Most people think of fundamental analysis and technical analysis when they consider methods they can use for trading forex. But there is a third option as well, called price action.
In this post, we will explain to you what price action is and how it works. We will introduce you to some common price patterns, and give you some advice for establishing context for your price action trades.
What Price Action Is
Price action trading means looking directly at price and what it is telling you on your charts. Instead of studying economic events or technical indicators, you just look for patterns in the bars or candlesticks.
Certain patterns tend to crop up again and again before breakouts. So, when you see such a pattern forming on your chart, it could indicate that a big move is on its way. It could be the start of a new trend or a reversal.
Whether or not you place any indicators on your charts is up to you. There are purists who feel that you should not have any indicators or lines on your charts whatsoever. But a lot of price action traders do still incorporate some drawing tools or indicators for context.
That said, relatively uncluttered charts are part of the price action philosophy. If you do decide to add anything to your charts, you should be taking a minimalist approach.
How Do You Use Price Action to Trade Forex?
Here are the basic steps to trading forex using price action:
- Open your charts and select a timeframe. Price action tends to be most reliable on higher timeframes. The daily chart is a favorite of many price action traders.
- Look at the far right-hand side of your chart at the bars that are forming. Do you see any familiar price action patterns?
- If you do, and if the pattern is well-formed, you can set up an entry and a stop loss.
- If your entry is triggered, you will be in the trade. Keep monitoring it, and exit according to your rules.
Some traders may set a specific take profit. Others might trail their stops.
As you can see, price action is extremely simple, which is a large part of its appeal. It is hard to get more straightforward than looking for a visual pattern in price and then making a trade when it appears.
Its directness is appealing as well. A lot of indicators lag behind what price is doing. Plus, all indicators are calculated using price data anyway. It makes sense to learn to interpret what price is doing for yourself. It can help you get in on trades rapidly and effectively.
Is Price Action Right for You?
Here are some signs that price action could suit your trading style and goals:
- Charts covered in indicators make you dizzy. With price action, you never need to look at an indicator again if you do not want to.
- You are frustrated with lagging indicators. You can ride out a trend from much closer to its start by looking right at the price for your entry signals.
- You want to keep trading as basic as possible. Forex trading does not need to be complicated. In fact, many of the most powerful systems are very simple. And it is hard to get simpler than price action.
- Spotting visual patterns is easy for you. If you are attuned to picking up patterns in visual data, you will probably find it relatively easy to spot potential trade setups with price action.
- You are patient. One of the tougher things about price action is just that making it work for you entails taking only the highest quality setups. This can be frustrating since you might have to wait sometimes for longer than you would like. Of course, this is also true with methods based on technical or fundamental analysis. So, if you are patient, you are more likely to be successful.
- You are in search of a method that can deliver over the long term. If you get good at trading with price patterns, you will have the basic tools you need for a lifelong career in profitable forex trading.
Some Common Price Patterns to Look For
Now that you know the basics of price action, here are some patterns that can help you spot profitable market moves.
- Pinbars (sometimes spelled “pin bars”): Sometimes you will see a candle form with a high or low that protrudes a significant distance from its flat body. That high or low shows a point where buyers or sellers “tested” whether they could keep pushing prices up or down, and failed. It is common for a pinbar to occur at a swing high or swing low point, signaling a reversal. The long high or low of the pinbar is its “nose.” Like Pinocchio’s nose, it is lying, telling you the price is going to go one way when it will end up going the other (thus the name “pinbar”). So, if a pinbar’s nose points up, the price is usually about to drop. If the nose points down, the price is usually going to rise.
- Inside bars: An “inside bar” is small enough to be completely contained by the bar before it. They form during periods of consolidation. Sometimes, bars will get smaller and smaller, each neatly contained by the one before. Four of these in a row form an “Inside 4 Bar,” or I4B. A breakout is likely. You should usually set entries above and below, as prices could go up or down.
