Price Action Trading Explained
We have been getting a lot of questions from newer traders to price action on what is price action and how can one do price action trading. What we are going to cover is the traditional definition of price action, how we approach it differently than others, and how can one trade price action in the forex market.
What is Price Action?
In the most traditional and technical sense, price action is simply price’s movement over time. This could be on any time compression from the 1min up to the weekly chart. Any price fluctuation for any instrument is a form of price action. Price action trading is the science and art of trading these price fluctuations over time with little or no indicators. By learning to read price action and price’s movement over time, one can;
-see where the institutional players are heavily involved
-where they are driving the market
-where are key support and resistance areas
-where to find precise entry and exits
-what is a key breakout
-how to catch reversals
-tops and bottoms
-get into trends
-what are impulsive vs. corrective moves
-what kind of market environment you are in
This is why learning to read price action can be a critical component of ones trading.
However, based on one’s approach to it, there are key differences in how one can trade it.
Various Ways to Approach Price Action
For the most part, all of the vanilla price action techniques you find out there are based upon patterns. Some of these patterns can be flags, triangles, double tops and bottoms, pinbars, inside bars, etc. But if you are trading these patterns just because they are a pattern, then you are really failing to understand what price action is.
The proximate driver of price action is order flow which is the total summation of all buy and sell orders that are executed in the market. It does not matter whether the market is moving because of a fundamental or technical reason. Order flow is the most consistent force which causes the price action to change.
Because we do not have direct access to order flow, we have to learn how to read its sibling which is price action. Price action has the fingerprints of order flow all over it. Since the most common driver of market movements come from order flow, then we have to learn how to read price action. This is how we approach it.
We trade price action strategies and patterns, but we do so with the key understanding that all price action is the result of order flow. And since order flow is what moves the markets, then we have to learn how to read order flow through price action. This how you can take your price action trading to the next level.
Trading Price Action
Price action trading in the forex market is a learnable skill that anyone can do. With the proper training, mentor and study, one can learn to trade price action successfully. In the forex market, because it is such a highly liquid market, trading becomes a lot easier because as you have more liquidity, you have a more technically pure market. There are various ways to trade price action in the forex market and we will share one method while explaining the order flow behind it. We will compare this to trading the pattern by itself and show you how it fails.
Trading Just the Pattern By Itself
An inside bar pattern is a common price action pattern whereby all of the price action (body and wicks) of a candle are inside the range of the previous candle. Here is a picture below showing an inside bar pattern:
Now inside bars can be traded as both reversal and trend continuation techniques. If one was just trading the pattern itself without understanding the order flow behind it, one could be seriously misled into trading a lesser inside bar simply because it was a pattern. Just because a pattern or formation shows up does not mean we want to trade it. We will give you an example.
Not All Inside Bars Are Created Equal
Lets say it is 12hrs before a major announcement, or a friday, or a holiday of sorts. During such events, order flow diminishes as the institutional players leave the market until the risk events are over. In these times, many inside bars can form since there is nobody in control of the market and no heavy liquidity or order flows. If you were just trading inside bars because an inside bar showed up, you could be trading during a non-optimal time because the market will not take a direction till after the risk event. So this is one example of how trading a pattern because it shows up could be harmful to your trading.
This is why it is critical to understand the order flow behind the market and why the price action is forming the way it is. This way you can determine who is in control (the buyers or sellers). You can determine if it is a powerful breakout or a false one. You can determine if the trend will likely continue or not. All of these are critical to trading price action and understanding how the order flow is creating such variables.
Below is a chart example of how not all inside bars are created equal and why you need to avoid some of them. Take a look at the chart below:
In this chart, you are seeing the price action from 9am EST up to 1am EST (a total of 18hrs). Take a look at all the inside bars above. Here you have a total of 3 inside bars, yet they produced no special reaction. Price was stuck in a virtual 50pip range for over an 18hr period.
If you were just trading inside bars because it was a price action pattern, you would have had many false breakouts and likely many losing trades. Now lets take a look at another example of how an inside bar can be used for a successful trade by reading the order flow behind it.
Taking a look at the chart below, we can see an inside bar forms after a very powerful with trend move. There could be several reasons for this but lets read the order flow behind it.
1) Price has been climbing for 4 days in a row suggesting the buyers are clearly in control.
2) The last candle was a very strong candle and the largest in this move suggesting strong participation
3) The inside bar comes right at the parity level suggesting the market is respecting it
4) However, the selling in the inside bar is quite weak communicating the sellers have little sway
5) Thus, the buyers are likely to continue the trend after this weak push back
So empowered with all this information on learning how to read the order flow behind the move and inside bar, we can make a much more informed decision on trading this inside bar. We can trade this as a with-trend continuation move knowing the buyers are heavily in control. And as we can see, the market climbed for over 300pips over the next three candles.
Price action in its most technical form is price’s movement over time. This is for any instrument on any time frame from tick charts up to monthly charts. All price action is the result of order flow which is the total summation of all buying and selling. All the price movements we see on the chart are derivatives of order flow. In other words, order flow is the cause of all price movement and its sibling is price action. Since we do not have access to aggregate order flow in the forex market, learning to read price action and the order flow behind it is key.
In trading the forex market, we can trade price action patterns by themselves, but we can easily see how dis-empowering this is. Patterns by themselves are meaningless unless we can read the price action and order flow behind it. When we can read the order flow, we can determine where the institutional players are buying and selling, the speed of buying and selling, where are key support and resistance areas, when the market will continue the trend, when it will reverse and when key breakouts are happening. All of these are critical to trading price action so our goal must be to learn how to read price action and the order flow behind it.
For those of you wanting to learn how to read price action and the order flow behind it, take a look at our Advanced Price Action Trading Course where you will learn rule-based price action systems to trade the forex market.
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