Introduction Into Price Action Trading

In today’s article, I want to spend some time talking to you about price action trading. Price action trading is very popular with forex traders but I know there is a lot of confusion out there, ( especially with beginning traders ) as to what price action trading actually is and more importantly……what it isn’t. In the article, I’ll show you some examples of popular price action trading strategies people use to trade the markets with, and I’ll also explain to you why price action trading is a far superior trading method to trading with indicators. On-top of that, I’ll give you my understanding of what price action trading is along with some useful links you can use to learn more about trading with price action.

I Hope you enjoy the article. Remember if you have questions, leave them in the comment section at the bottom of the page.

 

What Is Price Action Trading ?

Okay to begin, I think it’s best if I explain to you what I believe price action trading is, because there are many different interpretations found online of what price action trading is and a lot of these differ from one another so I just want to give you my take.

Price action trading is a method of market analysis which focuses on analyzing the current and past market prices to formulate ideas about which direction the market is going to move in the future. The main variable price action traders will concentrate on when trying to determine which way the market is going to move, is the market price itself. They don’t use any indicators or third party tools in their analysis of the market. To them the current and past market price contains all the information they need to make an informed decision about where the market is likely to move.

Some traders can get mixed up into thinking that technical analysis and price action trading are two different methods of analyzing the market. They’re not. Price action trading falls into the technical analysis discipline of trading due to the fact that most price action traders will primarily use a price chart to make all of their trading decisions. Technical analysis is where you make a prediction about which direction the market is likely to move in using nothing but a chart, therefore any trader who is using a chart to try to find out where the market is going to move, is a technical analyst whether they realize it or not.

Due to the similarities in name,  a lot of traders also feel like there is a difference between price action trading and supply and demand trading. Again, there isn’t. Supply and demand trading falls into the category of price action trading because of the fact supply and demand traders are using the market price to make all of their trading decisions. Supply and demand zones themselves are drawn from past price points and traders will often use common price action patterns to enter trades at supply and demand zones, so really there is no actual difference between the two, it’s just supply and demand trading is in-itself a price action trading strategy.

 

The Difference Between Price Action Trading And Trading With Indicators

If you’ve ever spent any length of time in online trading forums, you’ll have noticed there is often a huge battle underway between the people who think price action trading is the best way to trade and the people who think trading with indicators is the best way to trade.

Considering how different price action trading is compared to trading with indicators, it’s amazing how many similarities they actually share with one another. Both price action traders and indicator traders will make all of their trading decisions using a price chart and they will both determine which direction the market is likely to move in using just the market price. The big difference between the two, is in the way they both analyze the price to make predictions about the future.

Price action traders will typically tend to analyze the current market price in relation to the past market price to figure out which direction the market is likely to move in, whereas indicator traders will only analyze the past market price to try to find out where the market is going to move. All indicators are derived from past market prices, which essentially means the indicator traders are trying to predict the future using only the past. Price action traders do this too but with one very important difference, they are trying to predict the future by combining what happened in the past with what’s happening in the present.

A typical price action trading strategy will be one where the price action trader will determine a level in the market that’s formed based on the past price history, and then watch the price to see what happens when the market returns to the old level. If the market comes back to the level and produces a price action pattern the trader has knowledge of, he could see that as being a sign the market wants to reverse and move away from the level, in which case he may enter a trade to try and make some money from the reversal.

In this example, the price action trader has used the past in conjunction with the present to formulate a hypothesis as to where the market might be heading in the near future. He knew the market had reversed at the level in the past, but he doesn’t know if it is going to reverse at it in the future. So instead of just jumping into a trade betting the level was going to cause a reversal, he waited until the market returned to the level before seeing if the resulting price action confirmed the level had a high chance of causing a reversal.

This is how most price action traders trade, they either use the past combined with the present to make their trading decisions or they just base their decisions on what’s happening in the present.

Now lets look at how indicator traders will only use the past to make their trading decisions.

