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Price Action Trading Strategies Every Forex Trader Must Know

Price Action Trading Strategies Every Forex Trader Must Know, FP Markets

Reading time: 17 Minutes

Price action remains a widely followed trading strategy and falls firmly under the umbrella of technical analysis.

Representing a broad discipline, technical analysis ultimately enables traders and investors to interpret the Forex Market (FX Market) and generate well-informed (albeit often subjective) trading decisions.

Based on previous and real price movements, instead of depending purely on technical indicators, price action trading continues to gain in popularity. Although it’s beyond the scope of this article to demonstrate each price action technique, the objective here is to feature those approaches that have, shall we say, stood the test of time. As with all trading setups, nevertheless, future results are not guaranteed.

Price Action Trading Strategies

Price action trading is a trading technique that can be applied to the stock market, Forex market, futures market, options market, and really any market that provides continuous data. The great thing about price action methodologies is that they function on any timeframe, and as noted above, can be employed on any financial instrument. Many claims that higher timeframes offer more reliable price action signals – the four-hour chart (H4 timeframe) and daily chart timeframe, for example – through this remains trader dependent. Some traders generate consistent results as short-term traders, while others prefer the slower way of trading (or investing) and approach the markets from a long-term approach.

Whether you adopt more advanced price action strategies, such as Elliot Wave Theory or Harmonic trading systems, price action trading, offers something for every technical taste, if you will.

  • Chart Pattern-Based Trading.

Head and Shoulders Pattern.

The head and shoulders pattern is a predictive chart formation that often forecasts a trend reversal. This pattern has long been considered a reliable indicator and is popular to this day. Considered a reversal pattern, traders work with a head and shoulders top pattern as a bearish structure and an inverted head and shoulders to shape a bullish pattern.

The patterns consist of three defined peaks for a top and three defined bottoms for an inverted configuration.

The first peak in a top is referred to as a left shoulder, followed by a subsequent higher high to form the head and then another right shoulder forms following this: the final peak. Note the pullback to form the right shoulder must not break the recently formed head. This is crucial to understand as it would invalidate the pattern’s structure.

So, when the head and shoulders top is spotted, and a neckline is broken, it usually signifies the currency pair is headed lower. The neckline, for a top, is drawn across the bottom troughs (as shown in figure 1.A) that align either side of the head, essentially serving as a support line. When, or indeed if, price moves (closes) below the neckline, after forming the right shoulder, it confirms the head and shoulders top. For top formations, it is best to see the neckline either in an ascending position or horizontal, while for an inverted pattern, either a descending neckline or a horizontal neckline is considered best.

Price Action Trading Strategies Every Forex Trader Must Know, FP Markets

Source (Figure 1.A FP Markets)

  • Support and Resistance Forex Trading Strategy.

Support and resistance (S&R) is a common approach and forms the bedrock of many technical-based trading methodologies. Horizontal support and resistance is established upon price respecting an area in the market. For example, figure 1.B illustrates clear support and resistance—the support being the floor of the market (albeit temporary) at $1.2176 and the resistance representing the ceiling of the market at $1.2325—again temporary. The more times a support and resistance level is tested, the stronger that level (or area) is said to be.

Price Action Trading Strategies Every Forex Trader Must Know, FP Markets

Source (Figure 1.B GBP/USD H1 Chart Showing Support and Resistance – TradingView)

A common way of trading support and resistance is to buy a bounce from support and sell a rejection from resistance. Generally, traders will target opposing resistance and support levels.

Another way of trading support and resistance is to trade the breakout. For example, if the price closes above a resistance level, traders generally look to trade the retest of that level as support.

  • Japanese Candlestick Trading.

Since the 1700s, when a Japanese man who went by the name of ‘Homma’ created them, candlesticks have been applied. He realised that there was a link between the price of rice, supply and demand, and the rice traders’ emotions.

Fast forward a few centuries, Steve Nison, a Westerner, discovered this secret strategy known as ‘Japanese candlesticks’ after learning it from a Japanese broker. Nison subsequently researched candlesticks before beginning to write about them in his book: Japanese Candlestick Charting Techniques (Nison, 2001).

Without Steve Nison, candlestick charts might have remained a buried trading strategy.

