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Four Must Know Price Action Trading Strategies

Reading time: 19 minutes

Did you know that price action trading strategies are one of the most commonly used methods in today's financial market? Whether you are a short-term or long-term trader, analysing the price of a security is perhaps one of the simplest, yet also the most powerful, ways to gain an edge in the market.

Learn four must-know trading strategies

After all, every single trading indicator in the world is derived from price, so it makes sense to actually study it, understand it, learn from it and use it in your trading. In this article, we cover all you need to know about price action trading such as: what is price action and why you should consider trading price action forex - as well as - go through how to trade four price action trading strategies.

What is Price Action?

The term 'price action' is simply the study of a security's price movement. In price action trading, traders would look to study historical price to identify any clues on where the market could move next. The most commonly used price action indicator is the study of price bars which give details such as the open and closing price of a market and its high and low price levels during a specific time period.

Analysing this information is the core of price action trading. In fact, in answering the question 'what is price action?', it could be said that it is really the study of the actions of all the buyers and sellers actively involved in any given market. Therefore, by analysing what the rest of the market participants are doing, it can give traders a unique edge in their trading decisions.

The most commonly used price bars which are used as a price action indicator, are called candlesticks. All trading platforms in the world offer candlestick charting - proving just how popular price action trading is.

What is a Price Action Indicator?

As discussed above, we now know that price action is the study of the actions of all the buyers and sellers actively involved in a given market. The most commonly used price action indicator is a candlestick, as it gives the trader useful information such as the opening and closing price of a market and the high and low price levels in a user-defined time period. Let's look at an example:

Buyer and Seller candles

If you were to view a daily chart of a security, the above candles would represent a full day's worth of trading. Both candles give useful information to a trader:

  • The high and low price levels tell us the highest price and lowest price made in the trading day.
  • The seller candle, shown by a black, or sometimes red, body tells us that sellers won the battle of the trading day. This is because the closing price level is lower than the opening price level.
  • The buyer candle, shown by a white, or sometimes green, body tells us that buyers won the battle of the trading. This is because the closing price level is higher than the opening price level.

Using this simple candle setup is one of the first steps towards creating a price action strategy. For example:

  1. If after the seller candle, the next candle goes on to make a new low then it is a sign that sellers are willing to keep on selling the market. This weakness will cause some traders to initiate short positions or hold on to the short positions they already have.
  2. If after the buyer candle, the next candle goes on to make a new high then it is a sign that buyers are willing to keep on buying the market. This strength will cause some traders to initiate long (buy) positions, or hold on to the long positions they already have.

This type of price action analysis is just one way to use candlesticks as a price action indicator. However, the candles themselves often form patterns that can be used to form a price action strategy. Before we look at these patterns, let's first look at where they work best.

Price Action Forex Trading

As price action trading involves the analysis of all the buyers and sellers active in the market, it can be used on any financial market there is. This includes forex, stock indices, stocks and shares, commodities and bonds. You can view instruments within all these markets on candlestick charts and, therefore, implement a price action strategy on them.

However, the forex market has some specific advantages for price action traders, such as:

  1. Open 24 hours a day, five days a week - a true representation of buying and selling across all continents.
  2. Large liquidity - enabling you to trade in and out of markets within nanoseconds.
  3. Low spreads - some, not all, forex currency pairs offer low spreads which could keep the traders' commission costs low.
  4. Leverage - forex trading is a leveraged product meaning you can control a large position with a small deposit. This could mean big wins but also big losses, so please trade responsibly.

These are just some of the reasons why price action forex trading is popular. In the next section, we will use price action forex as examples before moving on to a forex price action scalping strategy.

Price Action Trading Strategies

A trading strategy requires three different elements: the why, how and what.

The 'why', is the reason you are considering to trade a specific market. This is where price action patterns come in use. Through your price action analysis, you will gain an edge on what is more likely to happen next - the market going up or down.

The 'how', is the mechanics of your trade. In essence, it is the manner in which you will trade. This analysis involves knowing your price levels for entry, stop-loss and target. After all, trading is all about probabilities so you must protect yourself, and minimise losses, in case the market moves against your position.

The 'what' is the outcome of the trade. What are you looking to achieve from it? Is it a short-term trade or long-term trade? This comes down to how you manage the trade to profitability and manage yourself if the outcome is not what you desire.

Price Action Strategy #1: The Hammer

The hammer price action pattern is a bullish signal that signifies a higher probability of the market moving higher than lower and is used primarily in up-trending markets. Here is an example of what a hammer candle looks like:

Hammer candle

A hammer shows sellers pushing the market to a new low. However, the sellers are not strong enough to stay at the low and choose to bail on their positions. This causes the market to rally back up, leading buyers to also step into the market. The open and close price levels should both be in the upper half of the candle. Traditionally, the close can be below the open but it is a stronger signal if the close is above the opening price level.

