In this article, we will look at the concept of price action trading and show an example of a price action trading strategy. Price action trading is a strategy which aims to trade assets strictly on the basis of price movements without the use of any technical indicators. Some authorities have therefore termed this manner of trading “naked trading”. Proponents of price action trading believe that the best determinant of future price action is price itself. Therefore by following the pattern of historical price action, it is possible to determine the future of price action.
Why Price Action Trading ?
Fundamental analysis makes use of the news, while technical analysis makes use of what is visualized on the charts. The use of technical indicators is the commonest way in which charts are used to predict future price movement. However, technical indicators have some drawbacks which price action trade proponents will readily point to. Many indicators tend to either lead or lag. Indicators are based on price and they are usually calculated based on price performance over time. It is not altogether possible to use one single indicator to make an accurate prediction on where price would go because there are many dynamics involved. If the indicator leads too early, the trader will get into a trade with a false signal. If the indicator lags, then the trader would enter a trade too late, missing out on profits or getting caught out on reversals.
Those who believe wholly in price action would therefore prefer to use price as the sole indicator and not use indicators which rely on other measurements for performance.
Examples of Price Action Trading: Candlesticks
One way in which traders can use price action in trading is via the use of candlesticks. Candlesticks are a method of defining price action in the market. They are not simply a collection of bars that look like candles as some people may erroneously believe. Each candlestick is a unique representation of the activity of buyers and sellers in the financial markets. By looking at one or a combination of candlesticks in what we call candlestick patterns, we can see not a random arrangement of candles but rather a very deliberately told story of what traders on both sides of the equation are doing in the market.
Examples of relevant candlestick patterns in the forex trading market are:
- Pin bars: The pin bar candlesticks are the hammer, hanging man, inverted hammer and shooting star. They represent an attempt by the traders opposing a trend to beat back the continuation of that trend.
- Engulfing patterns: Made up of a bullish and bearish variety, the engulfing patterns indicate a reversal of sentiment in the market as traders on the opposing side of the previous trend force prices back beyond where they are coming from.
- Doji: Indicates equal pressure by buyers and sellers in the markets; a sign of indecision. Appearance of a doji at the end of a trend always gets market players excited because something big usually happens thereafter.
Candlesticks can thus show when the price action is poised to continue in the original trend, or reverse. So by looking directly at the price action as depicted by candlesticks, it is easy to tell what market sentiment is prevailing in the market and to trade along with this sentiment. Several other candlestick patterns exist, but the ones mentioned above are some of the commonly seen price patterns that traders will come across.
Bullish engulfing candlestick pattern
The candlestick shown above is a bullish engulfing pattern. As you can see, the sentiment for this candlestick is a bullish one. The initial candle shows sellers in control as the candle closed the time frame lower than it opened. The 2nd candle also opens and starts to head lower, but buyers immediately seize control of the market and push prices so high that the candle closes higher than the open price of the first candle. This is why this candle shows bullish market sentiment.
Price Action Trading Strategy Using Support and Resistance
Support and resistance provide another method of trading forex based on price action. Price action strategies based on support and resistance dictate that price is most likely going to behave in a particular way at certain price areas.
A support area is a region where priced action finds it hard to go below, and a resistance is an area where price finds it hard to go above. In order to satisfy these definitions, it means that the candlesticks which represent price action must have tested those areas several times for them to hold true as either support or resistance. When support or resistance areas have formed, traders can then perform reversal trades if those areas hold on steadfastly to their statuses, or perform breakout trades if price action eventually breaches those areas.
A solid price action strategy commonly used in the markets usually combines a candlesticks pattern with support and resistance. For example, a trader can decide to perform a short trade if a bearish candlestick pattern forms near an area of strong resistance. What this does is that the resistance provides a solid basis for a short trade based on historical price action, and the candlestick pattern which shows sellers taking hold of the market then provides a solid basis for making a trade entry. This is demonstrated below.
Price action trading provides a better way of trading the forex market because it uses the activity of buyers and sellers to predict price movements. Traders must however, practice using these setups on a demo account, then a no-deposit bonus account like the one found on FBS Markets Inc before heading to a full-fledged live account.
Rate This Post :