What is Price Action Trading? My Crucial Guide For Forex Traders
A long time ago, technical analysis – like price action, was put in the same bucket as astrology, palm reading and fortune cookies.
No one actually thought there was any merit to it.
Anyone who was trading technicals back in the ‘old days’ was considered foolish. But hey, there was a time physicists believed if we traveled over 60 km/h, the g-force would rip our bodies apart… 🙂
Fast forward to the more intelligent age today (the information and data era, where we know things), you would be considered a fool not to have an understanding of price action concepts as a Forex trader.
Most traders now consider the technicals their ‘trading religion’, and rely heavily on them to make confident trading choices.
Therefore most technical analysis, like price action trading, now dominates the industry.
If you’re a passionate, aspiring trader, and truly want to attune your skills to become a master of the charts – one way or another, you will find yourself studying the concepts of price action. It is unavoidable.
As a warm up, let’s have a look at an example of a price action sell trade on the AUDUSD:
This was a sell signal that was very simple in nature – no complicated analysis necessary.
A large bearish reversal candlestick pattern formed off a lower high. At the same time, the weekly chart had a large bearish candle sitting on a big resistance level – really helping build value into the sell trade idea.
Then this happens:
This is the power of what price action analysis can do for you.
I risked $1000 on the trade to get these figures, but the numbers are all relative. $100 risk would have gotten a $400-$600 return, depending on how long you held the trade for.
Want to learn more more about how to go about identifying trade signals like the one above?
In this comprehensive guide, I am going to walk you through the ins and outs of price action, naked chart analysis, and candlestick trading.
Depending on your existing skill level, you should walk away from this guide with actionable information that you can apply to your trading methodologies today!
What is Price Action Trading?
Price action is a term given to a category of trading methodologies that use only basic chart data (like reading the story of candlesticks), to identify trade signals and forecast future price movement.
Because we are very analytical creatures, we tend to over complicate matters – making the ‘extras’ (i.e. indicators) very attractive and seductive!
Forex, and other financial markets exploit our hunger for extra data, setting us up to become easily paralyzed in ‘indicator land’.
This best thing you can do to help your recovery from ‘analysis paralysis’, is to hit the ‘reset’ button. Go back to basics and start again with price action.
So, what is price action?
Price action breakdown: it is the analytical study of historical price movement.
It is widely considered a compulsory learning step for Forex traders, as it’s the life blood, soul, and backbone of all things that have anything to do with technical analysis.
Most charts used for trading are graphical representations of price movement vs time (linear price on the y axis, and linear time on the x axis).
However, as will will discover further into the tutorial – this layout can change a little, and screw around a bit with the linear nature to get some really interesting charts.
Once you learn to the read the charts directly (without indicators) – you will develop the crucial skill of translating the ‘price footprint’, empowering you with the knowledge you need to transform yourself into a very confident trader.
Make the step towards understanding price action better, and I promise – you will look at the market from a whole new perspective. I want you to think of reading plain charts as interpreting the ‘language’ of the market.
The charts are trying to communicate to you through the price movements, you just need to be receptive to what’s being communicated.
When you think back to your dark trading days, you will wonder how you were ever able to survive trading without the knowledge of understanding price action!
As a technical, or even a quantitative analyst, it’s your task to look at current price behavior and compare it with past behavior.
The comparison of what’s happening now vs. the history of price behavior can arm you with the knowledge needed to accurately forecast future price movements – this is quantitative analysis 101.
The same price action candlesticks, and patterns occur repeatedly, and tend to produce the same reaction over and over again.
By learning these recurring patterns – we gain a statistical edge needed to become profitable over the long run!
Your edge as a price action trader boils down to how good you are at finding these reoccurring patterns, and recognizing all the conditions they form under.
Some price action nuances are:
- The behavior of the market you’re trading
- What session the signal/event formed in
- The structure of recent price action
- If the market is at a major decision point or not
Take a look at an example trade below which highlights the concept of using the market history to your advantage:
Paying attention to historical movements vs ‘the now’, can make a life or death difference in helping you forecast future price movement.
If you want to trade price action like a boss, study the chart history, collect data. Know your signals in and out, and you will be able to trade with a high degree of accuracy.
You would be surprised how many times these kind of price action events allow you the opportunity to position yourself ahead of the moves.
Price Action Explained in Different Market Conditions
One of the real skills you need as a trader, is the ability to work with most market conditions.
Granted, not all market environments can be traded safely, but at least the chart will communicate that message to you.
Markets are generally doing 1 of 3 things:
I am going to usher you in via the ‘keep things simple’ mantra, providing an insight into how you can trade these conditions pain free, via a no-fuss plain price chart.
Trending markets are considered the prime money making conditions because they are moving markets, and price movement = potential profit.
Trends are estimated to only occur 30% of the time – so while they are in motion, you’ve got to know how to take advantage of them.
I continuously keep coming across this question: “How can I determine the trend?”