GBP/USD weekly chart

Source: Admiral Markets MT5 Supreme Edition, GBP/USD, Weekly - Data range: from February 25, 2018, to February 27, 2019, accessed on February 27, 2019, at 6:18 pm GMT. - Please note: Past performance is not a reliable indicator of future results.

In the above price action forex chart of GBP/USD, there are two examples of a hammer pattern - both highlighted in the gold boxes. Through the analysis of the open, close, high and low price levels the pattern suggests a move higher is likely. In these examples, price did move higher after the candles formed. Of course, this will not always be the case but how could you have traded it?

THE ENTRY: A possible price level to enter a trade, could be when the next candle finally manages to break the high of the hammer candle. The high of the hammer candle - which formed on the week of February 10, 2019 - is 1.2959. Therefore, an entry price could be 1.2960.

THE STOP-LOSS: A possible stop loss level could be at the low of the hammer candle. If the market triggers the entry price but no other buyers step in, it's a warning sign the market may need to go lower for any buyers to be found. Therefore, you would not want the stop loss to be too close to your entry. With the low of the hammer candle at 1.2727, a possible stop loss could be 1.2726.

THE TARGET: There are multiple ways to exit a trade in profit such as exiting on the close of a candle if the trade is in profit, targeting levels of support or resistance or using trailing stop losses. In this instance targeting the previous swing high level would result in a target price of 1.3200.

THE TRADE: With an entry price of 1.2960 and stop loss of 1.2726 the total risk on the trade is 234 pips. Trading at 0.1 lot would mean that if this trade triggered the entry price, then hit the stop loss, the overall loss would be $234. In this instance, the market traded higher to the target price resulting in an approximate trade profit of $240.

Price Action Strategy #2: The Shooting Star

The shooting star price action pattern is a bearish signal that signifies a higher probability of the market moving lower than higher and is used primarily in down trending markets. In essence, it is the opposite of the hammer pattern. Here is an example of what a shooting star candle looks like:

Shooting star candle

A shooting star shows buyers pushing the market to a new high. However, the buyers are not strong enough to stay at the high and choose to bail on their positions. This causes the market to fall lower, leading sellers to also step into the market. The open and close price levels should both be in the lower half of the candle. Traditionally, the close can be above the open but it is a stronger signal if the close is below the opening price level.

GBP/USD weekly chart

Source: Admiral Markets MT5 Supreme Edition, GBP/USD, Weekly - Data range: from February 25, 2018, to February 27, 2019, accessed on February 27, 2019, at 6:54 pm GMT. - Please note: Past performance is not a reliable indicator of future results.

In the above price action forex chart of GBP/USD, there are three examples of a shooting star pattern - all highlighted in the gold boxes. Through the analysis of the open, close, high and low price levels the pattern suggests a move lower is likely. In these examples, price did move lower after the candles formed. Of course, this will not always be the case but how could you have traded it?

THE ENTRY: A possible price level to enter a trade, could be when the market finally manages to break the low of the shooting star candle. The low of the third shooting star candle - which formed on the week of November 4, 2018 - is 1.2957. Therefore, an entry price could be 1.2956.

THE STOP-LOSS: A possible stop loss level could be at the high of the shooting star candle. With the high of the shooting star candle at 1.3173, a possible stop loss could be 1.3174.

THE TARGET: There are multiple ways to exit a trade in profit such as exiting on the close of a candle if the trade is in profit, targeting levels of support or resistance or using trailing stop losses. In this instance targeting the previous swing low level would result in a target price of 1.2663.

THE TRADE: With an entry price of 1.2956 and stop loss of 1.3174 the total risk on the trade is 218 pips. Trading at 0.1 lot would mean that if this trade triggered the entry price, then hit the stop loss, the overall loss would be $218. In this instance, the market traded lower to reach the target price resulting in an approximate trade profit of $293.

Price Action Strategy #3: The Harami

The harami price action pattern is a two candle pattern which represents indecision in the market and is used primarily for breakout trading. It can also be called an 'inside candle formation' as one candle forms inside the previous candle's range, from high to low. Here is an example of what a bearish and bullish harami candle formation looks like:

Harami candles

A bearish harami forms when a seller candle's high to low range develops within the high and low range of a previous buyer candle. As there has been no continuation to form a new high, the bearish harami represents indecision in the market which could lead to a breakout to the downside.

A bullish harami forms when a buyer candle's high to low range develops within the high and low range of a previous seller candle. As there has been no continuation to form a new low, the bullish harami represents indecision in the market which could lead to a breakout to the upside.

Here are some examples of bullish and bearish harami patterns that form over a period of time:

Bullish and Bearish Harami candles

So how could you trade these patterns as a price action trading strategy? There are many ways and no one perfect way. However, many traders use this as a standalone breakout pattern. Here are some possible rules to build upon:

Trading The Bullish Harami Price Action Pattern:

1. Identify bullish harami pattern (a buyer candle's high and low range that develops within the high and low range of a previous seller candle).

