Four Must-Know Price Action Trading Strategies

Four Must-Know Price Action Trading Strategies

Almost all beginners have heard of the Price Action method, but many people identify it with the usual candlestick analysis, which is not quite correct. The fact is that the Price Action really takes over many of the provisions of the candlestick analysis, but it is an optimized method for the current market conditions.

We suggest taking a closer look at this type of technical analysis to understand what Price Action is and how it can be applied to enhance your trading results.

What is a Price Action?

Price Action is a relatively young strategy, it became known and popular in the 2000s. But its basis is clearly seen in the theory of Charles Dow - the founder of technical analysis.

One of the fundamental principles of this theory says: "price discounts everything". It means that the forecasting of the future price changes is based on the analysis of prices. They already have all the necessary information, and adherents of this strategy do not waste their time analyzing economic and political news. These are the basics of price action.

As an extension of the history of the price action strategy, it is worth mentioning Steve Nison who published a book on candlestick analysis in the 1990s. He was the first to talk about trading using only the knowledge of Japanese candlesticks. And Martin Pring taught how to trade based only on price behavior and price levels.

Gradually, interest in trading without the use of indicators increased. In 2005 the price asset strategy took shape and is used by traders all over the world. Its founder is considered to be an American blogger who devoted a ForexFactory forum thread to price action.

Today many traders are studying price action and teaching its principles to others. They include Al Brooks, Dan Chesler, Cory Mitchell, Bob Volman, and others. Lance Beggs has become particularly famous among them. He has developed a trading system based on price action named YTC Price Action Trade. Lance Beggs' course is suitable for beginners and experienced traders because of its simplicity, versatility, and profitability.

Price Action Forex Trading

As we have mentioned, the price action approach implies trading without indicators. An indicator is a mathematical formula. This tool registers price values without analyzing the reasons that led to them.

Many traders mistakenly take indicator signals as 100% motivation to place orders, even if the overall market picture contradicts them. That's where the mistake lies.

The price is constantly influenced by various factors. The price action strategy allows you to work with it, relying directly on the data it provides. Indicators lag significantly behind the price in time, so information derived from them cannot be considered reliable.

Working with price, you trade in real-time. Success here depends solely on your attention and reaction.

Price Action is a universal tactic; there are no restrictions on the markets used. Particularly, it gets along with major currency pairs, for example:

  • EUR/USD is one of the most liquid currencies and is used by beginners and experienced traders alike. However, due to its high liquidity, trading in this pair is associated with high risks.
  • GBP/USD is also in great demand. It has a sufficiently strong movement and liquidity.
  • USD/CHF and USD/JPY are calmer and are preferred by beginners at the beginning of their careers.

In addition to currency pairs, when choosing an asset for the price action, one should pay attention to commodity exchanges, for example, metals. These assets are stable and well predictable.

To a lesser extent, the Price Action suits to work with exotic instruments. There is a high probability of abrupt and unpredictable market movements, connected, for example, to Central Bank announcements, or sanctions against the corresponding country.

As for the stock market, it is advisable to limit yourself to highly liquid assets. The same recommendations apply to other categories of assets (cryptocurrency, commodity market). The lower the liquidity of the instrument, the worse Price Action patterns work. For example, it works on BTC/USD, but if you work with crypto pairs made up of altcoins, this methodology may fail.

As for time restrictions, the recommendation is standard - do not trade during the release of important news. If you work on the stock market, then the main source of surprises can be quarterly reports. It is not recommended to work 1-2 days before and 1-2 days after the reports.

Price Action Trading Strategies

Price Action strategies are based on well-known patterns, each has its description. In principle, each of them can be called a ready template for trading. They are structured and have a very precise guide to action. The pattern shows a certain situation on the market. For example, we all know that every first Friday of the month the U.S. labor market data is released. Depending on what was in the report, the forex market behaves differently. But in general, we can distinguish 4-5 scenarios, and each time everything will happen according to one of them. The observant trader will conclude and know in advance how to act accordingly.

