Price action refers to changes to the price of a forex pair during a given timeframe. Whatever sentiment or fundamental factors exert an influence on the decisions of traders it will be reflected in the price action for that trading period. All buyers and sellers impact the price of forex pairs, stocks, indices and other kinds of securities. Price action trading relies on this basic truth. The people who trade based on price action don’t have to make use of many other indicators or analysis tools. If you would like to learn more about price action in forex trading, read on!
Would you want your charts clean or messy?
Price action charts are the darlings of those who prefer a minimalist approach in everything they do. This is because the price action chart only has candlesticks depicting the price action of a given currency pair. It is therefore easier for a trader to spot patterns and make decisions regarding whether they should make an entry into the market, close an existing position, or sit tight and wait for an opportune moment to make a move.
In contrast, traders who aren’t sold on the sufficiency of price action charts clog their charts with all manner of indicators from Bollinger bands, MACD, Stochastics and many other such indicators. This makes for a very messy chart, and since some of those indicators require space at the bottom of your chart, you will have very little space to keep an eye on the price movement itself.
Learning how to use price action in forex trading can save you the headache of using a messy chart to make trading decisions.
Know when the market is trending or when it is consolidating
It is important for any forex trader to quickly identify the general direction in which the market is headed. Is there an uptrend, a downtrend or is the market moving sideways/consolidating? Price action charts can give you all this information.
For example, when you see the candlesticks on your chart showing higher highs and higher lows, an uptrend is in progress. Conversely, when lower highs and lower lows are evident, a downtrend is ongoing. A sideways price movement indicates that consolidation is taking place since neither buyers nor sellers are in control. The chart below shows a bearish trend, followed by a bullish trend. The sections where the price is neither rising nor dropping are zones of consolidation.
Information about the general directional tendency of the market isn’t sufficient for you to make a trading decision. Rather, you need additional information that informs you that it is time to enter, exit or wait until better market conditions manifest.
Set your triggers
Price action in forex trading makes it a lot easier for those who have mastered this approach to making trading decisions. This is because you don’t have to analyze the information provided by many tools before you can open or close a position.
For example, you can look out for pin bars as signals for you to enter a market. A pin candlestick is one characterized by a long line (pin) at its top or bottom. When a pin bar occurs at a point of resistance, it may be time for you to enter a short (sell) position. On the other hand, when you observe a pin candlestick at a point of support, it may be time for you to open a long (buy) position. The chart below illustrates a bullish pin bar.
As you can see from the chart above, the price went on to trend upwards after the bullish pin bar pattern circled in grey. Savvy traders would have made quite some profit once they based their action on this pin bar pattern.
Note that price action trading has a high degree of subjectivity because the data available is open to different interpretations by different people. For example, a zone of consolidation in a candlestick chart can be read as a sign of a possible trend reversal while another trader can interpret the same information as showing that the prevailing trend could continue more strongly. This is why there are no guarantees that when you use a particular strategy or tool you are certain to make the right decisions all the time.
You should also note that price action trading isn’t the only right way to trade because each approach has its own strengths and drawbacks. For example, price action in forex trading may bring unexpected outcomes when a major news event allows the price action to defy all the rules. Indicators that were tracking a currency pair could suggest the possible scenarios of where the price could go next.
Having said that, price action trading is one way to keep trading simple, and that is why forex traders of all levels of experience make use of this approach to some extent. You too need to learn how to use price action in your trading strategy and over time, you will know when to use it or switch to something else depending on your trading style and risk-tolerance level.
High-Risk Investment Warning: Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial adviser if you have any doubts.