How to trade with price action

Price action on financial markets, whether you’re trading Forex or stocks, is a method of analysing price charts. There are many ways to decipher market information. Most commonly, technical analysts make use of indicators to gauge trends, momentum, or volatility.

However, another form of analysing the markets comes from price action trading. In trading circles, price action trading can often be intimidating, especially for beginners to Forex trading. While there is some truth to this, with enough practice, traders can quickly hone their price action trading skills.

It takes a bit of practice and experience in order to master trading based on price action alone. Many traders feel intimidated because when you trade with price action; you are looking at price alone and some price-action-based techniques. Therefore, traders feel like they are riding a bicycle without the training wheels.

We know that although training wheels are important, at some point you need to learn to ride a bicycle without them. Price action can therefore be considered something similar to riding a bicycle without the training wheels, which are like technical indicators.

What is price action?

Price action trading focuses on understanding the market concepts of support and resistance. It can also include understanding market sentiment by looking at candlesticks or bar charts. As you can see, price action trading encompasses a few unique methods.

While it might be intimidating for some, sooner or later, traders will realise that price-action-based trading can be quite profitable. We often see cluttered charts with indicators where the most important variable; the price, is often lost amid the noise.

Price action trading brings the focus back to the price, while everything else is secondary. In fact, if you look close enough, you also notice that all the indicators are, after all, derived from the price.

How to determine a market’s trend

There are many ways to determine the market trend. Ask a few traders and the first thing that comes to mind is trading with moving averages to determine the market trend. But there is a simpler way to do this, which is based on price action techniques.

An uptrend is when the price consistently posts fresh highs and in the process, declines to make higher lows compared to the previous lows.

A downtrend is when the price consistently posts fresh lows and in the process, rallies to make lower highs compared to previous highs.

In simple terms, an uptrend is when you see the price rising from the lower left side of your chart to the upper right side of the chart. A downtrend is when you see the price falling from the upper left corner of your chart to the lower right corner of your chart.

The first image below illustrates the concept of trends in a very simple way.

Here, you can see a downtrend in action. As mentioned earlier, the price can be seen posting lower lows and lower highs. This downtrend is said to persist until the price starts to post subsequent higher highs and higher lows.

Figure 1: Example of a downtrend based on price action

Typically, in a downtrend, you would be looking to sell if you want to trade in the direction of the price (which is falling).

The next image below illustrates the concept of an uptrend in action. Here, you can identify the uptrend by the consistent higher highs and higher lows formed in the price. As long as the price continues to post higher highs and higher lows, the uptrend is where you would typically buy into the market to trade in the direction of the trend.

Figure 2: Example of an uptrend based on price action

Trending versus consolidating markets

Markets are said to be in one of two states at any time. A state of trend is where prices continue to move in the direction of the trend. In a state of consolidation, prices move within a sideways range.

It is often said that the markets trend only 20% of the time and the remaining 80% of the time, the markets tend to move sideways. While trading the trend is easy, trading and making a profit when the markets are trading sideways can be difficult. This state is also known as the choppy markets or the range established by price.

Markets consolidate typically after establishing a trend and the sideways market can occur at different frequencies and periods within a trend. Typically, when the consolidation is formed, you can either expect the price to resume its previous trend or establish a new one.

The next chart below illustrates the sideways or the consolidation markets and the trend.

Figure 3: Trending and consolidation markets

In the above chart, you can see that after the initial consolidation, which resulted in the price moving sideways, you can see the resulting breakout from this phase. Following the breakout, the price continues to move upwards, re-establishing the uptrend.

To the right, you can see that after the price starts to decline, a brief consolidation results in the downtrend resuming. Following this initial consolidation period, we again see a brief period of sideways trading.

The price then declines from this consolidation and maintains the downtrend.

How to trade Forex with price action: trading strategies

There are many ways to trade with price action. Some common examples include:

Trading with candlestick charts: In this method, traders make use of the candlesticks and the market sentiment that they convey. Buying on bullish engulfing or selling on bearish harami candlestick patterns are some of the more simple ways. Of course, trading candlestick patterns in isolation is not recommended and traders must combine this method with other price action strategies.

Support and resistance: Support-and-resistance-based trading is the most common way to trade. Support and resistance are the easiest ways to identify areas of supply and demand in the market. This helps the trader identify where to sell from and where to buy from. Analysing candlestick patterns along with support and resistance levels is a good way to combine two different elements of price action trading methods into one.

Chart patterns: Chart patterns are also a type of price action trading. Based on the recurring patterns that appear, traders can assess whether to buy or sell. Trading with chart patterns requires a lot of practice and developing an eye to recognise these patterns. They are very powerful and allow traders to trade both with the trend and against it.

Price action trading – why you should care?

Price action trading is one of the purest forms of trading. The trader focuses on price alone, and based on the concepts outlined above; traders can develop a profitable way to trade. However, there is some discretion needed when it comes to analysing price charts based on price action techniques. This is where price-action-based methods can differ from a mechanical trading system that can be built based on logical rules.

Still, whether you prefer to trade with technical indicators or other ways, understanding the basics of price action can help traders to develop a higher level of confidence on the markets.

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