Price Action Trading Explained
In this article
In the fast-paced world of forex, price action is the foundation stone for technical analysis.
Many short-term traders depend only on price action to make trading decisions.
This guide will explain price action trading and how you can boost your trading strategies with price action.
What is price action trading?
Price action is the price data of the forex market without indicators. The analysis part is learning to read these and make a trade based on patterns.
Price action trading is a trading method in which you base all of your trading decisions on a naked price chart.
This means that no indicators should be utilised, or at best, only a handful of moving averages to identify support and resistance levels.
As you can see on the chart above, the price action illustrates an uptrend and a downtrend. There are no indicators involved, just a simple explanation of the price movements.
A key point to note is that although global news events and economic reports impact currency prices, they are only one part of the narrative. This is because all-important announcements and economic data eventually become a component of price activity on the forex chart.
This removes the need to add indicators individually because price action displays the effect of all factors, including indicators, at any time.
All you’ll need are price action signals to build your own trading system, which will increase your chances of making profitable trades.
Price action trading essentials
As price action trading is based on recent historical data and past fluctuations, all technical analysis tools such as charts, trend lines, price bands, high and low swings, technical levels (of support, resistance, and consolidation), and so on are taken into account according to the trader’s preference and strategy.
You may observe simple price bars, price bands, break-outs, trend lines, or advanced combinations, including candlesticks, volatility, channels, and so on.
Psychological and behavioural decisions play a crucial role in price action transactions.
For example, if a currency pair sits around 1.4080 and crosses the personally-set psychological barrier of 1.4100, you may expect a further upward advance and enter a long position.
Other traders may hold the opposite perspective — once 1.4100 is reached, they expect a price reversal and thus enter a short position.
It is wise to note that no two traders will read the same price movement in the same way because everyone has their own interpretation, set rules, and behavioural understanding of it.
In a nutshell, price action trading is a systematic trading practice aided by technical analysis tools and recent price history. You are free to make your own decisions within a given scenario to take trading positions based on subjective, behavioural, and psychological states.
How to use price action?
Price action tends to repeat in diverse patterns due to the repetitive nature of forex market participants and how they react to global economic variables. Price trading strategies are another name for such patterns. Price action patterns that repeat indicate the continuity or change in market sentiment.
Simply said, by learning to recognise price action patterns, you can acquire insight into where a currency’s price is likely to move next.
To begin trading price action, you must first remove all irrelevant data from your chart. So, remove all of the indicators and expert adviser signals, leaving only the plain price bars.
Keep in mind that, depending on your preferences, you can use traditional bar charts or candlestick charts. The ability of candlesticks to convey price data more dynamically makes them more popular than traditional bars.
After removing all indicators and unnecessary factors from your charts, you can begin drawing key chart levels and looking for price action setups to trade from. One major use of price action trading is learning how to tell the difference between a consolidating and a moving market.
Core characteristics of price action analysis
The following are the basic things you need to know:
- Plotting the price movement of an asset or item over time can be described as price action.
- In raw price charts, the candles are the averages, not the averages plotted on the chart.
- Traders often use candlestick charts to visualize price movements, since they display the open, high, low, and close values in the context of ups or downs.
- Price action and the formations and trends discovered from it are major sources of trading information for many short-term traders.
- Price action is the basis of all technical analysis. In technical analysis, past prices are used to inform trading decisions, instead of raw data.
- Two traders might come to different conclusions when analyzing the same price action: price action trading is more of an art than a science.
- According to a trader’s personal experience reading the charts, one might see a downtrend and another might perceive a turnaround.
Price action strategies in practice
A price action analysis is generally used for short- or medium-term trading rather than long-term investments. In most cases, it’s for smaller profits as well.
To determine if a market is likely to turn, you must first analyze the movement of the price – whether it’s in a bullish or bearish trend.
Positive and negative market movements are referred to as bullish and bearish, respectively. A bullish trend is an upwards trend, and a bearish trend is an upwards trend.