Let me clear this up for you right now. Please, remember these key points, burn them into your mind!
- A trending market will leave a price action footprint of higher highs & higher lows (bullish), or lower highs and lower lows (bearish). It’s as simple as that, that’s how you find a trend.
- Real trends are established on swing trading time frames (4 hour and above). Don’t use low time frames to go trend hunting – you may find micro intra-day trends, but they often don’t align well with the bigger picture – providing low potential for return on investment.
- Sometimes there just isn’t a trend at all. Doing ‘nothing’ is sometimes the best position to take when trading.
Check out my article on trading without indicators to get more of an idea about price action trading with swing points in trending markets. For now, let’s keep things simple by looking at the diagrams below. Finding trends should not be more complicated than this…
A bullish trend – higher highs and higher lows.
A bearish trend – lower highs and lower lows.
When you see the trending footprint broken – for example the market stops making higher lows, or lower highs, then the trend momentum has probably died out, and you can expect some consolidation, or ranging markets to follow.
The ‘golden rule’ of trading (or any market place) is to buy low and sell high. Sounds simple enough, but does everyone actually understand that concept?
During trending conditions, many traders do the opposite, buying high and selling low…
Remember this quote: “Buy the dips, and sell the rallies“.
This is a good way to remember how to position yourself into a trend correctly, and avoid the chance of being taken out by corrections.
It’s a very common saying – meaning you look for selling opportunities when the market is rising in a bearish downtrend, or watch for buying opportunities when a market is falling in a bullish uptrend.
Sometimes, it’s important to go back to the basics and identify what a trend really is.
A trend is just a ‘stair-stepping market’, and a stack of exotic indicators are not needed to determine a trend. Remember the core trend rules from this lesson for identifying real trends.
That’s why price action is the best way to evaluate a market’s structure. You can quickly see if there is a trend or not.
Ranging markets are pretty straight forward. They are often called a ‘sideways market’ because their neutral nature makes them appear to drift to the right, horizontally.
There are two containment lines that act as the range structure. To put it simply, price bounces from range structure high to low, giving us price action traders an opportunity to make some money.
A ranging market performs a tennis match pattern, where buyers and sellers just keep knocking price back and forth between the invisible boundaries (support/resistance levels).
This will generally continue until the range structure is broken out of, and trending conditions start to organize. It’s important to remember that range boundaries are often ‘overshot’, giving the illusion a breakout is occurring. This can be very deceptive, and it does trap a lot of traders who positioned into the breakout…
You can see how these kind of fake outs can give off the wrong impression. Don’t try to trade range breakouts directly, especially if you’re new to the charts.
The best buying and selling opportunities occur at the range boundaries, in the form of reversal signals. Watch for candlestick reversal signals at these points to see if the tennis match is going to continue…
There are periods where the market doesn’t have any clear directional movement and congests to create consolidation. Some consolidation periods are just too hostile and volatile to trade and should be avoided.
Other consolidation periods do form more uniform price structures that can act like an early warning sign that a violent breakout is about to occur. These are called price squeeze patterns – sometimes referred to as wedges, or triangles by price action traders.
The idea is not to try and trade the bounces at the structure edges, but rather to wait for a clear breakout outside of the structure.
The important thing to know with these patterns is that you need to wait for a candle to decisively close outside the pattern before a breakout is confirmed…
Generally speaking, when you get a convincing close outside the squeeze structures, a decent move will follow. You must be very cautious about being the aggressive trader, looking to trade breakouts ‘as they happen’, because these consolidation patterns are notorious for fake outs!
As you can see above, the aggressive breakout trader can easily get trapped as the market gives off the illusion that a breakout is occurring. Getting caught in a fake out can be embarrassing. It may motivate you to negatively evaluate yourself, and kick off all kinds of self-destructive trading responses, like revenge trading.
It’s best not to trade these patterns in an aggressive manner, if you do choose to do so – just account for the extra risk of a fake out in your risk management plan.
Different Mediums of Price Action
There are more charting formats out there than just classic candlestick charts (though that is what most people are familiar with). There are other mediums for delivering price data can be used by technical analysts to get different perspectives on the market.
These other mediums may allow you to see opportunities that normally would have eluded you with your traditional candlestick chart.
This is an area I am researching heavily at the moment, but the preliminary findings look promising.
So, lets looks at the classic candlestick charts and some compare them against some of the other formats available.
Most traders believe New York close charts are the only charts you should be looking at. But the reality is, New York close charts only provide a reference point to base your analysis on.
I am not saying New York close charts are bad, they are excellent and I use them every day. But, have you considered using the London open time as a reference point for your cross analysis?
Let’s compare a New York close chart and a London Open chart…
With the London open charts, we are able to see a strong sell signal that was otherwise not as obvious on the New York Close chart.
But this is no reason to discount NYC charts either, as we can see a nice big sell signal there which was not as obvious on the London Open chart.