Price Action strategies have a similar principle. The patterns reflect the typical behavior of market participants. Of course, if we look at the 1-minute chart, it is unlikely that we will find two identical cases of pattern construction. But on the hourly chart, there will be a lot, not to mention the four-hour and daily chart. Attention is paid to the following aspects:

  • The position of the candles relative to each other. This usually looks at the high/low and closing of some candlesticks in the pattern.
  • The proportions between the candlesticks or the proportions between the individual indicators of a candlestick - the candlestick body to the whole range.

Of course, there are many trading patterns of Price Action, but we will discuss the most popular strategies that you will often encounter in practice.

Price Action Strategy #1: The Hammer

To understand what happens in the market when the Hammer candle eventually appears, let's look at everything in order. To do this, you can go to a lower time frame and remember a simple sequence:

There is a bearish trend in the market, the price is going down. The trend should consist of several candles.

At some point, the price comes to the area where the demand is large enough and starts to exceed the supply, and significantly. There is a reversal of the short-term downtrend, and our candle begins to draw a long lower shadow.

This change in trend causes the Hammer candle to close well above its low.

Thus, we get a Hammer-like shape. The long shadow indicates that the price is in the area of high demand, in addition, currently some of the sellers begin to fix the profit on their trades. This is usually the further construction of a bullish trend, even if sometimes it is a local one. The model is quite common in forex, stock market, metals, and cryptocurrency.

In the classic definition, the Hammer candle has strict proportions between the range of the candle itself and the range of the body. It is believed that the most accurate patterns can be called those in which the entire range is at least 2 and a maximum of 3 times the range of the body. That is, the body makes up from 1/3 to ¼ of the candle.

So, if we have a candlestick on the chart that fully fits the description, we can start trading. The main thing to remember is never to enter before the end of the formation of the candle. No matter how beautiful everything looks, even a four-hour candle can change dramatically in just 5-10 minutes. So, we calmly wait for the end of the formation and only then buy.

It is not necessary to buy the entire planned volume at once. It can be evenly distributed into several trades and buy as the price decreases during the formation of the next after the pattern candle. However, this may not be the case, so the decision must be made by the trader, based on his principles of risk management. It can happen that in the pursuit of higher profits he will miss a good entrance and then everything will not be so profitable.

The stop order should be placed behind the lower shadow. At the same time, it is advisable to make another small indentation of a few points, because in Forex there are sharp and rapid movements that can bring down the stop, which is right behind the shadow of the Hammer. One should not go too far away. On the H4-D1 scale, 7-10 pips are enough. There are traders who believe that the Stop should be placed farther away, but the transaction should be closed manually if the next candle after the Hammer completely overlaps its range and closes below its lower shadow. This has some logic to it, there are a lot of examples when the price broke out the Stop and then ran upwards. If you use the variant with split entry, then you can also put a separate Stop-Loss - one below the shadow, and the second farther away.

As for the Take-Profit, we can select one of three options:

We set a Take-Profit equal to the size of the Hammer candle, i.e. it is assumed that the price will increase by the range of this candle. This is a practical observation, which is also peculiar to some patterns from the graphical analysis.

Price Action Strategy #2: The Shooting Star

The shooting star is a bearish reversal pattern consisting of just one candle. It is formed when the price rises significantly, and then a correction occurs, leaving a long wick at the top of the candle. The long wick should be at least half the total length of a shooting star candle.

Also, the closing price should be near the low of the candle. As a result, a bearish pattern is formed, because the bulls couldn't keep the price at higher levels.

A similar pattern is observed in the Inverted Hammer pattern, but the inverted Hammer is a bullish reversal candlestick, contrary to the bearish pattern of the shooting star. The latter appears after an uptrend, while the inverted Hammer appears at the end of a downtrend near a support level.

