How To Understand Price Action In Forex
Finance

How to Understand Price Action in Forex

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How to Understand Price Action in Forex

How to Understand Price Action in Forex

Price action in Forex refers to a financial asset’s price movement. The study of price action is part of technical analysis. Rather than using chart pattern recognition or applying technical indicators, which are derived from moves in price and have a natural lag, Understanding price action in Forex is about getting to the bare bones of trading. By studying the movement in price over a set period, you get all the information you need to trade trends, breakouts, and swings effectively. Japanese candlestick charts perhaps the most commonly used form of price action in analysis. Price reacts to all known news, which means that moves in price tell you what the collective view of breaking news is rather than any single individual. The fundamental belief of price action analysis is that price is never wrong. So if you’re losing money, you are wrong. Your job as a trader is to manage this risk and close the trade. Learning about risk management is a key step to become a better trader. Not everyone is speculating and reacting to the news. Every day, billions of dollars are transacted through markets by entities that aren’t speculating. Perhaps it’s an insurance fund rebalancing its portfolios at the end of the month, a central bank managing its currency exposures, or a huge American smartphone company buying camera sensors from Japan in JPY. Either way, price action in Forex looks at all global capital flows at any one time and provides a holistic picture of what the market thinks of the currency pair that’s on your chart.

Price action is the raw price data of a market — without indicators. The ‘analysis’ part is learning to read these and make a trade based upon patterns. Indicators are the mathematical formulae that traders use on their charts to decide when to make trades. And, without them, it can be difficult to act on the insights the data provides. But indicators aren’t without limitations. They can be delayed, based on past data and don’t always tell the whole story. Price action in Forex is a simpler and sometimes more accurate way to make the right decision. By combining this guide to Price Action in Forex with forex trading tools, you’ll have a good grasp of trends and how to manage your money.

Core characteristics of How to understand price action in Forex

Here are the basic things you need to know:

  • Price action refers to the up and down movement of an asset/item’s price when it’s plotted over time.
  • Often you’ll see charts with averages plotted on, but raw price charts have the ‘candlesticks’.
  • Many traders use candlestick charts for trading decisions, since they help better visualise price movements by displaying the open, high, low, and close values in the context of up or down sessions.
  • Many short-term traders rely exclusively on price action and the formations and trends learned from it to make trading decisions.
  • Technical analysis is all based on price action. This means you’re not looking at the raw data when using technical analysis because it uses past prices to inform trading decisions.
  • Price action trading is more of an art than a science: two traders may arrive at different conclusions when analysing the same price action.

One trader may see a downtrend, while another might believe that the price action shows the possibility of a turnaround — purely based on their personal experience reading the charts.

Price action strategies in practice

For the most part, you use price action analysis for short- or medium-term trades rather than long term. Usually it’s for smaller profit gains too. First steps You must first take a look at the movement of the price action — identify whether it’s in a bullish or bearish trend — and make a decision on whether you think it’s likely to turn. The terms bullish and bearish refer to a positive or negative market movement. They are inversions of each other: bullish is an upwards trend and bearish a downwards trend.

Price Action Trading System

Price action trading is simplistic, and most systems usually have a two-step process for identifying and taking advantage of trading opportunities in the market. The steps are as follows:

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  1. Identify the Prevailing Market Conditions As mentioned above, a market can either be in an uptrend, downtrend or moving sideways. By observing asset prices, traders should quickly be able to tell what phase of price action the market is in at that moment.
  2. Identify the Trading Opportunity After identifying the prevailing market condition, a trader then proceeds to establish whether there is an actionable trading opportunity. For instance, in an uptrend, the price action should tell the trader whether prices will continue extending higher, or whether a retracement is expected. An example of a price action trade is when the gold price has been trending higher and is approaching $2,000. If it successfully breaks that level, then $2,000 will now be the new support area. A long position will now be entered after a pullback fails to break below $2,000. If an earlier support level was $1,980, the price action trader would place a stop loss level below that price, which is exactly where the uptrend will be deemed invalid. The exit on the trade can be triggered when the trader satisfies their risk/reward ratio, or when the market does not make higher highs and higher lows.

Price Action Indicators

The only relevant trade elements for a price action trader are price and time. This makes a price chart the most important trading tool for a price action trader. On almost every platform, candlestick charts are the most popular due to the detailed information they give traders on asset prices as well as their graphical appeal. A typical candlestick will display the high, low, opening and closing prices (HLOC) of an asset over a specified period. On most platforms, a candle with a higher closing price than an opening price is green in colour (bullish candle), whereas a candle with a lower closing price than its opening price is red (bearish). This detailed price information can tell a price action trader a lot about the collective action of market participants. The positioning of HLOC price points determines the size and shape of the candle as well as the information it provides to a price action trader. For this reason, some candle types provide bullish signals such as hammer; bearish signals such as hanging man; and neutral signals such as Doji. You can learn more about the different types of candlesticks in our comprehensive candlestick patterns guide. As time goes, multiple candlesticks are printed on a chart. This gives price action traders more price information as candlestick patterns form on the chart. Candlestick patterns allow traders to track the ebb and flow of market waves, and if understood and interpreted efficiently, they can help pick out lucrative price action opportunities in the market. Reading candlesticks and chart patterns is why price action traders trade with clean charts. Numerous chart patterns give traders three primary signals: continuation, reversal or neutral.

  • Continuation patterns, such as directional wedges and flags, form in trending markets and signal that the dominant trend will continue;
  • Reversal patterns, such as head and shoulders as well as double bottoms, signal that the momentum of the prevailing trend is fading and a reversal is to about to happen;
  • whereas Neutral patterns, such as symmetrical triangles, can form in any market and while they signal that a big move is about to happen, they do not provide a directional cue.

When it comes to candlesticks and chart patterns, reading and analysing the information they provide is more important than actually memorising their formation. Follow the candlesticks to determine the price pathway in the market. Learn how to read price chart patterns effectively in our comprehensive chart patterns guide. In addition to candles and candlestick patterns, price action traders can also use Trendlines to pick the most optimal price points in the market for entry and exits.

 

 

Price Action Trading Strategies

Price action strategies involve reading the psychology of market participants by watching price changes in the market. Here are some of the most reliable price action setups in the market:

Long Wick Candles

A candle in the market is depicted by a body and wick(s). The body is the distance between the opening and closing prices, while the wicks represent the extremes (the high and low achieved). Long wick candles are a favourite for price action traders. For instance, a candle with a long upper wick shows that in that period, buyers attempted to push prices higher by some distance, but sellers resisted the attempt and even managed to return prices close to the opening price. With this information, a price action trader can back the sellers again in the succeeding period or can wait for confirmation. Either way, long wick candles are a must-watch for price action traders.

Inside Bar After Breakouts

When breakouts occur, the challenge for traders is if it is a genuine one or a fake one. An inside bar breakout pattern is when one or more candles trade within the highs and lows of the large breakout candle, hence the name ‘inside’. The psychology for the setup is that market participants are unwilling to give back any breakout gains and are ready to defend and back the new trend going forward.

Trendline Trading

Trendline trading involves the use of lines to establish the optimal points to enter trades in trending markets. In an uptrend, a trendline is drawn from a particular swing low to a subsequent one and then projected into the future. Retracements to the trendline represent an ideal price point to join the uptrend. Horizontal trendlines can be used in ranging markets to map out support and resistance areas.

Conclusion: How to Understand Price Action in Forex

Price action in Forex is a powerful way of picking out and trading high probability trading opportunities in the market.

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