to make all their trading decisions.
This means that they don’t use lagging indicators other than a few moving averages that help them identify support and resistance areas and trends.
Every financial market generates data about the price movement of a market over different periods of time, and this data is shown on price charts.
The price charts act as a reflection of 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”.
International news events and economic data cause price movements in the market, but we don’t have to analyze them so as to trade the market successfully.
This is because all world news and economic data that cause price movement in the market are finally reflected via price behavior on the price chart of a market.
So, the market price behavior is a reflection of all the variables affecting the market for any particular period of time.
This means that the use of lagging price indicators like MACD, Stochastics, RSI, and others is pure waste of time.
You only need price movement to come up with a profitable and high-probability trading system.
Such strategies are referred to as price action trading strategies and they give traders a way to make sense of price movements in the market.
Traders can use these strategies to predict future movements of the market with a high degree of accuracy and built winning trading strategies.
When a trader uses historical charts and real-time price information such as offers, bids, volume, magnitude, and velocity, he can identify the most favorable entry point for a trade.
This is an entry point that allows for risk control, while offering a potential profit at the same time.
Price Action Indicators
With this trading technique, a trader can know the thoughts and the actions of other market participants.
The candlestick is the most popular indicator among traders who use this trading strategy.
With the candlestick, a trader can determine the opening and the closing level for a market as well as the high and the low levels that have been reached within a particular period of time.
Consider the figure given below…
The above figure shows how both the seller and the buyer candlesticks look like.
The seller candlestick has been shown in red.
Note that it can also be shown in black.
The buyer candlestick has been shown in green.
It can also be shown in white.
Both the seller and the buyer candles provide very useful information to traders.
The high and the low price levels tell traders about the highest price and the lowest price made in a trading day.
The seller candle tells traders that the sellers emerged the winners in the battle of the trading day.
This is because the level of its closing price is lower than the level of its opening price.
The buyer candle tells traders that the buyers emerged the winners in the battle of the trading day.
This is because the level of its closing price is higher than the level of its opening price.
You can use the above candle setup as one of the first steps to coming up with a trading strategy that is based on price behavior.
For example…
If the candle that forms after the seller candle makes a new low, this is an indication that the sellers are willing to keep on selling the market.
This will cause many traders to enter short positions or keep holding onto short positions that they already have.
If the candle that is formed after the buyer candle makes a new high, this is an indication that buyers are ready to continue buying the market.
This will make most traders initiate long positions or keep holding the long positions they already have.
This is just one of the ways to use candlesticks as indicators.
Many candles create patterns that traders can use to create a trading strategy.
Most trading platforms such as MetaTrader4 and TradingView support the use of candlesticks.
They are used worldwide, which is a proof that they are very useful to traders.
Price Action Setups that Traders should trade cautiously
Although the goal of each forex trader is to make money, it doesn’t mean that you jump into every single opportunity that you see in the market.
After seeing a price formation in the market, it’s good for you to do a proper analysis before you can make the ultimate decision of entering the market.
In this section, I will be discussing some of the price setups that you should trade carefully.
#1: Price Signals formed in the middle of a Range
Such price patterns don’t “stick out” from the price behavior around them.
They are formed in the middle of a range, but not at a swing high or a swing low.
Such signals are normally generated without a substantial pullback and they are formed after a sideways trading.
Another characteristic of these signals is that they are formed with a lot of traffic.
Too much traffic or trouble areas around the price prevents it from freely moving from one area to the next.
This is because such traffic areas are normally support and resistance zones and when the price encounters them, it will struggle to break out through them, creating another range.
Consider the chart given below…
The above chart shows the formation of a pin bar during a time when the market is in a range.
The pin bar has been pointed to by a black arrow.
The chart shows that the pin bar was not formed at a swing high or swing low and it is surrounded by traffic.
Also, the pin bar didn’t stick out and it was not formed after a substantial pullback.
After the formation of the pin bar, the price tried to move higher.
However, the price encountered the resistance zone, which is the black line running horizontally on the chart.
