The main challenge for new traders is information overload.
Newer entrants often suffocate charts with technical indicators, seeking the holy grail of trading strategies.
Price action, however, proposes a cleaner alternative. Some traders refer to this as ‘trading naked’.
All financial markets generate data – data that can be observed through price charts. This movement is price action, the collective trading decisions of market participants.
To anticipate future price movement, learning to read price structure is essential.
Figure 1.A displays a candlestick chart of the GBP/JPY, on the H1 timeframe.
Based on the candlestick’s colouring:
- A green candle indicates a bullish tone, a move to the upside.
- A red candle indicates a bearish tone, a move to the downside.
Do note you are able to colour code candles to suit personal preference via the trading platform’s settings.
In addition to the candle’s colour, its arrangement is important to understand.
At its core, candles display five key points (see figure 1.B).
A candle high signifies the highest point the market traded during the candle’s life. The life of a candle is dependent on the timeframe selected. It could be a day, an hour or a minute. The low represents the lowest point the market traded during the candle’s life.
Low and high points are also referred to as shadows or wicks (for highs) and tails (for lows). The length of a candle’s shadow is significant, revealing data that occurred outside the candle’s body.
The open is the price level the candle began its formation, whereas the close is the price the market concluded trade during its time period. A candle that opens at 1.2500 on the daily chart, for example, and closes at 1.2530, 24 hours later, represents the closing price.
The candle body, or real body, demonstrates market sentiment (the direction) throughout a specified period. This is the range between opening and closing price points.
Bullish and bearish candles basically demonstrate the same characteristics. The key differences, though, are colouring of the candle, along with open and close prices – they’re reversed.
It is with candle structure price action traders define candlestick patterns – patterns which help forecast future price movement. Popular patterns are the pin bar (hammer or shooting star candlestick patterns) and engulfing formation.
As the ocean ebbs and flows, so does price movement via peaks and troughs (these are also called swing highs and swing lows). This is market structure.
Analysing peaks and troughs can be the simplest way to define the market trend. To begin, traders generally focus on the extreme points, ignoring inner movement from the intraday (short term) timeframes.
Figure 1.C shows the GBP/JPY H1 chart demonstrating clear peaks and troughs.
May 17 to early June shows price movement forms higher peaks and troughs (higher highs and higher lows), establishing a trend to the upside. After topping, this followed with a series of lower peaks and troughs (lower highs and lower lows) to the downside, the beginnings of a downtrend.
The trend break to the downside, according to figure 1.D, was seen on June 11 (blue arrows). Price action penetrated the trough formed prior to establishing the apex/top in the uptrend, signalling a potential downtrend.
Lower-timeframe price structure, however, shows the trend break could have been spotted sooner.
Three main charts are used by retail traders: the candlestick chart, which we’ve been working with above, the bar chart and line chart.
Candlestick charts are considered to have originated in Japan, as early as the mid-1600s. To this day, candlestick charts remain one of the most popular forms of charting.
Candlestick charts offer similar construction to bar charts, depicted in figure 1.E. Like candlestick formations, price bars display a high, low, open and close (often referred to as an OHLC chart). The open for a bullish candle can be found by the left horizontal line and the close by a right horizontal line. A bearish candle is the same, just reversed.
The difference between the two is its visual presentation. The candlestick body is prominent and filled, allowing traders to quickly determine price direction, whilst bar charts display the body by way of a vertical line.
A line chart (see figure 1.F) provides traders with basic information.
A continuous line is formed, calculated using closing prices.
Line charts can be particularly useful to display correlations (figure 1.G). Another common use is to help establish support and resistance levels – line chart data overlooks high and low extremes, effectively filtering price action.
Price action trading is a popular division of technical analysis, covering several different areas.
Understanding the basics of price action enables traders to consider more advanced trade setups, incorporating concepts such as support and resistance levels, trendlines, chart patterns and Fibonacci studies.
Price action also equips you with the ability to define a trending market, identify breakouts within that trend and recognise pullbacks/retracements.
The article has barely scratched the surface regarding what price action offers. What it has hopefully done, however, is empowered newer entrants and provided a stepping stone to further enhance their trading skills.
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