2. Enter one pip above the high of the last candle.

3. Place a stop loss one pip below the low of the previous candle (to give the trade some room to breathe).

4. Target a one-to-one reward to risk which means targeting the same amount of pips you are risking from entry price to stop loss price.

5. If the trade has not triggered by the open of a new candle, cancel the order. If the trade has triggered leave it in the market until stop loss or target levels have been reached.

Based on these rules above, here is an example of what it would look like on a chart:

AUD/CAD weekly chart

Source: Admiral Markets MT5 Supreme Edition, AUD/CAD, Weekly - Data range: from June 11, 2017, to February 28, 2019, accessed on February 28, 2019, at 11:49 pm GMT. - Please note: Past performance is not a reliable indicator of future results.

In the above chart of AUD/CAD, a bullish harami has formed. Using the rule above, one could have an entry price above the high of the last candle, with a stop loss at the low of the previous candle. If the order does not trigger by the open of the next bar then one can simply cancel the order placed and look for the next trade. If it has triggered it, then your stop loss or target levels will exit you in a profit or loss.

Trading The Bearish Harami Price Action Pattern:

1. Identify bearish harami pattern (a seller candle's high and low range that develops within the high and low range of a previous buyer candle).

2. Enter one pip below the low of the last candle.

3. Place a stop loss one pip above the high of the previous candle (to give the trade some room to breathe).

4. Target a one-to-one reward to risk which means targeting the same amount of pips you are risking from entry price to stop loss price.

5. If the trade has not triggered by the open of a new candle, cancel the order. If the trade has triggered leave it in the market until stop loss or target levels have been reached.

Price Action Strategy #4: Forex Price Action Scalping

There are a variety of forex price action scalping strategies available to traders. However, as scalping involves taking very short term trades multiple times a day, there are more filters required to trade a price action setup.

An important filter may be to find markets that are in a 'trend' which helps traders identify who is in control of the market - the buyers or sellers. Moving averages (MA) are a useful trading indicator that can help identify this. As scalpers are looking for short term moves, faster moving averages - such as the twenty period and fifty period moving average - are commonly used.

Now let's create some rules for a possible forex price action scalping strategy, that combines moving averages for trend and price action for entry and stop loss levels.



LONG SETUP

SHORT SETUP

4 Hour Chart

4 Hour Chart

20 MA above 50 MA

20 MA below 50 MA

Hammer or Bullish Harami pattern

Shooting Star or Bearish Harami pattern

Price action pattern to form in between 20 MA and 50 MA

Price action pattern to form in between 20 MA and 50 MA

Entry: 1 pip above candle high

Entry: 1 pip below candle low

Stop Loss: 1 pip below candle low

Stop Loss: 1 pip above candle high

Target: Previous swing high or pip risk (entry minus stop loss price)

Target: Previous swing or pip risk (entry minus stop loss price)

Cancel the order if not triggered by the start of a new candle

Cancel the order if not triggered by the start of a new candle



This is just an example to get you thinking about how to develop your own trading methodology. Any strategy, will have winning and losing trades so manage your risk sensibly. Now let us look at the strategy in action.

CAD/JPY daily chart

Source: Admiral Markets MT5 Supreme Edition, CAD/JPY, Daily - Data range: from July 14, 2017, to February 28, 2019, accessed on February 28, 2019, at 3:32 pm GMT. - Please note: Past performance is not a reliable indicator of future results.

The above chart of CAD/JPY shows a recent steady move higher. Let's view this on the four-hour chart:

CAD/JPY hourly chart

Source: Admiral Markets MT5 Supreme Edition, CAD/JPY, 4 hour - Data range: from February 5, 2019, to February 28, 2019, accessed on February 28, 2019, at 3:34 pm GMT. - Please note: Past performance is not a reliable indicator of future results.

The twenty period moving average (blue line) is above the fifty period moving average (red line). This meets part of the rules above for the forex price action scalping strategy. The next steps are to identify price action forex setups that develop in between the moving averages.

CAD/JPY 4 hour chart

Source: Admiral Markets MT5 Supreme Edition, CAD/JPY, 4 hour - Data range: from February 5, 2019, to February 28, 2019, accessed on February 28, 2019, at 3:38 pm GMT. - Please note: Past performance is not a reliable indicator of future results.

In the chart above, the gold boxes show hammer and bullish harami patterns that have developed in between the moving averages. The first two price action setups triggered the candle high price levels and then moved lower to the stop loss, resulting in two losing trades. However, the next price action setups triggered the candle high price levels and continued to move higher, possibly resulting in winning trades depending on how they were managed.

Conclusion

Price action trading is a powerful tool and widely used by traders all around the world. Is it time for you to incorporate it into your trading?

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