FX Price Action: core concepts and operating principles
Novice traders employ multiple indicators and theories in order to try and catch all the figures on the chart for an accurate entry into the Forex market; they trade taking into account the latest financial news and still do not get a result. However, the practice has long shown that indicators are good to a greater extent as an additional tool, while the Price Action methodology is relatively young but very effective and a kind of universal tool for analysis.
In this article, we will talk about the difference between Price Action and classical Technical analysis methods and evaluate the effectiveness of using Price Action as the main decision-making tool, as well as consider its operating principles.
What is Price Action in Forex trading?
First, let’s define what exactly we are dealing with. Price Action is a technique for determining the objective reason for a price change, based on candlestick analysis patterns as a representation of an imbalance between supply and demand.
The founder of Technical analysis, Charles Dow, argued that the price includes all the necessary information, whether it be economic news or political. Everything that happens to the foreign exchange or other markets is encrypted in the price movement. For this reason, adherents of this method study the very essence of price movement, instead of reading miles of news announcements and analytical calculations. The advantage here is that the trader frees his mind from unnecessary information and has a clear vision of what is happening on the exchange.
The Price Action strategy is attracting an increasing number of active traders and investors for three reasons:
- It is universal.
- It is relatively simple.
- It is very popular.
Trading on the Price Action strategy implies a rejection of indicators, trading advisors, and any other assistants. The assumption about the further movement of the market is based on how the price of the asset behaves at the moment.
Price Action uses:
- Candle patterns. The configuration of individual candlesticks and models consisting of several candlesticks allows you to understand how the balance of power between bulls and bears has changed;
- Horizontal levels, trend lines. These tools are used as filters, if the pattern is formed near the level, it strengthens the candlestick pattern.
Besides, Price Action is a technique basically for working on larger timeframes. With a decrease in the working time interval, the probability of the influence of random price fluctuations increases. The same pattern on H4-D1 works many times better than on M5-M15.
But there are no formal restrictions on time intervals. In history, you can find examples in which the technique also gives ideal entry points on M1-M5, but when working in real-time, it is better not to fall below H1-H4.
Why are indicators not used in Price Action?
In general, there is no strict prohibition on the use of indicators, and if desired, a trader can use any instrument as a filter or as the basis of a trading strategy.
In the latter case, Price Action elements turn into filters for evaluating trading signals.
The classic version of Forex Price Action does not involve the use of indicators for the following reasons:
- Lack of support for a number of indicators in different trading terminals. Standard tools (moving averages, a series of oscillators, Bollinger bands) are available in almost all platforms, but custom indicators will have to be redone from scratch for a new terminal;
- With indicators, a trader loses the habit of analyzing the market on his own. Instead of working directly with the chart, the trader switches to working with indicators, they give a specific signal, but do not show the picture of what is happening as a whole;
- All indicators are price-derived and lagging. As a rule, with an increase in the period of the indicator, the delay increases. A signal about a trend change, for example, in the form of a moving average crossover is not bad, but if the trader receives it at the end of the movement, it is of no use.
The use of Price Action is not regulated by strict rules. The trader has space for maneuvering, no one forbids him to add, for example, Stochastic as a filter to work on pin bars.
Where and when to use Price Action in Forex trading?
Price Action is a fairly universal tactic, there are no restrictions on the markets used. The same methods are used in the foreign exchange market, and when working with stocks, precious metals, and commodity market instruments. The methodology as a whole does not change, only take-profits and stop-losses will differ, as they depend on the volatility of the asset.
As for time limits, the standard recommendation is not to trade during the release of important news. If the work is carried out on the stock market, then quarterly reports can become the main source of surprises. It is not recommended to work 1-2 days before and within 1-2 days after the release of the report.
If trading is carried out on H4-D1, the signal formation time does not play a role. With smaller timeframes, it is advisable to limit yourself to the opening hours of the main financial centers of the world (the recommendation applies to the Forex market).
How to work with Forex Price Action?
In fact, trading with the Price Action technique is not that difficult. This technique is suitable for both beginners and professionals. Traders love Price Action for its undistorted view of the market, as Japanese candlesticks reflect price fluctuations themselves. Another advantage is that Price Action signals do not redraw on the chart over time.
