In recent years, the professional trading community has increasingly applied the concepts of price action trading to traditional, technical and fundamental analysis. The underlying premise of price action was once considered, among those techniques requiring a more subjective/artistic approach to price analysis as in predicting the future direction of currency values. Although it is not a new way of looking at the markets, price action trading was considered less scientific in this respect and therefore unattractive to those either new to trading or with minimal trading experience. However, with the surging popularity of forex trading over the past ten years, this form of analysis has become a highly effective method of finding profitable trading opportunities and for those wanting to develop an additional edge in the market beyond popular technical techniques.
What is price action?
Despite having a fairly ambiguous name, price action trading is actually one of the most straightforward methods of chart analysis available. It works on the basis of stripping charts down to their most basic level, initially removing all indicators and traditional methods of technical analysis. The first step to trade price action is to create a skeletal ‘map’ of the most influential support and resistance levels that exist on a price chart. Traders wait for price to react (this is the ‘action’ part of price action) at these important levels and look for profitable trading setups based on these.
Step 1: looking for high-probability price action zones
In creating the foundations to analyse price action, the key support and resistance areas need to be identified. These can be quickly and easily found by moving through the timeframes of any forex chart and observing where the historic support and resistance levels exist. The understanding, for price action traders, is that the market memory of these levels will still be influential, with those levels providing consistent support and resistance being the most powerful and thus harbouring the most opportunities for profitable trades. Those zones which can also be considered the most influential are price levels which have acted as both support and resistance (“flip-zones”) and which can be identified visually very quickly by looking through price charts on any timeframes. Typically, these may form around large round numbers or previous highs and lows, trend lines or Fibonacci retracement levels. These zones are formed by a large number of orders collecting at these prices levels. Once these are triggered the resulting price action will demonstrate if the support or resistance level is going to be maintained.
Step 2: confirming the existence of a price action setup
The next step in observing price action trade setups is how price reacts to these key support or resistance levels. This can be in a number of ways, with a confirmation reversal pattern being formed at these strategic points indicating a high-probability setup. One of the most successful ways to look for such price action trades is to analyse individual price bars in order to determine if the price action is confirming that the support and resistance levels are continuing to perform. An example of this is using candlestick analysis in order to visually confirm the performance of price once it comes in to contact with these trading zones. Traders will typically look for candlestick patters which suggest that a reversal is imminent at these points. The most reliable of these patterns can be the popular “shooting star” formation, “morning/evening stars” and the “doji”. The occurrence of these in addition to a number of other popular patterns can alert price action traders that the support or resistance level is holding firm.
Step 3: trading price action failures
Price action trading is not only limited to reversal patterns and looking for established areas of support and resistance to once again hold firm. It can also inform traders when a new trend is emerging with the breakthrough of price at these levels. Breakout trading is a reliable way of getting involved in a trade when a support or resistance area fails and price subsequently moves past this, typically moving powerfully beyond this as trades close positions which were opened in anticipation of a price reversal. Trading breakouts of previous support and resistance can either be aggressive, once two consecutive price bars have closed beyond the support/resistance zone, or more conservatively in waiting for a pullback. The conservative technique can be considered one of the most reliable forms of breakout trading, with price action likely to show the breakout and then a re-test of the support/resistance zone once this has been completed. Placing a limit order back at this level once price has broken through and moved beyond this is a popular and effective price action trading technique.
A quick note on support and resistance zones
These zones may not necessarily be at any one exact price level but should be considered as broad zones incorporating several pips higher and lower. Looking for price action trades within these broad zones, as well as breakout trades above and below these can be one of the most effective ways to trade using these techniques.