Candlestick Structure Explained:

The illustration below shows a bullish (white) and bearish (black) candle. This could be for one day, one week, or even one minute. It depends on the timeframe selected. The main section of the candlestick’s arrangement is the real body: the open and close of the candle. This informs the trader when the candle began its life and ended. These are important points to be aware of, and are often the preferred chart type precisely because of the real body, something which the bar chart lacks. We also have the upper and lower shadows; these are sometimes referred to as wicks. The upper shadow shows how high the candle traded during its life, and a low shows the lowest price traders were willing to sell.

It is obviously beyond the scope of an individual article to cover the entire library of candlestick patterns. However, as referenced above (Japanese Candlestick Charting Techniques), Steve Nison’s book is a good read with clear and concise explanations. As with any trading, education is key.

Price Action Trading Strategies Every Forex Trader Must Know, FP Markets

The shooting star is a popular bearish reversal pattern and can be found at market topping points. Its form implies that the price opened at its minimum, rose, and then retreated to the minimum. This indicates that traders sought to increase the price, though sellers prevailed, an unmistakable bearish indicator since no more buyers remain as they have all been defeated. A shooting star candlestick pattern’s structure consists of a real body that should form within the lower 1/3 of its range, with an upper shadow accommodating the upper 2/3, as demonstrated in the image below. Do bear in mind that it is best to see a non-existent lower shadow.

Price Action Trading Strategies Every Forex Trader Must Know, FP Markets

The hammer price action pattern is a popular bullish reversal sign that implies a larger possibility of the market moving higher rather than lower and is generally applied in upward-trending markets.

A hammer candle indicates that sellers drive the market to a new level. However, the sellers lack the strength to maintain their holdings at a low and liquidated which caused the market to recover and prompted buyers to re-enter the market. The hammer pattern’s form is exactly the same as the shooting star, only the mirror opposite. We want to see a real body accommodate the upper 1/3 of the candle range, with a lower shadow covering the lower 2/3. Again, the upper shadow should be limited.

A common strategy that candlestick traders employ is trading the hammer and shooting stars from defined support and resistance levels. They serve well as confirmation patterns.

Price Action Trading Strategies Every Forex Trader Must Know, FP Markets

Price Action Terms you Should Know

  • Breakout Trading.

As its name implies, breakout trading involves initiating a position following a break of an important level. A common example is a break of a round number ($1.2000, for instance), which traders look to buy (assuming resistance) once a level is breached.

  • Moving Averages.

Moving averages, at its simplest, provides an average value based on a number of predetermined observations. A 10-day simple moving average, as an example, provides an average value that represents the past ten closing prices.

  • Trading Styles.

There are four common trading styles: scalping (scalper), day trading (day trader), swing trading (swing trader), and position trading (position trader). The first two are considered short-term trading strategies, while the final two are longer-term trading approaches.

  • Chart Types.

Three of the most popular chart types employed by market participants are line charts, bar charts, and candlestick charts.

  • Pullback

A pullback is a move to the upside seen within a down-trending market.

  • Reversal

Most technicians understand the phrase as a transition from an uptrend into a downtrend or vice versa.

  • Pip

A pip (price interest point) is the Forex market’s smallest unit off-price change. GBP/USD trading from $1.40000 to $1.40010 equates to a 1-pip advance.

  • Demo Account

A demo account is essentially a practice account, designed to allow traders (and investors) to familiarise themselves with the platform’s features and also forward test trading methods using simulated funds.

FP Markets offer various types of Contracts for Difference (CFD) accounts, including demo accounts, for beginners, a recommended path before you commence real-time trading. They also offer various trading platforms, such as MetaTrader 4 (MT4) and MetaTrader 5 (MT5).

  • Financial Markets

Financial Markets facilitate a number of services, enabling buyers and sellers to exchange bonds, shares, foreign currencies, and derivatives.

  • Currency Pairs

A currency pair is made up of two currencies, and hence two nations. EUR/USD, or the Euro vs the US dollar, is a popular currency pair.

  • Fibonacci

Fibonacci is a popular trading strategy, composed of retracements, extensions, projections and expansions. These are commonly applied in trend-based trading strategies.

  • Technical Trading Indicators

Technical trading indicators, generally derived from price action and volume, are used by many traders and investors, measuring things like momentum, volatility and trend strength. Common indicators are the relative strength index (RSI), Bollinger Bands, and moving averages.

References: Nison, S. (2001). Japanese Candlestick Charting Techniques, Second Edition. In S. Nison, Japanese Candlestick Charting Techniques, Second Edition (2nd ed., p. 299). New York: Prentice Hall Pres. Retrieved July 1, 2022

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