Here is a New York Open chart thrown in for good measure…
There isn’t anything obvious screaming out here, but this is just to show now with this one pair, we can have 3 different time perspectives which dramatically changes the chart.
This is like a panning for gold approach where you look through different time slots and see if anything jumps out at you.
You could really shift the charts 23 different ways, as you could generate a chart with every single GMT hour, but I think it’s important to keep things simple and stick to the ‘main event’ times like New York close, London open and the New York open if you really wanted to.
This really opens up the door to some unique analysis for price action traders!
Have you ever seen a renko chart?
They look absolutely beautiful – just one glance at you will be enchanted by their beautiful structure.
If you want to know more about how they work, see my renko charts explained tutorial.
To summarize: they are the result of removing time out of the equation – candlesticks that are price movement based, not time based.
Here is the same chart as the previous two above, but in renko format…
This is a 50 pip Renko chart, meaning the body of each Renko candle is exactly 50 pips – no more no less.
Every time the market moves 50 pips, a new candle (sometimes called brick) will form, regardless of how long the market takes to do so.
It could take 5 mins, 5 hours, or 5 days to create a new Renko candle, it’s purely a momentum based trigger.
Renko charts are great in the way they help eliminate noise, and really let you peer into the core movements of the market.
During strong trends, Renko charts paint a pretty clear picture…
It just paints a really clear picture to what’s going on with the market and can make chart analysis very pleasant. Things like finding market structure, and locating important support and resistance levels start to become very easy.
Obviously, you have the freedom to alter the renko chart size to whatever you like, you could have 10, 25, 200 pip Renko charts. The same principle applies as candlestick charts, if you start going too low – then the renko chart can become too noisy and lose its analytical value.
Heiken Ashi Charts
This is a chart format that is talked about only in smaller circles, but I’ve known about them for many years.
The easiest way for me to describe a Heiken Ashi chart is the result of applying ‘averaging’ math to a candlestick.
A new candle is created based off of averaging formulas applied to the previous candle. So in laymen’s terms, a Heiken Ashi candle is a unique ‘averaged’ perspective of the previous candle.
The end result is this ‘chained average effect’, helping ‘smooth out’ the chart noise. These charts are attractive because they filter short term vibrations in the market.
The Heiken Ashi average math does make the candles look unconventional. To understand what these charts are trying to communicate, the trick is to compare the body size to the wick.
If the body size is large, and the wick is small – this indicates strength in the price movement. If the body is bullish, then you’ve got strong bullish pressure, and a bearish body indicates strong bearish pressure.
If the body is small, and the wick is large – this can indicate the opposing side is ‘putting up a fight’ and momentum is slowing down. As a trend comes to an end, you will generally see the bodies get smaller and the wicks get larger.
If you see Heiken Ashi candles with wicks protruding out both ends of the body – this communicates indecision. Here is the same chart example from the candlestick and Renko sections above, put into Heiken Ashi format…
If you would like to learn more about Heiken Ashi charts – check out my Heiken Ashi charts explained tutorial.
My Custom Chart Builder For MT4
If the custom types of price action discussed above sparks your interest, and you would like to get them into your metatrader 4 platform – it is possible.
Disclaimer: This is a pitch for my custom chart builder software.
Before I continue, there are other ways to get these custom types of price action in your MT4. There are custom plugins floating around on forums.
In my experience they are a real pain to use if you’re trying to trade off them everyday – that’s why I made my custom chart builder, to solve all the annoying problems.
My chart generator allows you create all the charts discussed above, in as many different ways, and spin as many different charts as you like – all managed from the one panel.
You can see with the panel, I have a lot of control with the kinds of charts I can create. In this setup I’ve created
- 8h EURCAD New York Close Heiken Ashi chart
- 8h AUDUSD London Open candlestick chart
- 8h USDCAD New York Open candlestick chart
- 50 pip EURJPY Renko Chart
- 25 pip EURJPY Renko Chart
- 12h GBPUSD Heiken Ashi London open chart
- 8H AUDJPY candlestick chart applied to +2 GMT
Want to Learn More About Price Action?
If you’ve made it this far, you’ve probably gotten a clearer understanding of price action trading.
You should be starting to realize by now that a price action based approach to Forex trading is a very powerful and lucrative skill to invest the time in learning.
Any trading system that has a price action based methodology as its foundation is probably going to be around for the long term too.
I hope the guide here has been a nice ‘kick starter’ into your journey.
If you’re one of those ‘hungry for knowledge’ kind of people, you will probably start looking through Forex forums and google searches for more info.
The price action I explained here is only the tip of the iceberg. If you want to take your price action knowledge to the next level, check out our price action course – in my private war room for traders (which also contains all my custom MT4 tools).
Don’t forget to leave your comment below, your feedback on these tutorials is important to me and gives me the positive motivation to make more tutorials like this.
Look forward to hearing from you, best of luck on your new price action journey!