Price Action Trading – Introduction

The majority of consistently profitable forex traders make their money in the markets utilizing price action trading. Retail newbies, in their oblivion, tend to overcomplicate things. It’s not completely their fault though…

The digitalization of the trading industry has led to the field of technical analysis becoming increasingly complex and overwhelming for new traders!

All too often these traders are dazzled by indicators when they first start to study up on technical analysis. At the time, they may seem like the holy grail to trading!something that will give you an edge in the markets and that 100 percent win rate we all desire.

Unfortunately, this couldn’t be further from the truth!

Indicators are simply mathematical formulas that are a derivative of price. Most technical indicators actually lag price and do not offer any “new” data that isn’t already baked into the market.

Charts cluttered with indicators often provide mixed signals and lead to analysis paralysis. This is likely doing more harm to your trading than good!

In this article, we teach you how to apply price action trading to increase your edge! So grab a coffee and enjoy!

Step 1 – Price Action Trading – Identify Market Conditions

The first step in price action trading is to learn how to identify the current market condition. This is an important skill in your arsenal because it will help you determine the right market to trade and the best strategy to use to profit from that market.

A market will either be in (1) a trending condition, (2) a ranging condition or (3) in a choppy condition at any point in time.

Many traders blow their accounts trading certain strategies in the wrong market conditions. Imagine trying to fade tops when a market is trending higher. Or buying breakouts in a range bound market. Being able to identify the current market condition correctly will help you identify the strategy that will give you the best edge.

A rule of thumb is that the markets spend about 70% of the time in a range and only about 30% of the time in a trend, so let’s do a quick overview of this concept to bring you up to speed.

(1) Trending Conditions

A market is in an uptrend when it makes higher highs and higher lows. This means that buyers are taking out levels of supply overhead and defending higher prices on dips.

Alternatively, a market is in a downtrend when it is making lower lows and lower highs. In this scenario, the sellers are removing demand levels below and defending lower prices on rallies.

(2) Ranging Conditions

A market in a ranging condition will be trading sideways within a well-defined range. In this scenario, the sellers step in at the upper bound of the range and the buyers step in at the lower bound of the range, which represents equilibrium in the market. We usually see this market condition occur after a trending period and can utilize reversal strategies to profit from these conditions.

(3) Choppy Conditions

This type of market condition is characterized by price moving up and down sporadically without any real oscillations or net change. If you identify a market in this type of condition, it is best to ignore it!

Now that you know how to identify them, you’ll want to focus on markets that are either in a trending or ranging condition and to stay away from those that are choppy/indecisive. Once you’ve found a market that is oscillating in a trend or range, proceed to the next step.

Step 2 – Price Action Trading – Identify Market Rotations

The next important concept to understand when trading raw price action is market rotations.

Rarely do markets move in a straight line! A common adage in the industry is that the trend is your friend. When we dive deeper, price only moves in the direction of the trend about half of the time! The rest of the time is spent rotating against the trend or in periods of consolidation.

When a market is trending, you will often see a move in the direction of the trend, followed by short counter rotations (pullback) that precede further rotations in the direction of the trend (rips).

Our goal as speculators is to “buy low and sell high” and being able to identify these rotations will help you achieve this!

Let’s take a look at some examples to help you better understand this concept.

The market in the chart below is in an uptrend as it is oscillating between higher highs and higher lows. The areas highlighted in green represent rotations in the direction of the trend (rips) and the areas highlighted in red indicate countertrend rotations (pullback)

Case Study

We want to see a strong uptrend establish itself and then use countertrend rotations to enter at a good price and sell into the rotations higher.

The market in the chart below is in a downtrend as it is oscillating between lower lows and lower highs. The areas highlighted in red indicate rotations in the direction of the trend (rips) and the areas highlighted in green represent rotations against the trend (pullback)

Case Study

In a downtrend, we want to see a strong move lower and then use countertrend rotations to position ourselves short within the trend. The end goal is to cover our short trades as the market rotates back lower.  

You might have noticed swing highs and swing lows labeled on the last two charts. These are important levels we focus on as they represent price extremes which we use to forecast where future market swings may occur. Let’s take a look at these next.