After hitting the resistance zone, the price tried to break out in a bullish direction, but the sellers were so strong to push the price downwards.
The price then begun to move downwards as shown by the red arrow shown on the chart.
Traders who had entered long positions after the formation of the pin bar in the middle of the range are now caught on the wrong side of the market.
So, price patterns that are formed in the middle of a range cannot be trusted, hence, it will be good for you to trade them carefully.
The reason is that they mostly send a false signal and you will only realize after you’ve entered the trade.
This can cause you to make a loss.
#2: Price signals formed against obvious and strong trends
Most traders will trade such signals while knowing that they should not.
These signals are normally formed against very obvious and strong trends.
Traders enter into the market after spotting such chart formations thinking that the market is about to make a pullback sooner or later.
However, many are the times when the trend continues and it never makes a pullback.
If the trader had entered into a trade, his account may end up being wiped out.
So what next?
The trader decides to make a revenge trade, and the impact of this is further losses.
Always remember that emotional trading is the number one enemy to forex traders.
So, what is the best approach to trading such signals?
It’s simple!
Just wait for the price to make a pullback then you trade in the new direction of the market.
You can identify strategic levels within the existing trend to enter the market.
This way, you will increase your chances of making profit compared to entering a trade while anticipating that the price will make a pullback.
The point here is, it is better to be sure that a pullback has happened before entering a trade rather than trading based on anticipation.
Consider the chart given below…
The above chart shows a pin bar formed against a recent short term bullish move.
This has been shown by a black arrow marked as Pinbar.
Most traders will see the formation of the pin bar as a signal that the price is about to make a pullback.
Due to this, such traders will exit their long positions, and others will enter short positions.
The price made a short-term bearish move, which can be seen as a consolidation period.
This did not take long as shown by the two, weak bearish candles before the price resumed its bullish move.
So, instead of the price making a strong bearish move as it’s the expectation of most traders, it resumed its bullish move.
The black arrow shows that this bullish move continued for some time.
So, a trader who had entered a short position is now on the wrong side of the market.
A trader who exited his long position after spotting the pin bar will miss on making additional profits.
The pin bar was formed against a bullish trend.
A closer look at the trend prior to the formation of the pin bar reveals that the bullish move is very strong.
This means that the buyers are in control of the market, and that the sellers are weak.
The small consolidation that occurred after the formation of the pin bar could have been caused by the profit-taking activities of the buyers.
This means that it’s not a signal that the market is about to make a reversal from a bullish to a bearish trend.
The fact that the bullish move resumed is that buyers are ready and willing to continue buying and pushing the price of the forex pair higher.
A trader who interpreted the pin bar as a signal that the market is reversing made a wrong trading decision.
Hence, price signals that are formed against a very strong and obvious trend should be traded carefully because they can send a wrong signal to the traders.
#3: Price signals that are hard to identify
Yes, there are price signals that traders have to work very hard to identify them.
They are not large or obvious.
Most traders, especially the newbies, will look for any reason to make sure that they enter a trade.
As a trader, you must ask yourself…
Is there actually a trade here, or am I just entering one to participate in the market?
Trading can be a very daunting task even at its best of times, let alone when traders enter trades that they should not have entered.
This lands the trader into a sequence of psychological dilemmas, like emotional trading.
The trader may find himself placing trades to revenge for the money he has lost, or placing trades that are not there to be placed.
This has made many forex traders fail to make a profit.
They can’t sit back and learn to be picky and trade only the most obvious and best setups.
Consider the chart given below…
The above chart shows the formation of a small and insignificant bullish engulfing bar on the price chart of a forex pair.
The bullish engulfing candle has been pointed to by a black arrow and marked accordingly.
Note that the candlestick has been formed during a bearish move.
Most traders will conclude that this candlesticks signals the end of the bearish trend and the beginning of a bullish trend.
Due to this, most traders will exit their short positions.
Others will enter long positions.