One of the most popular indicator trading strategies is the moving average crossover. The moving average crossover is a strategy in which the indicator trader will place a fast moving average and a slow moving average on his chart and then wait for the fast average to cross over the slow average. When they cross, the indicator trader will enter a trade in the direction to which the fast average has crossed over the slow average, as one average crossing the other is supposed to be a signal the market has reversed.

It sounds like a decent simple trading strategy until your realize that in order for the averages to actually cross one another, the market has to have already moved in the direction to which they have crossed.

image of moving average crossover on aud/usdTake a look at the image above.

You can see I’ve placed two different colored lines on the chart. The black line is a slow moving average and the red line is a fast moving average. If you look to the right of the chart (where I’ve placed the arrow ) you can see the point where the fast average crosses over the slow average. The bullish candle I’ve marked with an X is the candle which causes the averages to actually cross one another. When this bullish candle closes ( marked with a black line ), the indicator trader will enter a buy trade because he believes the market is now going to continue moving higher.

image of price action before moving average crossover

Here’s what happened in the hours after the averages had crossed.

As you can see, a couple of hours after the averages crossed, the market fell below the point where the indicator trader has entered his buy trade. At this point, despite being at a loss, the indicator trader will not close his buy trade due to the fact he still believes the market is going to rising. You’ve got to remember, the indicator trader makes all his decisions using the indicator, it doesn’t matter to him if the market has reversed and is already falling, until it has fallen enough for the averages to cross over again he doesn’t realize a reversal has taken place.

A short time after the market has fell below the point where the indicator trader had placed his buy trade, the fast average crosses below the slow average and the indicator trader closes his losing long trade.

When it comes down to it, the reason why this trader lost was because his trading strategy is based on trying to predict the future using the past. The moving averages cannot cross until the market has already reversed, so the indicator trader is always late into realizing a reversal is taking place. This is true for all indicator traders as well. Don’t think that this only applies to the traders using moving averages because it doesn’t. All indicators are calculated using past price history, which means they will all be late in picking up on changes in the market no matter which indicator a trader decides to use.

If you look at the image above again, you can see I’ve marked two candlesticks with ticks.

These two candles were an early warning sign the market might be getting ready to move higher. A price action trader would have seen these candles and knew a reversal could be about to occur at point A. The indicator trader would have never had this information because he relies solely on his indicators to tell him what’s happening in the market.

The is the main advantage price action trading has over trading with indicators.

By understanding how to read price action you can react to changes in the market much quicker than any indicator trader can, this allows you to anticipate market events well before they take place. You saw in the example how the moving average trader only realized a reversal was taking place AFTER the market had already reversed and moved higher, a price action trader would have been expecting this reversal to occur based on the price action that was forming before the market even began moving higher.

Another, more obvious difference between price action trading and trading with indicators, is what your charts will look like when trading with indicators compared to what they’ll look like when trading with price action.

image of chart with indicatorsHere’s an image of the 1 hour chart of AUD/USD. I’ve placed a few of the most popular trading indicators on this chart so you can see for yourself just how confusing it can be trading the markets using indicators. In the image it’s pretty difficult to even see what the current market price is. It gets even more confusing when you realize that each one of these indicators is a variable the trader must check before entering a trade. If all the indicators aren’t lining up properly ( in terms of what they suggest the market is going to do ) the indicator trader will not place a trade and will have to wait for another opportunity to arise.

image of support and resistance levels Here’s the same image again, only with all the indicators now removed.

Notice how much easier it is to see what’s really taking place in the market ? Now we can see what the market is actually doing instead of just relying on the indicators to tell us what’s happening. The image above is typical of what price action traders will be looking at when analyzing the market for potential entries into trades. The three black lines you can see I’ve marked ( called support and resistance levels for those who don’t know ), identify some points in the market where price action traders will look for entries into long and short trades. A few black lines are all a price action trader needs to make a decision about when to buy or when to sell, compare that to the indicator trader who needs each one of his indicators to be in the right place in order to enter a trade, and you can clearly see price action trading is much simpler than trading with indicators.

I hope you can now see the clear differences and benefits price action trading has over trading with indicators. There really is no comparison to be honest. Price action trading is simpler ( for the most part ) and more profitable than trading with indicators.