Step 3 – Price Action Trading – Identify Key Levels of Support & Resistance

Once you’ve filtered out your favorite markets based on the first two steps, you’ll want to identify the best levels to execute your trades.

Support and resistance is probably the most basic principle of technical analysis!

Support refers to a level which will likely act as a floor in a market, whereas, resistance refers to a level which will likely act as a ceiling in a market.

We embrace the “Keep it Simple” motto and like to focus on key monthly-weekly-daily swing highs and lows. They are simple to spot and that means a lot of eyes will be on these levels.

Traders tend to cluster their orders around previous highs and lows so they offer lucrative trading opportunities for us.

Let’s look at some charts illustrating these levels as key support and resistance:

Rule of Thumb: When a market is trending, swing highs and swing lows tend to reverse roles. This is an important concept I want you to remember!

During uptrends, swing highs are often breached and tested as support before rotating to new highs.

Alternatively, during downtrends, swing lows are often breached and tested as resistance before rotating to new lows.

Now that you’re all caught up with market conditions, rotations and support and resistance, let’s put it all together with price action patterns.

Step 4 – Price Action Trading – Using Candlestick Patterns to Identify Low-Risk Trading Opportunities

With hundreds of candlestick patterns available on the internet, it is difficult to weed out which are the most reliable.

From experience, the engulfing pattern and doji patterns tend to be most reliable.

For our personal style, we prefer hammer or dragonfly dojis as they signal deceleration and offer us the best opportunities to jump in on pullbacks.

The below chart offers a nice visual reference to what we look for. The market created a swing high and sold off. This pair then traded back into the swing high and failed to break higher, effectively trapping breakout traders. The next day the sellers stepped in and a bearish engulfing candle was printed indicating sellers gaining momentum. After this, the market sold off to new lows.

After creating new lows, this pair found temporary support and staged a bit of a bounce. There wasn’t much momentum on the bounce and the market then re-tested the swing low as support and failed to break lower, effectively trapping short sellers. After several days of sideways consolidation, the buyers overwhelmed the sellers who bid the market higher by scrambling to cover their shorts. This price action formed a bullish engulfing candle, which led to a move higher over the next several weeks.

These are our preferred setups to trade as we look to take advantage of trapped traders by taking the opposite side of their positions.

Golden Nuggets

Here are some tips to remember when using candlestick patterns to qualify your entries:

  1. Location is king. These setups are more probable when they occur at key support/resistance zones such as swing highs or swing lows.
  2. The market is telling a story via price action and as a trader, it is your job to decipher it.
  3. Do not focus on individual candlesticks. You want to pay attention to the clues that price is the chart by focusing on context.
  4. Trading signals will only be meaningful when they make sense in the context of previous price action.
  5. The higher the timeframe, the stronger the signal. We prefer these signals on the weekly, daily and 4 hour charts.
  6. Pay close attention to the bodies of the candlesticks. Traders that successfully buy dips and sell rallies prefer to see some sort of deceleration of the counter-trend rotation in order to jump in for the next impulse move in the overall trend direction.

Price Action Trading – Final Thoughts

Indicators may seem like a holy grail at first, however, as experience sets in, most profitable traders prefer the keep it simple approach of trading forex without indicators.

By following the four-step process outlined in this post, you will effectively be able to remove the noise from your charts and start to see the market for the living and breathing organism that it is.

Your goal as a speculator is to analyze the market, determine order flow and to jump on board when the probabilities are stacked in your favor. Rinse and repeat. It’s as simple as that!

Remember that trading is a numbers game. No individual trade should make or break your account.

Next Steps

Your next step is to apply the concepts introduced in this post and to truly master your edge.

Exercise patience, diligence, and discipline as you wait for the highest probability, low-risk opportunities and skip the rest. Protect your capital and only trade the best setups. Trading is not a race, it’s a marathon. If you want riches overnight, this is not the place for you!

There is a saying in the industry that “there are old traders, there are bold traders, but there are no old, bold traders”. Focus on the process, manage risk, and the profits will come as a result.

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The information contained in this post is solely for educational purposes, and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable to your own financial situation. TRADEPRO Academy is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.