Why trade with price action?
The reason for using price action is simple: the price is at the heart of any financial market. It’s similar to math. You will be unable to propose solutions if you do not comprehend the conditions of the work.
As a result, if you don’t know how to interpret a market’s price action, you’re unlikely to understand what a price chart is telling you. So, you won’t be able to trade forex using price action.
Every professional trader who tries to persuade you that it is easier to trade using indicators or trading software other than price action indicators is ignorant of the market’s realities. The market’s truth is that the present price is the sum of all variables associated with the market.
Tools used for Price Action trading
Technical analysis tools such as a chart, trend line, price band, swing highs and lows, and technical levels (of support, resistance, and consolidation) play an important role in price action trading due to past price movements and historical data. Traders’ choices and strategies make a difference.
There are several tools, and patterns traders observe, such as price bars, price bands, breakouts, trend lines, and candlesticks.
Traders’ interpretations of psychological and behavioural signals and subsequent actions make up an important part of price action trading.
A trader may assume a further upward movement if a stock hovering at 580 crosses the psychological level of 600, for instance, no matter what happens. Other traders believe that once 600 reaches, the price will reverse, and they will short the stock.
Two traders can’t interpret the same price action in the same way since they each interpret it differently, define rules, and understand it differently behaviorally. In contrast, a technical analysis scenario (such as 15 DMA crossing over 50 DMA) will lead to similar trading behaviour.
Price action trading involves taking trading positions according to subjective, behavioural, and psychological factors and is supported by technical analysis tools and historical price data. In this scenario, traders have the freedom to take their own decisions as to whether or not to take trading positions.
What does ‘pure’ or ‘naked’ price action mean?
Naked or pure price action implies that you are trading only based on what you can see in the market. In a way, it’s like driving without your GPS. By understanding the market, you make your trades instead of relying on complicated formulas and time-consuming analyses.
What are price action signals?
Market signals like price action patterns and price action triggers can be used for predicting future market behaviour by identifying easily identifiable patterns in a market. Experienced traders can sometimes spot these signals by recognizing certain patterns and shapes.
Price action vs indicators vs technical analysis: what is the difference?
Price action indicators indicate a trend emerging on a trading chart by flickers of activity. Trading experts can make in-the-moment bets based on these indicators quickly and accurately.
To forecast future price movements, technical analysis uses various calculations. On the other hand, the price action approach relies solely on an asset’s price movements during your trading period.
Technical analysis is a way of bringing order into the seemingly chaotic world of trading. At the same time, price action allows traders to take a gut-based approach to trade by identifying price action indicators.
Price action Trading – Identify market conditions
A price action trader begins by identifying the current market condition. With this skill, you will gain valuable insight into the right market to trade and the best strategy for profiting from it.
A market can be in one of three conditions at any one time:
Certain strategies often fail in the wrong market conditions, which results in traders losing their accounts. Fading tops during a higher-trending market are difficult. Alternatively, you can buy breakouts in a rangebound market.
You will be able to identify your best strategy if you correctly identify the current market conditions. Markets typically trade in about 70 per cent of the time and in trends about 30 per cent, so let’s look at this concept in more detail.
A market where highs are higher than lows is in an uptrend. In other words, buyers remove levels of supply overhead and defend higher prices when prices dip.
If a market makes lower lows and lower highs, then it is in a downtrend. The sellers in this scenario defend lower prices on rallies by removing demand below them.
The market will trade sideways within a clearly defined range if it is in a ranging condition. In this case, the buyers and sellers enter the range’s upper and lower ends, establishing market equilibrium. These market conditions usually arise after a trending period, and reversal strategies can be used to profit from them.
There are no oscillations or net changes in price in this type of market condition. It is best to ignore markets in such conditions!
With your knowledge of identifying them, you should look for markets that tend to trend or range and stay away from choppy or indecisive ones. Next, you can find a market oscillating within a range or trend.