Price Action is based on the Dow theory, which means that it requires the basics of Technical analysis. In this system, we cannot do without support and resistance zones, as well as channels.
Before starting work, you need to determine the direction of the market trend in order to understand how to trade: to sell or to buy. The best way to do this is to determine the price lows and highs on the chart:
- To identify a downtrend, it is necessary to look at lower highs (LH) and lower lows (LL).
- To identify an uptrend, you need to see upper highs (HH) and upper lows (HL).
When the dominant trend in the market is already known, it is worth focusing on the types of candlesticks and patterns that the Price Action technique provides.
There are a huge number of patterns, but this does not mean at all that you need to use absolutely everything. Moreover, it is worth noting that it makes sense to take 2-4 patterns for yourself and hone your skills in using them, which will be more than enough.
Consider some popular ones:
Pin Bar in Forex trading
Pin Bar is perhaps the most powerful pattern, consists of one candlestick and predicts a reversal:
- A bullish pin bar looks like a candlestick with a small body and a long tail on the upside. The lower shadow is either absent or small compared to the upper one.
- Bearish looks like a mirror in relation to form at the end of the downward movement, the shadow is located below.
There is no strict relationship between the length of the body and the shadow, it is desirable that the shadow exceeds the range of the body by 3-5 times. Candles on which the shadow is 10+ times larger than the body indicate market instability, Pin Bars of this type are not taken into work.
Pin Bars can form both during trend reversals and at the end of corrective movements.
Forex Inside Bar
This figure corresponds to the temporary respite that large players take after a strong move. The pattern consists of 2 candlesticks:
- The first is large, full-bodied with small shadows, its range is larger compared to neighboring ones. On this candlestick, a breakdown of a strong support/resistance level can occur.
- The second is small, with a small body and shadows, and completely falls within the range of the first. This is the respite before moving on.
When working with this pattern, its position relative to the level is of key importance. If support/resistance is broken and the inside bar rests on it from the opposite side, then this can be considered a confirmation of the truth of the breakout.
Forex Outside Bar
This Price Action pattern looks like an Inside Bar with the first and second candlesticks swapped:
- At first, there is no strong movement, an ordinary candlestick is formed.
- Then it is absorbed by a large full-bodied candlestick, which indicates the direction of further movement and completes the formation of the pattern.
As in the case of the Inside Bar, the position of the candlestick pattern relative to the support/resistance levels is important. The strength of the pattern increases if the level is broken during the formation of the outside bar. In this scenario, Outside Bar acts as a signal to continue moving.
This candlestick pattern can also act as a reversal pattern. This requires the chart to approach the level and form the Outside Bar.
Rails pattern in Fx trading
The Rails pattern is similar to the Outside Bar, but unlike it, the first candlestick should be approximately the same range as the second. Outwardly, this figure looks like 2 candlesticks of different colors and comparable sizes. It is desirable that both elements of the pattern be full-bodied, without long shadows.
Rails can form both at the moment of a trend change and at the end of corrective movements. As in the case with other designs, you need to rely on the level, the pattern itself is not particularly strong.
Forex Hook Reversal
The second name of the pattern is a reversal of the Inside Bar. It resembles rails, but there are additional requirements for the ratios between the candlesticks, the second candlestick should not go beyond the range of the first, and their sizes should be comparable.
This is the first hint of an upcoming reversal. This figure is called a reversal on the Inside Bar because the second candlestick does not go beyond the range of the first one.
Forex Closing Price Reversal (CPR)
Another reversal pattern appears as a result of the inability of the bulls or bears to continue moving. Consists of two candles:
- Bearish pattern. In a rising market, the first candlestick corresponds to an uptrend, there is no hint of a reversal yet. On the second candle, the previous high is updated, but it is not possible to gain a foothold at the reached level, and the candlestick closes below the high of the first bar. If we are talking about the stock market, then a gap can form between the candlesticks, which strengthens the reversal 1 formation.
- Bullish CPR. The rules are mirrored, a downward movement is needed, a gap is formed, the next candlestick updates the Low, but then the bulls go on the offensive, and the closing price is above the low of the previous bar.
Each of the candlestick patterns mentioned above should only be traded if it is based on support/resistance levels. It is in these places that you should look for signals to improve trading.
