An Introduction to Price Action Strategies

An Introduction to Price Action Strategies

Reading time: 6 minutes

Price action is the movement of a security’s price over a given time period, and price action strategies assess and generate trading decisions based on this price movement. 

Financial markets produce data over various timeframes and, depending on the chart type, encompass open, high, low, and close (OHLC) values for each period. For example, the hourly chart offers OHLC data for each hour a market trades. A price chart essentially displays the current beliefs and expectations of all active market participants, thereby establishing price action. 

Price action provides a complete system that can offer high-probability trading opportunities. This is why so many traders, both steadfast technical analysts and those who combine technical and fundamental analysis, turn to price-action strategies for their chart reading. However, reading price action is a unique skill that requires time to understand and has numerous elements, including trend identification, the use of support and resistance, and much more.

Trend Studies

Identifying a market’s trend is enormously important for a price action trader, particularly if they seek to establish trading strategies that are aligned with the trend (or even trade countertrend). 

At its core, recognising a trend helps distinguish between a trending market and one that is consolidating (rangebound). Although there are technical indicators that help identify trend direction – for example, simple moving averages (SMAs) and the Average Directional Index (ADX) – most indicators are calculated based on underlying price action or volume (they are derivatives of price). 

To identify an uptrend, you must locate a series of higher highs (HH) and higher lows (HL). 

To identify a downtrend, you must locate a series of lower lows (LL) and lower highs (LH). 

Following an initial HH (LL) and HL (LH), the subsequent HH (LL) will confirm an uptrend (downtrend), as shown in Figure 1 (GBP/USD daily chart).

Once you learn to isolate trending movements, you can use this knowledge to trade in line with the trend. For instance, a common trend-following strategy that incorporates price action is that in an uptrend, the corrections that form higher lows (HL) are potential buying opportunities (usually at support), and vice versa for a downtrend: traders sell pullbacks that form lower highs (LH), typically from resistance levels.

Figure 1: FP Markets MetaTrader 4 (MT4)

Figure 2 displays consolidating price action.

Figure 2: FP Markets MetaTrader 4 (MT4)

Support and Resistance

Support and resistance are the floors and ceilings on a price chart, defining many price action trading strategies. They are therefore considered essential understanding for all traders and investors. Support is generally viewed as a location to consider longs (a buy position), and resistance as an area to consider shorts (a sell position).

Numerous techniques are employed to discover support and resistance on a price chart. On one side of the fence, objective support and resistance could be as simple as big figures (round numbers that attract attention, such as $1.2500 on GBP/USD or $130.00 on a stock you are watching), utilising the pivot point indicator, Fibonacci ratios (albeit the application can be subjective) and dynamic moving averages. Yet, many professional price action traders tend to opt for more of a subjective approach, involving not only support and resistance areas but also supply and demand zones (there is a difference). 

Figure 3 illustrates the daily price chart for Amazon (ticker: AMZN). You can see that resistance formed in 2022 and was subsequently breached in July. Following this, a test of that same area occurred as support in August and produced a moderately bullish reaction. Extending this area into the future enables the trader or investor to view potential support and resistance where price action could respond, particularly if aligned with the current trend and other technical tools.

Figure 3: FP Markets MetaTrader 4 (MT4)

In addition to trend identification and support and resistance, Japanese candlestick patterns are regularly used among price action traders. Often viewed as confirming signals at support and resistance, they also provide clear entry and stop-loss levels to work with. Take one of the more basic signals, the Hammer candlestick pattern (Figure 4). This single-candle formation is a bullish reversal indicator that can identify a location where selling has exhausted, usually following a downtrend or at support. Traders frequently enter the market following a hammer candlestick pattern via a buy-stop order above the candle’s upper shadow (upper wick [high]) and place a protective stop-loss order either below the candle’s lower shadow or beneath neighbouring support. 

Figure 4: FP Markets 

Adding to candlestick patterns, some traders use chart patterns as supplementary confirmation forms at support and resistance areas and as signals to enter or exit trending markets. Like candlestick formations, the number of chart patterns is vast. You can explore these more here. 

Putting it Altogether

Even though some traders choose to simply employ trend direction and support and resistance levels to form price action trading strategies, price action is a broad field. It is recommended that you learn the core elements – trend, support and resistance, candlestick analysis and chart patterns – as this is often enough to formulate high-probability trading strategies and start trading. 

To find a price action strategy you can trust, it is imperative that you conduct thorough back-testing on your chosen strategies; this helps validate whether the method possesses an edge. 

Price Action FAQs

1. What is price action?

Price action is the movement of a market’s price, usually viewed in candlestick formation using open, high, low and close (OHLC) values for each period.

2. What is support and resistance?

Support and resistance are key for many trading systems. Identifying a trending market is also considered essential for anyone exploring price action strategies.

3. Where can I learn more about price action trading?

If you have just begun your journey into price action and are unsure what to do next, this is where the FP Markets Academy comes in – a space that provides comprehensive articles and videos for beginner and advanced traders.