However, a closer look at the bullish engulfing candlestick reveals that it is small and doesn’t send a strong signal.
Actual, a trader will struggle to identify the bullish engulfing candle.
The bullish engulfing candle is not obvious or large.
After the formation of the bullish engulfing candle, the price resumed its bearish trend.
This means that the bullish engulfing pattern was not worth trading.
A trader who had entered a long position is now caught on the wrong side of the market.
A trader who exited his short position now misses the opportunity of making more profit.
So, as a trader, avoid trading price signals that are hard to identify.
Teach yourself to relax and wait for the most obvious setups before jumping into trades.
Make sure that you are convinced that there is a trade in any particular price pattern that you trade.
Otherwise, your chances of running successful forex trades will be narrow.
#4: Trades that fail to break the price action signal bar in the desired entry direction to confirm the price action signal
Many traders have found themselves in the losing end as a result of such trades.
These are price formations that fail to break in the desired direction of the trade.
So, anytime you spot a particular price signal on your chart, it will be good for you to remain patient for some time until the price signal is confirmed.
Don’t jump into a trade just because a price signal has been formed in the market.
Consider the chart given below…
The above chart shows a pin bar formed at a time when the price is in an uptrend.
The pin bar has been pointed to by a black arrow and marked accordingly.
Although the pin bar looks like an okay setup, it doesn’t manage to break the lower part of its predecessor.
When you compare it with the previous bullish candle, the bullish candle is lower than the pin bar.
Most traders will conclude that the pin bar signals the end of the uptrend immediately they spot it on the chart.
However, the chart clearly shows that this was not the case.
Instead of making a pullback, the price continued with its bullish move.
Although there were consolidation periods during the uptrend, the price never managed to go down below the level of the pin bar.
The consolidation periods shown by the bearish candles could have been caused by the profit taking activities of the buyers in the market.
Because much profits are accruing during the bullish move, the buyers may decide to take out some of the profits, leading to the formation of the consolidation periods.
However, the consolidation periods didn’t go long before the bullish move resuming in the market.
A trader who exited his long position after seeing the pin bar on the chart will miss out on making more profits.
Some traders will enter short positions after spotting the pin bar in the market thinking that the pin bar is a signal that the bullish move has come to an end for a bearish move to begin.
Such traders will incur a loss because this never happened.
A wise trader should have never entered the trade.
The reason is that the pin bar signal did not confirm itself by breaking below the low of the previous bullish candle.
Such a trader will not incur a loss.
So, if a price signal fails to confirm itself, don’t enter a trade.
Instead of jumping to trade this signal, it is worth waiting to see whether the price will make a pullback or not.
If it makes a pullback, you can enter the trade.
If it doesn’t, you don’t have to enter the trade.
#4: Signal from Incorrect Swing
This is one of the main challenges that traders face when learning how to trade reversal price trading signals.
It is a very important step when it comes to finding high probability reversal trade setups.
As a trader, there are a number of points that you need to keep in mind when trading the reversal signals.
These will help you avoid entering into trades when it’s not necessary.
These points include the following…
- When trading reversals, ensure that you enter trades at the correct swing point.
- You cannot trade reversals as continuations.
- There is no specific number of candles that make a price swing.
- A single candle is not a price swing.
The major problem with trading a reversal signal from an incorrect swing point is that there are traders entering from areas in the markets where big traders are taking out their profits.
This means that entering a trade at the incorrect swing point is similar to entering a trade at the point of least value rather than the best.
Consider the chart given below…
The above chart shows a bullish pin bar formed at a high swing.
The bullish pin bar has been pointed to by a black arrow and marked accordingly.
A bullish pin bar is a signal that a bearish trend is about to end and a bullish trend is about to begin.
The bullish pin bar is normally expected to form at a swing low, meaning that it should be preceded by a bearish move and succeeded by a bullish move.
However, in our case, this did not happen.
The bullish pin bar was formed at a swing high and it’s preceded by a bullish move and succeeded by a bearish move.
So, we have a bullish pin bar signal formed at an incorrect swing.