Support is the level from which the price bounces when approaching from top to bottom and goes back up, while they say the bulls won. The support level, as it were, puts a barrier and supports the price, preventing it from going lower.
Resistance is a level from which the price, when approaching from the bottom up, turns around and goes down again, in this case, it is considered that the bears won, as they forced the price to fall. This level is a barrier to price growth and does not allow it to go higher.
When the price approaches the level, a rebound from the level or a breakdown of this level may occur, as a result of which the further impulse of the price movement is determined.
The levels on the chart appear due to the clash of interests between supply and demand: some market participants want to sell assets, while others want to buy, and for each the price is optimal. As a result of flurry trading, the movement is stalled at a certain price value until demand outweighs supply or vice versa.
Besides, it is best to practice Price Action trading skills in a trading demo account with virtual money. In this case, the trader will be able to practice trading patterns at the speed of the tester that is comfortable for him, without fear of losing real money. In addition, the trading simulator will allow you to consider the features of the formation of each pattern in different periods of the market: in a flat, in a trend; and will also allow you to gain great experience by working in any historical segment of the market.
In general, the essence of work on Price Action comes down to the following points:
- It is necessary to determine the current trend within which trading will be conducted.
- Place key support and resistance levels on the chart.
- Wait for a price correction to these levels.
- Pay attention to the reaction to the test of these levels and wait for the formation of the Price Action pattern in the direction you need.
- Open a deal according to the pattern.
- Set a stop-loss for the pattern.
- Set a take-profit according to the basic principles of your trading system: to be 2-3 times more than the stop, to the nearest support/resistance level, to the border of the price channel, etc.
Forex trading strategies and Price Action
Price Action as a method of trading should be used in conjunction with another trading strategy that will prompt the trader in which area of the chart to look for a pattern and in which direction to trade.
Many traders use Price Action in conjunction with simple horizontal support and resistance levels, as well as moving average indicators, to determine the trend.
There are other popular Price Action combinations: with Fibonacci levels, a price channel, VSA analysis, margin zones, option levels, and oscillator indicators.
The Price Action method is good because it can be combined with almost any strategy and any timeframe. You can use Price Action for both positional, medium-term trading, and scalping. Some traders combine Fundamental analysis with Price Action by highlighting significant news and waiting for a pattern to form after the news is released.
Trade with Price Action or indicators?
Each trading strategy has its pros and cons. The Price Action technique is easy to learn and does not require additional indicators to work, thus reducing the trader’s costs for extra software. In addition, this strategy allows you to analyze the price chart without distortion, which most indicators give. Thus, when trading with Price Action, we see the price movement in its purest form, and the patterns give us an idea of the actions of large players.
Indicator trading strategies reduce part of the burden on the trader by making calculations automatically. They greatly simplify the analysis of the graph, displaying the analyzed data in a convenient form on the screen. Thus, the trader has visibility, which allows him to find patterns in the market and turn them to his advantage. However, all indicators have a common minus: they show a derivative price value, which can distort the real picture of the market. Behind the multitude of indicators, a trader may not see the Price Action, and the price is the essence of the market. Many professionals believe that price is the most reliable indicator.
Forex Copy trading
Price Action is one of the most popular trading concepts. A trader who knows how to use Price Action correctly can often greatly improve his results and his ability to read charts. However, there are still many ways that can help in understanding trading and save a lot of time, such as Social and Copy trading, the essence of which is quite simple: the trader does not bother with either charting or analysis, and does not delve into the principles of the indicators, but simply copies the actions of the guru. This way of trading gives you the best possible trading experience without the deep trading skills, time, and analysis required to monitor the market and manage risk.
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Top trusted brokers for Forex trading
The methodology for trading with Price Action is quite universal. With Price Action, you can trade on any market and any timeframe.
There are a large number of Price Action patterns from which a trader can choose the most suitable for himself and his trading style. You should not immediately try to learn all known combinations. It is enough to take a few into service and work them out as much as possible on a free demo account without losing real money.
With the help of Price Action, you can assume further short-term price movement and determine the entry point with the place for placing such risk management tools as a stop-loss.
It is up to you whether to apply the Price Action technique in your trading, but you should still know the main patterns since at a certain controversial moment in the market, it is the knowledge of Price Action patterns that will help you make the right decision.
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Price Action in Forex trading - FAQ