Price action trading – Identify market rotations
The concept of market rotation is also important when trading raw price action.
There is rarely a straight line in the market! In the industry, it seems that trends are your friends. About half the time, the price moves against the trend when we dig deeper!
The remaining time occurs in periods of consolidation or rotation against the trend. The market trends when it moves in the trending direction, followed by a short counterrotation (pullback) before continuing to trend (rips).
As speculators, our goal is to “buy low and sell high”, so identifying rotations will help us accomplish this.
Price action trading – Identify key levels of support & resistance
Following the first two steps, you’ll want to identify the best levels to enter trades in your favourite markets. In technical analysis, support and resistance are probably the most basic concepts!
Generally, support is the level below which a market will most likely floor, whereas resistance is the level above which a market will most likely be ceilinged. As we follow the “Keep it Simple” motto, we focus on key swing highs and lows monthly, weekly, and daily.
Due to their simplicity, these levels will attract a lot of attention. Trading opportunities are typically found around previous highs and lows since traders cluster their orders around these points.
Price action trading – Using candlestick patterns to identify low-risk trading opportunities
It is challenging to decide which candlestick patterns are the most reliable from hundreds available online. It is most reliable to use the engulfing and doji patterns from experience.
We prefer hammer and dragonfly dojis for our style, as they signal deceleration and allow us to pull back at the right time.
To qualify your entries with candlestick patterns, keep these tips in mind:
- The location is everything. Swing highs or swing lows are key support/resistance zones where these setups are more likely to occur.
- Price action tells a story; as a trader, it’s your job to discover what it means.
- Don’t focus on the candlesticks individually. Concentrate on the context of the chart to notice the clues price leaves.
- They will be meaningful only when trading signals make sense in the context of previous price action.
- High timeframes produce stronger signals. Charts showing these signals weekly, daily, and four-hourly are the best.
- Keep an eye on the candlesticks’ bodies. For successful traders to take advantage of the next impulse move in the overall trend, they prefer a deceleration of the counter-trend rotation.
Common bulls and bears
You can analyze the data using the following common trends. There can be a lot of complexity to price action charts.
Three White Soldiers
In a pricing chart, you can use a bullish candlestick pattern to detect a reversal in the trend.
The pattern consists of three consecutive long-bodied candles, one of which opens within the previous candle’s body and the other of which closes higher than the previous candle’s high.
Price action on the chart is indicating a major change in market sentiment based on the three white soldiers.
Three Black Crows
An upside-down black crow pattern occurs when three consecutive long-bodied candlesticks open within the body of the previous candle and close below the previous candle.
A bearish candlestick pattern with three black crows indicates an uptrend may be reversing.
There are three candles in the evening star candlestick pattern: a large white candlestick, a small body candle, and a red candle. Investors use this pattern to detect the beginning of a reversal of an uptrend.
Trading strategies with price action signals
Price action trend trading
When price action trading is about analyzing price movements, price action trend trading is about analyzing trends. The head and shoulders trade reversal is one of the popular price action trading techniques that traders use to spot and follow price action trends.
For new traders, this is a great tool for learning from their more experienced peers as price action trends develop. You would either open a ‘buy’ position to benefit from the green uptrends or a ‘sell’ position to benefit from the red downtrends.
Pin bar pattern
Pin bar patterns sometimes appear as candlestick patterns due to their distinctive shape. The ‘wick’ or tail indicates the range of rejected prices, with a sharp reversal and rejection of a particular price.
The trader decides whether to take a long or short position in the market; traders assume that the price will move in opposite directions to the tail. Pin bar patterns, for example, have long lower tails, which suggest that lower prices have been rejected in the past, which has implied a possible rise in price.
An inside bar pattern consists of two bars, the inner bar being smaller than the outer bar (or mother bar) and falling within the outer bar’s high and low range. There are times when inside bars form during a market consolidation, but they can also serve as red herrings that indicate market changes.