Traders should learn to ignore such signals as they are misleading.
As you can see from the chart, the price did not behave the way it should behave after the formation of a bullish pin bar.
It was expected that the price should move higher, but it moved downwards.
A wise trader should not have traded the signal.
Consider the chart given below…
The above chart shows the formation of a bullish pin bar at a swing low.
The bullish pin bar has been pointed to by a black arrow and marked accordingly.
The bullish pin bar has been preceded by a bearish move and succeeded by a bullish move.
It has also been formed at a swing low as it is expected.
So, such a signal is worth trading for any trader.
Remember that the bullish pin bar is a signal that a bearish move has come to an end and a bullish move is about to begin.
This is exactly what happened on our chart.
So, ignore price formations that are formed at incorrect swings.
This calls for you to know where various price patterns are formed.
Of course, some price patterns are formed at swing lows while others are formed at swing highs.
If a price pattern is formed at a wrong swing, it will be good for you to ignore it rather than risk your capital in a trade.
Always remember that you trade to make money, not to be in a trade.
#5: Pin bars with shadows on the other end
The best pin bars are those with big long shadows or wicks that stick out, but we don’t want such pin bars to have wicks on the other end of the candle.
Consider the figure given below…
The above figure of a bullish pin bar shows that it has a large lower wick, which is exactly what traders are looking for when trading this type of price formation.
However, the pin bar has a large upper wick, and this can create a problem.
So, when you are trading a bullish pin bar, trade carefully or avoid those with large upper or lower wicks.
The problem with the wicks on the pin bars is how they were created.
The candle wicks are normally created when the price rejects a level.
For example…
The price may move higher, which is an indication that the buyers are controlling the market.
However, sellers may jump into the market and push the price lower.
This will lead to the formation of an upper wick.
In the example given above, it’s very clear that resistance came from higher prices and this explains why the upper wick was formed.
There is a risk in that if the price manages to go higher again, the resistance may well hold again.
This means that it is never good to trade straight into an area of support or resistance.
Consider the figure given below…
The above figure shows a bearish pin bar.
It is formed in an uptrend.
This is the time when the buyers are controlling the market.
However, the sellers jump into the market and push the price lower.
The long upper wick of the candle is formed because the price met resistance from higher prices and rejected it.
The price then moved lower leading to the formation of the upper wick of the pin bar.
The pin bar also has a lower wick.
The wick was also formed through the same process, and this explains why wicks formed on the other ends of pin bars can be dangerous and tricky to trade.
The bears/sellers were in control of the market, so the price was in a downtrend.
However, the price found a support levels and the bulls/buyers jumped into the market, pushing the price higher.
This led to the formation of the lower wick of the pin bar.
The upper and lower wicks of a pin bar presents a challenge to traders when they want to enter a trade.
For the above pin bar, a trader would go short to trade it.
However, selling at this position is dangerous because the lower wick shows that the price attempted to move lower but it was not able to.
Instead of going lower further, the bulls joined the market and pushed it higher.
So, you may enter a short trade only for the bulls to keep pushing the price higher, hence, you will be stopped out.
Conclusion:
This is what you’ve learned in this article…
- The price formations that forex traders use to enter the market are regularly formed on all forex pairs and time frames.
- Examples of such price formations include Inside Bars, Engulfing Bars, Pin Bars, and Two Bar reversals.
- However, most traders get excited by these price formations, hence, they enter trades that they should not enter.
- This means that not all price formations are worth trading.
- There are price formations that you should just watch go by without trading them since the place where they are formed on the chart doesn’t give you a clearly defined edge.
- Price signals that are formed in the middle of a range should be traded carefully.
- The reason is that many are the times when they don’t “stick out” from the price behavior that surrounds them.
- Again, these signals are formed in a lot of traffic, hence, they struggle to move freely from one area to the next.
- Traders should also avoid trading price signals that are formed against obvious and strong trends.
- Any price signal that is difficult to identify on a price chart should not be traded.