What is noteworthy, the shooting star candlestick gives traders the same signal, regardless of the asset (forex, stocks, crypto).

Because of its simplicity, a shooting star pattern is a great tool for novice traders. The algorithm for detecting a shooting star candle is very clear if traders strictly adhere to the theoretical framework described.

However, it should be noted that sometimes the shooting star pattern signal may not be confirmed because a single candle may not be the most important one in the general trend or market dynamics. For example, a candlestick might occur near an important resistance level, but after a "break" the bulls might increase the pressure and break it down. Therefore, a proper risk management strategy is very important when using this candlestick pattern. It "backs up" the trader in case the situation develops negatively for him.

Trading on this figure is quite simple. First, the candlestick implies a further price decline, so traders aim to open a short position when a shooting star is detected. Since the bears had previously fought back near the top of the shooting star, traders set a Stop-Loss at the recent high of the price swing.

The trader can place an order after the next candle opens or, if the trader is following a more conservative strategy and would like a better risk/reward ratio, watch for a retest of the wick.

After the formation of a shooting star, the price often corrects and temporarily returns to levels above the low of the wick. An experienced trader may wait to enter the market at the midpoint of the wick, rather than opening an order immediately after the close of the shooting star. It means that the trader opens a short position at a higher price level closer to the Stop-Loss, which reduces the level of risk. Regardless of the chosen entry point, the Stop-Loss level will remain unchanged.

As for the profit target, traders often set the Take-Profit level at least twice as low as the Stop-Loss level relative to the entry point. It presents a 1:2 risk/reward ratio.

Price Action Strategy #3: The Harami

The Harami candlestick pattern is easy to spot on a chart. It is formed in a trending market and is a combination of 2 candles of different sizes and directions.

The pattern serves as a signal of a possible change of trend. The combination can be described as follows:

A candle with a pronounced body and slight shadows in the direction of the trend is formed. This candlestick is called a "mother" candlestick.

The second candle is at least 2-3 times smaller than the “mother”. It is the opposite of her in direction, called the "child.

Here is the essence of the pattern. If after the second candle, the asset starts a strong move in the opposite direction, it means the trend began to change and it is possible to open the appropriate position.

The Harami pattern reflects the market sentiment with a weakening trend. They're making a last-ditch effort to drive the price down or up, which is reflected in the "mother" candlestick. After that, a "child" is formed, which shows the uncertainty of traders. And when the asset makes bright moves in the direction of the new trend, it becomes obvious that the old trend has lost strength.

Harami is used in real trading as an additional signal confirming a trend change. It is often accompanied by other technical analysis techniques such as indicators, support/resistance levels, and Price Action patterns.

When entering the market, it is important to analyze exactly where the pattern was formed and how the asset behaved afterward. Several additional factors increase the chances of success:

The application of Harami is only possible if there is an established trend. In this case, the longer the trend exists, the more probable is the appearance of the reversal signal.

The assumption of a trend reversal can be made only when the model has already been formed and the corresponding opposite candles have appeared.

The larger the bodies of those candlesticks, the more certain they are that the reversal has occurred. It is important to pay attention to the fact that the first bar after the pattern closes appreciably higher than the Harami.

If the Harami is formed near an important support or resistance level that has already been tested many times by the asset in history - this is another reason to enter a trade.

If a "child" candle is formed without a body or with a very small body (Doji) - this greatly increases the chances of success.

It is a very important skill for traders to skillfully combine the use of patterns and technical indicators. For example, if there is an increase in volumes on the chart along with the formation of the Harami - it gives much more reason to place an order.

Finally, the time frame analyzed by the trader is also vital. Usually, the Harami is not considered at intervals below one hour. That said, there is an important feature for the daily charts: the "child" candle is not formed inside the "mother” but rises in line with it.

Harami cannot be called a win-win candlestick pattern. If you trade this pattern, you will have both triggered Stops and trades that closed at breakeven. But if you learn to filter this type of pattern, you will get a reliable tool for making money.