The skilled trader can detect these trends at a glance and can use their macro knowledge to predict whether the inside bar signals consolidation or a change in trend. Inside bars are a good indicator of whether a price will rise or fall.
Trend following retracement entry point
The trader follows the trend as it develops using this price action strategy.
A trader might consider shorting a price if it is clearly on a downtrend, with lower highs consistently being created. The trader might want to buy if the highs and lows trend upward incrementally.
Trend following breakout entry point
After a price spike this trend anticipates a retracement after a price spike occurs. In technical analysis, a breakout occurs when a market moves outside of defined support or resistance lines.
Professional traders may take a long position in a stock trending upwards or breaking above the resistance line. In the case of a stock trending downwards, traders can take a short position.
Head and shoulders pattern reversal trade
Head and shoulders patterns, as their name suggests, are market movements that resemble silhouettes of heads and shoulders. This means prices rise, fall, rise, and fall again before rising to a lower high and dropping gently.
Several price action trading strategies take advantage of a temporary peak (the head), including a head and shoulders reversal trade. It is relatively easy to set a stop loss after a temporary peak (the head) and to enter after the first shoulder.
The sequence of highs and lows
As a fundamental concept, price action trading is all about highs and lows. For traders following price action strategies, a sequence of highs and lows is an effective way to identify emerging trends.
Traders can tell if a price trend is upward if its highs and lows keep rising. Trading at lower highs and lows indicates that it is trending downward. The sequence of highs and lows can help traders identify entry points and put stops just before higher lows in an upward trend.
Price Action Indicators
An individual trading price action focuses only on price and time as trade elements. Traders using price action are most likely to use price charts. Most Forex trading platforms offer candlestick charts because of their visual appeal and the detailed information about asset prices they provide.
Candlesticks typically display an asset’s high, low, opening, and closing prices (HLOC) over time. When a candle closes higher than its opening price, it refers to a bull market candle; when it closes lower, it refers to a bearish candle.
A price action trader can learn much about market action from this detailed price information. Besides determining the size and shape of a candle, positioning the HLOC price points provides valuable information to price action traders.
Thus, some candle types offer bullish (hammer) or bearish (hanging man) signals, while others provide neutral (Doji) signals.
Fibonacci retracements for support and resistance
An uptrend is indicated by a Fibonacci retracement and a downtrend by a high-to-low retracement. These areas indicate potential pullbacks for the price. There are levels of 23.6%, 38.2%, 50%, 61.8%, and 100%.
Strong trends typically have shallow pullbacks, often reaching 38.2% or less. Most trends often pullbacks of more than 50 per cent or 61.8%.
Relative strength index (RSI) for momentum
The relative strength index (RSI) measures how the price compares with its 14-period range. Price is at its highest level when the RSI is above 70% in the last 14 periods. Prices below 30% are lower than where they have traded over the last 14 periods.
A trader often waits for the price to move out of these areas during trending conditions to confirm a trade. RSI moves below 30 during an uptrend, which signals a buy signal. Shorts are usually taken during downtrends when the RSI moves above 70 and drops below. Confirmation of these signals usually depends on other price action signals.
Stochastic oscillator for identifying trend reversals
Stochastic can be useful for spotting turning points and confirming price action signals. The RSI is similar to this indicator. Stochastics have two lines: stochastics and signal lines. Signal lines are moving averages of stochastics, so they move more slowly than stochastics.
Traders can watch the stochastic crossing the signal line to trade a price action signal.
The price action and stochastic should rise above the signal line before contemplating a long trade.
Using time to your advantage
Traders’ success largely depends on their ability to profit from their edge in the market. Real-time analysis is much harder than scrolling through charts in hindsight and identifying all the winners.
In the market, a constant game of cat and mouse is going on. False setups appear everywhere, whether they are from quants or smart money. Other off-chart indicators cannot tell whether a formation is false as a price action trader. However, you must have strict rules to know when to get out since you live in the “now.”