- Outside bars: This is the opposite of an inside bar. It is a bar so large that it completely engulfs the one before it. You can have bullish outside bars (BUOBs) and bearish outside bars (BEOBs). A BUOB is a buy signal, and a BEOB is a sell signal.
- DHLC and DLHC: At swing highs and lows, you may sometimes spot these patterns. Two bars that hit the same approximate high followed by a lower close are a “double high lower close” formation or DHLC. Two bars that hit the same approximate low followed by a higher close are a “double low higher close” formation or DLHC. They signal reversals.
That is not an exhaustive list of price patterns. Be sure to look up others to trade.
How to Establish Context for Price Action
Now, here is the “catch” with price action trading. You need two things for your price action trades to be profitable:
1-Well-formed price patterns.
2-Price patterns in the right context.
“Context” here refers to 1-the location of the bars in question and 2-the overall state of the market.
So, you will need to first examine the general state of price overall. Is it smooth? Is it choppy? How choppy is it?
The smoother price is, the less likely it is that you are going to get faked out by whipsaws. Lots of choppy moves up or down, on the other hand, can put you in danger of false price action signals.
Once you have made sure the price looks relatively smooth and you have a nice pattern, you might be ready to trade.
But depending on your approach, you might want to go a little further and check for confluence.
What is confluence? It is a fancy-sounding word that just means that other sources confirm your price action signal.
Those other sources could include:
- Technical indicators (moving averages are a top choice among price action traders).
- Trend lines you draw on your charts.
- Pivot zones you daw on your charts.
- Fibonacci retracement levels.
In all of these cases, we are focused on identifying areas of support and resistance.
A Simple Example
Imagine, for instance, that you see a pinbar forming with the nose pointed upward. Up until this point, the market has been trending upward.
The pinbar has formed nicely. You are thinking about setting up an entry. But the question remains—is this really going to be a swing high/reversal? Pinbars can form in the middle of trends that keep on going.
You could scroll back through your charts and look for previous areas of support and resistance. You could then mark them with horizontal lines. Then, scroll back to your formation.
If you notice that one of those lines falls right where the pinbar is, acting as resistance, that is a great sign. Both the pinbar and the pivot zone are now telling you the same thing—that price might reverse and drop.
So, you have some confluence. With the added confidence you have in your setup, you could enter the trade. Hopefully, you will be right, and make a nice profit on a bearish move.
Best Practices for Price Action
- Look at numerous examples of well-formed price patterns. You can find hundreds of pages on forex forums with example charts. You also can scroll through old data in your trading platform. The more examples you see, the easier it will be for you to recognize the patterns in real time.
- Understand that not every price pattern is worth taking. In fact, a lot of them are not. If you find yourself thinking, “Well, that is almost a pinbar,” that probably is a situation where you should hold off. Price action works best if you only take top-shelf setups.
- Do not trade in markets that are plagued with whipsaws. So many times, you will think you spotted a pinbar, but it will just be another whipsaw. You could find yourself in situations where you get continuously stopped out by alternating spikes up or down.
- Remember, you need a complete method and plan to go with price action. It is not just finding price patterns that are important but also setting reliable rules for entering and exiting.
- Backtest and demo test your method before you try and go live. Price action is simple, but that does not make it easy. You will need the practice to master it.
- At least start with longer timeframes. You can move to fast timeframes if you want later. But you will find it easier to learn price action and apply it successfully with the slower timeframes first. It may not seem like it now, but ultimately, it is going to speed up your learning curve.
If the complexity of technical or fundamental analysis is overwhelming to you, you will probably find yourself breathing a sigh of relief when you experience the refreshing elegance of price action trading.
Once you become an expert at spotting well-formed price patterns in suitable contexts, you will be able to let price speak to you directly. Soon, reading the markets will start to feel like reading a book.
Price action trading works great across a broad range of markets and timeframes. It has also stood the test of time, delivering excellent results for decades for many professional traders. So, give it a try. If you master it, you will have a trading method you can use for reliable profits again and again.