Let’s move on and take a look at which price action trading strategies you should use in your trading.

 

Which Price Action Trading Strategies Should You Use ?

Knowing which price action trading strategy you should use depends solely on what kind of lifestyle you currently have. If you’re someone who is not a full-time forex trader, then it’s not going to be possible for you to trade some price action trading strategies, due to the fact they require you to be in front of the computer during the day.

I think one of the best, and probably most popular price action trading strategies, is looking for pin bars to form at levels of support and resistance. Pin bars are a very simple price action pattern that form in the market all the time, as soon as you know what a pin bar looks like you’ll be seeing them appear on your charts everywhere. The reason pin bars form is because the bank traders are either placing trades to make the market reverse or taking profits off trades they’ve already got placed. Support and resistance levels are points in the market where the price has turned multiple times in the past. The idea is if the market has turned at the level in the past, it might want to turn there again in the future. So what price action traders will do is watch for pin bars to form when the market encounters a support or resistance level, because the appearance of a pin bar at a level of support or resistance is a signal the market might be getting ready to move away from the level.

image of bullish pin bar at support levelHere’s an example of a bullish pin bar which formed at a support level.

Before this bullish pin bar appeared, the price action trader would’ve already had the support level marked on the charts as a point where the market could potentially reverse, based on the fact there had been a number of occasions in the past where the market had fallen into the level, reversed and started moving higher. When the market begins to fall towards the support, the price action trader will be watching closely to see if a bullish pin bar appears, because if it does he knows it’s a strong signal the market might be about to move higher.

The price eventually falls into the support level and produces a bullish pin bar, at which point the price action trader would enter a buy trade with his stop loss below the low of the bullish pin, just in case the pin does not end up working out as he expected. As you can see from the image, a short time after the bullish pin bar has formed the market begins to move up. The price action trader is now at a profit on his buy trade and will close it when he feel’s like the market is no longer going to continue moving higher.

I hope you can see from this small example just how simple trading pin bars at support and resistance levels really is, all you need to do is take some time learning what pin bars look like and learning how to draw support and resistance levels on your charts. Once you’ve done this, you have a versatile trading strategy which you can use to trade the markets with.

What makes trading pin bars at levels of support and resistance such a versatile trading strategy, is that you can adapt it to suit whatever your lifestyle needs are. If you’re not a full-time trader or have work commitments during the day, you’re still able to use it as your trading method because pin bars and support and resistance levels appear on all time-frames in the market.

image of bearish pin bar at resistance level Here’s another image of a pin bar, only this time instead of looking at a bullish pin bar which formed at a level of support, we’re looking at a bearish pin bar that’s formed at a level of resistance. The main difference between these two images is that the bearish pin bar you can see in the image above has formed on the daily chart of EUR/USD, whereas the bullish pin seen in the previous image formed on the 1hour chart of AUD/USD. Because the pin has formed on the daily chart, it means it takes a whole day for the pin bar to actually form in the market, when the day comes to an end at 12:00pm GMT (or 10:00pm GMT if you use New York close charts) a new day begins and any pin bar which might have formed for that day now becomes valid for trading.

Because it takes a whole day for a pin bar to form on the daily chart, it means someone who is not available during the day can still successfully trade pin bars at levels of support and resistance because they can take their trades at the end of the day.

Summary

I hope this article has given you a decent understanding of what price action trading is and why it’s superior to trading with indicators. I know there are a lot of people out there who may want to learn more about the “trading pin bars at levels of support and resistance” strategy I mentioned during the article, so I’ve left the links to a couple of additional articles below which should help you understand the method better

How To Trade Pin Bars

Support And Resistance

Also, I’ve put the link to download the New York Close version of MT4 below so each trading day terminates at 22:00pm instead of 24:00pm. I’m just want to make it clear that I’m not affiliated with the trading broker who offers these charts in any way, so please make sure you do your proper research about them if you want to use them as your broker.

New York Close Charts

Thanks for reading, please leave any questions in the comment section below.

 

 

 

 

 

 

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