In this sense, time can be a helpful tool instead of a technical indicator. Generally, chart formation is the first signal, but time is always the deciding factor if the chart formation is unclear.
As a personal note, over 85% of the winning trades in my recent analysis were made in full within five minutes. You can check your average winner’s playout time after trading for a while if you’ve been doing it for some time.
Benefits of price action trading
A price action trader is a Zen trader of active trading. In their opinion, the human brain has more power than any machine. Their Zen state is not the same as not having a system. Traders can make their next move based on price action and charts.
In the beginning, you won’t have as much information to process so you can focus more on the chart action. Second, you are not to blame for falling victim to a trap. It’s not worth the hassle of emailing a guru with a proprietary trade signal that puts the market against you.
Price action traders have the advantage of processing data as it occurs. Interpreting trade data does not lag.
The only way to identify winning chart patterns is to rely solely on price. To succeed, you must identify which setups work and memorize them.
Next, you should pay attention to how much the stock moves in your favour and against you. In this way, you can set realistic price targets for each trade. At some point, you’ll be able to assess the setup and determine when to exit.
Is price action trading profitable?
Trading strategies and tools are only as successful as how you apply them. Several successful traders and investors have proven that price action trading can be profitable. However, traders who rely solely on price charts and ignore fundamental factors, such as economic indicators and news announcements, can possibly miss key events that affect security prices.
It is only through the price that traders make profits or lose money. The purpose of price action traders is to make money by anticipating where the price may go next based on historical and current patterns.
The price action trading technique has been successful for many traders, but learning the techniques and spotting trends and patterns can take time.
Limitations of price action trading
Price action interpretation is a very subjective process. When two traders analyse the same price action, it is highly common for them to draw radically opposite conclusions.
One may see it as a potential near-term turnaround, while another may see it as a bearish trend.
Moreover, the timeframe under evaluation influences how traders understand future currency price changes.
To keep in mind, predictions based on the price movement analysis of any timeframe are only theoretical.
Other tools can be used to confirm the correctness of the forecasts. The more tools you employ, the more confirmation you will receive for your trade.
Who is price action trading for?
Price action trading is better suited for short-to-medium-term traders like scalpers or day traders than long-term trading.
Most traders feel that the market behaves randomly and that there is no obvious systematic way to design a strategy that will always work.
Price action trading can work wonders by combining technical analysis tools with recent price history to uncover trade opportunities depending on the trader’s interpretation.
So, there you have it. Don’t get the notion that you will somehow succeed in forex trading without a proper and thorough knowledge of price action trading concepts.
Therefore, be prepared with as much knowledge as possible.
Does price action trading work?
It works for understanding the market’s behaviour. This is useful for explaining the current state of the market. The tool is useful for forming informed opinions about the market.
It is not a simple way to earn money from the Forex markets. Trading the markets is hard, regardless of your chosen method.
What is the best timeframe for price action trading?
Answering the question in a nutshell is:
- What is your risk tolerance?
- What is your available time?
- What is your speed of analysis of price action?
- What are your market’s volatility and liquidity like?
- What is your trading strategy?
Which is better to trade, indicators or price action?
Firstly, this dichotomy is false. Price action and indicators are not mutually exclusive. Both are acceptable. The second step is to explore both options and decide which is the best for you.
Can price action be called a form of technical analysis?
The answer is yes. Price, volume, and time are some of the market data used in technical analysis.
Prices and their relationship to time are typically the focus of price action charts (price-time charts). Therefore, it is a type of technical analysis.
Is price action good for scalping?
It has no advantage over other scalping methods, such as trading indicators. However, price action traders can react directly to price movements. For quick scalping, this attribute may translate to better execution.
Jason Morgan is an experienced forex analyst and writer with a deep understanding of the financial markets. With over 13+ years of industry experience, he has honed his skills in analyzing and forecasting currency movements, providing valuable insights to traders and investors.
Forex Content Writer | Market Analyst