What is price action trading?
Price action trading is the rawest form of trading financial markets. Price action traders prefer to rely on price as their key market sentiment indicator to make trading decisions.
Here we’ll discuss many aspects of price action trading, including defining it, finding it, and building credible price action strategies.
What does price action mean?
Many novice traders go through a metamorphosis once they discover financial trading. They’ll find technical analysis and experiment with many combinations of technical indicators. Then they’ll begin to remove them from their charts one by one and trade off a more vanilla chart.
Price action is self-explanatory; you’re looking to identify movements in the price of a security as displayed on various timeframes. The price acts, and so do you.
You’ll mostly use candlestick formations to make your decisions. But you might prefer bars, lines, Renko or Heikin Ashi bars. All will display price but interpret movements in diverse ways.
Instead of cluttering your charts up with many different technical indicators, you’ll concentrate on sudden price movements, which may indicate the beginning of a trend.
Price now becomes your primary focus. You look at how aggressively price moves and the reasons why. Increased trading volume and volatility typically underpin the rapid action, and there must be a reason.
- Is it due to a macroeconomic news event, or has some published data pushed the price of a currency pair up higher or forced it lower?
- Has the price of a currency pair hit a support or resistance level or breached a round number handle like 1.3000 for GBP/USD?
What is price action in forex?
Price action in forex primarily occurs when the sentiment of a country’s currency suddenly alters. However, that initial change can lead to a trend developing which might remain for days or even months. Therefore, it’s crucial to note that price action isn’t particular to one type of trading style.
Whether you’re a scalper, day or swing trader, or position trader, you’ll use the same price action methods to make decisions.
Long term traders like position traders might look for daily candles to close each day to help them decide if a trend is continuing or if it’s nearing its end.
Many traders believe that price action on daily time frames is more defined than other frames because the original proponents of candlestick trading recommended its use on daily charts. They may use weekly resistance and support levels and apply moving averages such as the 50DMA and 200DMA to underpin their decisions.
Shorter-term traders might use daily support and resistance levels and watch breaking news events to be ready to act.
What is pure price action?
Pure price action is using the movement of price only to make trading decisions. You only concentrate on the charts and various time frames and apply minimal technical analysis using indicators.
You may even ignore fundamental analysis; you might believe it’s redundant because trying to guess how the market will move depending on macroeconomic data is not an exact process. And by the time the data is published, you might be too slow to react.
You look to either react quickly as price swiftly alters, or perhaps use an end of day strategy to look at 4hr candlesticks or the daily candles to make your decisions. You can ignore all other analyses and purely fixate on the candlestick patterns.
Such traders will also look for critical levels, perhaps S1-S3 and R1-R3, to make decisions. They’ll always be wary and mindful of round numbers/handles and may concentrate on the volume of orders in the market.
Does price action forex trading work?
If you develop the right skills, price action trading can be a dynamic and profitable method to trade the forex market. Many traders will develop straightforward strategies and concentrate on major currency pairs only.
Day traders tend to favour price action methods. They’ll keep an eye on their economic calendar and have a plan in place if the bulletins miss or beat the forecasts.
Often, it’s when the data gets published that price action can develop. If the currency pairs they trade suddenly react to the published data or news, they’ll execute their market orders. As previously mentioned, such traders will prefer vanilla or uncluttered charts.
How to develop a price action trading strategy
The process to create a credible price action trading strategy begins with a commitment to remove the most redundant technical indicators from your charts.
Then decide which style of trading you prefer; this will dictate the time frames you’ll use to make your trading decisions.
Next, decide which forex pairs you’ll trade. In some ways, this decision is made for you because the major FX pairs are the ones you’ll get the best spreads, experience less slippage and get the best fills. They’re also the pairs most likely to react to high impact macroeconomic calendar events.
Finally, decide if you’ll manually trade around the times you expect high impact news events to move markets. Alternatively, you could put automated strategies in place to capture the price action movements.
Things to be mindful of with price action trading
You might pay wider spreads when you practice price action trading because the sudden movement corresponds with increased volatility.
As more traders (both institutional and retail) enter the market and react to sudden movements, the technology might struggle to get your order filled. Therefore, the spreads you see quoted might quickly alter.
Alternatively, the spreads might get tighter. The important thing is to be aware that during times of rapid movement and comparative temporary market instability, rapid changes affect all aspects of trading, not just price.
- Better or worse fills closer to the quotes
As price changes and the liquidity pool copes with the increased activity and volatility. Therefore, your fills mightn’t be as close to the price you saw quoted when you click buy or sell.
You might experience slippage as your orders get filled a few pips away from the price you saw on your platform. But you might get positive slippage too, where you get a much better price putting you in immediate profit.
- Ensure you’re available for high impact breaking news
Being ready to act when the price of a currency pair is on the move is a tricky issue because we never know when markets will suddenly move, but we can make informed decisions about when they’ll probably move.
As we mentioned earlier, knowing what data or announcements are due to be published on the economic calendar each day is critical for price action traders.
So, you could decide to trade EUR/USD over the coming week and note when the high impact calendar events will happen, which are most likely to move the euro or US dollar price. Those events could be inflation reports, interest rates or monetary policy decisions by central banks.
But you must either make sure you’re able to at once act if the breaking news moves the needle on EUR/USD or use automation to capture the movement.
- Forex automation in its simplest form
A straightforward strategy that could be effective is to look at the economists’ consensus about a high impact event. For example, if the panel of economists predict inflation might rise in the USA when the latest data is published, and the Federal Reserve will tighten monetary policy consequently, USD might rise versus its peers.
You could be in long USD positions before the data is published or place a long order at a certain level you think might get breached if the economists’ predictions prove correct and the market for USD remains or becomes more bullish. Using orders like this while putting limits and stop losses in place is one of the most popular and rudimentary forms of automation.
Your platform choice is critical
If you want to make quick decisions and use all your skills to capture price action movements, you must use a trading platform like MetaTrader’s MT4. If you use a proprietary platform developed by a broker, you’re at the mercy of their technology.
MT4 is independent, designed to rank alongside the institutional platforms traders at banks would use; it has a massive and well-earned reputation for being the best in its class.
The automation mentioned can be easily adapted through MT4, and brokers who offer the platform tend to be the fairest.
You also must consider how you access the market through your broker. Think about the ECN, STP, NDD models. If you choose a dealing desk broker, they’ll place your orders to benefit their model, not your profitability.
Speed and accuracy are essential for price action traders. If you’re a day trader or scalper, the quotes, spreads, fills and overall efficiency of the process is critical to your success.
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