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This week’s question comes from Megan, who asks:
What is Forex price action?
In its most basic form, Forex price action is precisely what its name implies.
It’s the “action” of “price”. It describes the way a market moves, including its trends and key support and resistance levels.
However, trading Forex with price action also includes buy and sell signals.
When we combine these signals with key levels and momentum, we get a style of trading that is both simple and effective.
In fact, it’s the only method I have used to trade the Forex market since 2010. Before that I was lost in a world of unprofitable trading robots and unnecessary indicators.
While some of you might already be familiar with the contents of this post, for others it will offer an entirely new perspective.
Even if you are familiar with price action in Forex, I encourage you to read on. This post will be a great refresher for you and may even shed new light on the topic.
I’ll cover a simple 3-step process to this style of trading, and also discuss the importance of being patient while making price action trading work for you.
Ready to do this? Let’s get started.
Trading with price action is about listening to the market and then reacting accordingly.
The advantage of trading this way is that it gives you insight into where buy and sell orders are located. We use the upper and lower wicks of candlesticks to view these buyers and sellers.
An entire candlestick, such as the engulfing pattern, can also give you the upper hand. Again, it’s all about using the patterns on your chart to decide whether or not you should act.
I should note that price action can take on two forms. It can take the form of candlestick patterns on your charts or even of entire price structures like a head and shoulders pattern.
Both forms of price action can be extremely telling. They can also be misleading.
So how do you go about finding these price action signals?
Here’s a simple 3-step approach:
The very first thing you should do after opening a new chart is to draw key support and resistance levels.
These can include trend lines, horizontal areas and even patterns such as ascending and descending channels.
I wrote an entire lesson on drawing key levels. Be sure to review it before attempting to trade the price action we’re discussing in this post.
Once you have identified the critical areas on your chart, it becomes a waiting game.
Patience is important here. It’s no coincidence that this is also where most Forex traders slip up.
In order to trade the daily time frame, you need to wait for the session to close.
Which session am I referring to?
I trade New York close charts. That means each 24-hour period closes at 5 pm EST.
Not all Forex brokers offer this type of chart. However, if you’re serious about trading with Forex price action, using New York close charts is a must.
Want to know my two favorite price action signals?
When it comes to candlestick patterns, the pin bar is my favorite and the engulfing pattern is a close second.
The two share more in common than you may know. More on this later.
The pin bar is a candlestick with a long upper or lower wick, also called the tail. It’s what makes this pattern so profitable.
When buyers push the market back above key support, it suggests an increase in demand.
The same goes for a pin bar that occurs at resistance. But in this case, that long upper wick signals an increase in supply.
When trading price action, you want to look for bullish pin bars at support and bearish pin bars at resistance.
Be sure to also pay attention to the market’s momentum. We’ll cover this shortly.
First, let’s take a look at one last chart.
Both signals above offered incredibly favorable risk to reward ratios. Notice how long the wicks are compared to the surrounding price action.
Although different in shape, the engulfing signal is similar to the pin bar in that it suggests an increase in supply or demand.
The engulfing candlestick is an excellent way to identify exhaustion within a trend.
There is some controversy as to whether the body of the engulfing bar must completely engulf the previous candle.
I have been trading these patterns for more than seven years, and in my experience, it makes no difference.
As long as the body of the engulfing bar is about 80% of the previous candle and the range engulfs the former session, it has potential.
Here’s something else you may not know…
If you were to combine the engulfing bar and preceding candlestick in the AUDUSD chart, you would get a shape that looks like a pin bar.
This is why I mentioned that the two patterns share more in common than you may realize.
I often see traders discussing various momentum indicators. These individuals are looking for a way to spot trends and reversals.
Well, guess what?
You don’t need a fancy indicator to do that. Simple price action is all you need.
Those momentum indicators give off a lot of false positives. In other words, they will signal that a market is changing direction when it actually has no intention of doing so.
This is where you can use Forex price action to evaluate the momentum. And just like everything we’ve discussed up to this point, it’s incredibly simple.
Now, I’m by no means saying that price action doesn’t give false positives. No trading style, method or strategy is 100% accurate.
That said, I have found it to be the most reliable way to analyze momentum.
Here’s how I do it:
Using the daily time frame, identify the swing highs and swing lows.
You’re looking for the turning points in the market. The amount of time between these points can range from a few weeks to a few months.
Perform this exercise for the last six months or so.
Once complete, you will begin to see a pattern. As long as the market is making higher highs and higher lows, it’s in an uptrend.
You want to be a buyer here.
If a market is carving lower highs and lower lows, it’s in a downtrend.
You want to be a seller here.
These swing highs and lows often form a trend line. When they do, spotting reversals in the trend becomes almost effortless.
By using this technique, you’re letting the price action do the talking. There’s no need for fancy momentum indicators or the like.
Even for those of you who already know this stuff, the simplicity illustrated by the charts above is a good refresher.
Now that you know what to look for when trading Forex price action, it’s time to discuss listening methods.
By listening, I’m referring to the way you interpret the market’s behavior.
Trading price action effectively is about reacting to what happens on the charts. You never want to try to outsmart the market by guessing what might happen.
You have no trading edge if you do that.
It’s far better to take a defensive and reactionary stance. By waiting for the market to make the first move, you can react with confidence.
You’ll have evidence that warrants action—or in many cases, a seat on the sideline.
One of the greatest hurdles when it comes to listening to the market is a lack of patience. Most traders want to trade the price action on their charts, regardless of what it’s telling them.
Bad habits such as this one stem from the desire for action. Many traders, both experienced and new, find that doing nothing gives them a sense of impotence.
Those who struggle spend most of their time trading in and out of the market.
The profitable traders spend most of their time doing nothing.
Price action has been around for hundreds of years. There’s nothing new about it.
Yet there’s a reason it’s still used today—it just works.
It isn’t for everyone, and it’s important that you find a style that suits you. But if you’re tired of struggling with messy indicators and want a simple yet effective approach to the markets, this is it.
Trading Forex with price action allows you to view supply and demand in a way that no other trading style offers. You can see where buy and sell orders are without cluttering your charts with unnecessary indicators.
One of the best ways to use price action comes from the daily time frame. It offers a unique perspective that lower time frames can’t, particularly if you’re using New York close charts.
Just remember that a Forex price action signal such as a pin bar is only reliable if it forms at a key level. This is why it’s so important to draw support and resistance levels before scanning for signals.
Patience is the key to making Forex price action work for you. Always remember that the quality of the setups you take is far more important than the frequency.
I’d love for this new weekly Q&A to be successful and provide an invaluable repository of answers to common Forex questions.
To do that, I need your help.
Here’s what you can do to get involved and have your question answered in next week’s post:
Justin Bennett is an internationally recognized Forex trader with 10+ years of experience. He's been interviewed by Stocks & Commodities Magazine as a featured trader for the month and is mentioned weekly by Forex Factory next to publications from CNN and Bloomberg. Justin created Daily Price Action in 2014 and has since grown the monthly readership to over 100,000 Forex traders and has personally mentored more than 3,000 students.Read more...
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