My philosophy on Forex trading is that: Price Action (PA) is the best system that can be utilized for trading the currency markets, while money management is your defensive edge (and the key to preserving and building your capital), and strong mental discipline is your offensive edge (enabling you to stick to your trading plan confidently and not trade based on your emotions). These three key elements make up the ‘three-legged-stool’ of trading success, and without any one component - a trader is very likely to fail. Today, I am going to discuss what makes Price Action better than the alternatives.
First of all, what exactly is Price Action trading?
Price action is a technical trading system used by Forex traders that does not require the use of indicators or fundamental analysis when interpreting the currency charts. Price action literally looks at what ‘price is doing’, it lets you read into the overall market psychology to anticipate future price movements.
Price behaves the way it does as a result of the behavioral patterns and decisions of the traders (human and algorithmic) who are participating in the market at any given time. Though people are unpredictable and somewhat chaotic (making every moment in trading unique); when viewed as a whole – traders have a ‘herd mentality’, generating recurring patterns can be learned, recognized, and taken advantage of.
Take a look at one of the most occurring price action patterns that we trade in the market everyday - it’s called a ‘Rejection Candle’. It demonstrates the market ‘rejecting’ and important support or resistance level, in this case a rejection of support - communicating higher prices are very likely to develop in the near term.
After the bullish rejection candle formed - we seen higher prices develop in the following trading days.
After the initial bullish rejection signal, the following trading sessions generated bullish rejection candles as price made its way higher. All these bullish price action setups seen higher prices develop from them. It’s a nice easy setup to identify and build a high probability trade setup off – without the use of any fancy indicators or ‘magic’ chart tools.
What are the benefits of trading a Price Action system?
At the most basic level, traders who use PA are at a HUGE advantage because they actually learn how to read the raw price charts and trade directly from them. Think about this statement. Many people who are trading Forex, do not actually understand what they are doing, but instead rely on indicators and luck, hope or intuition, or maybe at best they stick to a general rule (such as trade with the trend, ‘the trend is your friend’, etc.) - but beyond that do not really understand what they are seeing when they look at the charts.
Can you imagine the exhilarating feeling of confidence that you experience when you genuinely understand what you are seeing on the charts and you can “read them like a book“? Learning the language of price action is in my opinion the ONLY way to trade Forex. At the very least I think all traders can gain an advantage from understanding price action trading - considering most technical trading systems are derived from price action in the first place.
It is proven that people (i.e., traders) do not react rationally to financial news releases and the various fundamental variables that drive the economy and the currency markets. This is why many traders find themselves frustrated after they have ‘studied up’ on all the key variables that should be affecting the pair they are trading, and yet it does not ‘act as it should’.
It is not these news releases or economic variables that we must then learn to understand and master, but people’s reactions to them. You can observe this if you take a look back through your chart history. The news will generally create short term ‘noise’ on the chart - but at the end of the day, it’s the technicals that end up being respected by price.
This is another advantage of trading with price action, you have TONS of historical trading data right at your fingertips - and if you feel compelled to spend hours pouring over the charts (especially as many new traders do), instead of mindlessly watching the price tick up and down, use your time wisely and study and learn these previously illustrated patterns.
Better yet, utilize the internet and educate yourself on price action and look into high probability candlestick signals, like the rejection candle, or the Inside Candle. This can significantly cut down the time it takes you to become competent and really speed your learning curve.
Take a look at another favorite price action setup of mine - the Double Inside Day.
This is a consolidation pattern where you get one candle, whose range is completely engulfed by the previous candle’s range, and then that pattern is repeated again with the next candle. SO you have an inside candle within and inside candle.
Check out the double inside day breakout setup that formed on the Gold spot market recently (xau/usd).
Inside Day patterns can produce nice breakouts if you trade them correctly, but double Inside Day Patterns are the catalysts for really explosive breakouts - and tend to work much better than their single inside day counterpart.
Notice how potent the breakout was from the double Inside Day pattern. You don’t need any fancy charting software to spot these kinds of price action setups. Just work with the plain price charts and you can catch nice breakouts like this – BEFORE they occur.
Price action is incredibly simple and clean when compared to trading with indicators. There are many ‘signs’ for traders to follow based only on the candles/candle combos that are printed, support and resistance levels (a.k.a., S/R levels), and EMAs (‘exponential moving averages’ used as guidelines for dynamic levels of support and resistance) - tip we use the 10/20 EMA’s to map out dynamic support and resistance.
Price action is a method of looking for the most commonly repeated patterns, so that you can gain an edge as you begin to learn to pick out certain situations that have a “low risk/high probability” of playing out in a specific way. In other words, this approach to technical analysis allows you to get into the ‘mind’ of the market to anticipate what is likely going to happen. Price action analysis focuses on what the market is doing ‘NOW’ in relation to what happened in the past over what you ‘THINK’ the market should be doing based on your logic or projected by some lagging indicator.
Here is an example of a messy, confusing and frustrating charting environment…
Seriously – I don’t know how any Forex trader can work with a system like this…
Here is our price action chart ‘no fuss’ template that we work with every day in the markets…
I think most traders would appreciate the refreshing change that price action provides from all the other intense trading systems out there.
Indicators are based on the mathematical data from previous price action, so they are always lagging. Unless the market is in a strong trend, the constant changing and fluctuating of the market makes indicators ineffective because by the time they tell you to make a move – it is too late, and the conditions are already changing. Even worse, some indicators can make some charts indecipherable. They just clutter up and confuse the ‘message’ that PA is sending us.
When used properly, price action traders only trade when the circumstances are just right. They don’t just guess and jump into a trade because they see price moving, or because their indicators gave them a green light. They can look at a chart and instantly know if they should even consider a trade on a pair (here’s a hint: if price is in consolidation, or whip-sawing around wildly - don’t!) Price Action traders look for confluence to strengthen their decision to take on a trade, meaning ideally: What are the market conditions? Is there a stable trend in place? What is the bias of price right now?
Also, consider the bias of price in general (such as on the weekly chart). Is price respecting the mean value as a dynamic S/R? Do you have a strong trade signal? Can you expect to achieve a positive risk/reward scenario of 1:3 (or 1:2 minimum)? Are you getting in at a good price? – The classic ‘buy low/sell high’ mentality, taking advantage of retracements or reversals. By having these checks and balances in place, a disciplined trader should be able to keep himself from overtrading or trading based on emotions.
Many other benefits that come with price action trading involve understanding the nuances of the price behavior, such as “What might happen as price approaches this S/R level?” Conditions may be perfect for buying in to a strong bullish trend with the ideal signal candle presenting itself, on a retracement, etc.; but, if you are approaching a strong level of S/R - you may decide to wait to enter and see if price shows further buying pressure to drive it through that level first. Or you may think that price is going to reverse and you can get in at the top of a long profitable downtrend.
Either way, it may be in your best interest to be patient. Another example could be, “What should you do when price is straying too far from the EMAs?” Price action traders can look at their simple clean charts with only with important support and resistance levels, then quickly and easily interpret whether or not it would be wise to enter a given trade.
The message here is that it is just as vital that you recognize which trades to avoid as which trades to take. Price action is simple and systematic, and this takes a lot of the stress and uncertainty out of trading.
Most traders seriously only start to find their way in the markets when they learn how to trade forex using price action. It is the most stress free, logical and easy to understand method used in the markets today – and it works!
I hope this article has inspired you to make the switch to price action - trust me you will never look back.
Cheers to your trading future!