Trading The Bullish Harami Price Action Pattern

Traders can identify a bullish Harami pattern using the five checklist points:

  • There is a clear downtrend.
  • A bullish Hammer appears in front of the Harami, which gives the first clue that the trend may reverse.
  • The bullish candlestick is no more than 25% of the previous candle's range.
  • A bullish candlestick opens and closes within the range of the previous candle.
  • The RSI indicates that the asset is oversold. It may entail that the bearish momentum is reaching the low point, but traders wait until the RSI crosses the neutral line (30 pips) again for confirmation.

Stop-Loss can be placed below the new low, and traders can enter when the candlestick following the bullish Harami pattern opens. Since Harami candlesticks theoretically appear at the beginning of an uptrend, traders can use several target levels to maximize profits from the entire uptrend range. These targets can be located at recent support and resistance levels.

Price Action Strategy #4: Forex Price Action Scalping

The combination of scalping and Price Action is quite unusual but very effective. When scalping, candlesticks can also be useful, for this it is necessary to keep a list of the best and most common patterns. Another obvious advantage is that we can have a lot of signals in low time frames because appropriate trading situations will occur quite frequently.

So, scalping according to the Price Action is based on the following principles, which are carried out sequentially:

  • Identify potential reversal areas on the chart. This is the most important thing, and it is exactly what will allow us to apply scalping, candlesticks are more suitable for higher time frames, and the presence of such an area is simply necessary. They are not difficult to find. We will use the simplest option - the area of support and resistance. To do this, it is necessary to identify the levels in a high time frame on the chart. For example, if we trade in the periods from five to fifteen minutes, then supports and resistances will be marked on hourly and four-hour charts. This can be explained by the fact that the reversals should be significant. With M5, the price can make 10 reversals in the same place even during one trading day; that is, such levels should not be taken seriously.
  • Wait. When the price approaches this area and breaks it out, it is a key moment, as the reversal will happen. Sometimes the price can easily pass such a level, but we should not think about it at present. So, the price reaches the reversal area, after which it forms a reversal signal. In our case, it needs to be candlestick pattern, even if it is formed in a low time frame. So, the appropriate and most common combinations when using scalping are Engulfing, pin bars, rails, and outside bars. These patterns should be studied carefully, they work perfectly in low time frames.
  • Trading itself. We have an important reversal area, we have a combination of candlesticks, now we can consider entering the trade. As we mentioned earlier, the possibility of trading is because there are the first two factors. The candlestick patterns on M15 without justified levels are not suitable for trading, there are too many false signals. And here we have everything ready. From the classic scalping techniques, we can add a couple of filters, for example, use a standard combination of two Moving Averages with different periods and wait for the crossover or use some oscillator for reversals. That is, it will be one more confirmation that the price reverses. A Stochastic oscillator with standard settings (5;3;3) is very suitable, it is very responsive to reversals. Additionally, you can use the MACD, it will give a signal for the continuation of the rebound, which we will use as a confirmation of the reversal and a signal to hold the position.

This strategy is very intuitive and understandable. The main idea is that we use different combinations and approaches, but they all are aimed at the same thing. As in any trading system, the more filters, the better the signal, but this, on the other hand, significantly reduces the number of such signals. In the case of scalping on Price Action, everything turns out harmoniously - we just should wait for the moment and then enter the trade.

Conclusion

If we assess what Price Action is in trading from the position of an ordinary trader, then upon first acquaintance with it, one may think that it is a real grail. The technique is not outdated and provides a 70-80% win rate if the rules are followed. Later it becomes clear that this tactic is not without disadvantages. One of the main problems for beginners is learning to wait for the formation of a signal that is 100% consistent with the rules.

If this problem is solved, Price Action is guaranteed to provide profits. But it is necessary to perceive this style of trading correctly at once. This technique is not and never has been a grail, it's just a good trading methodology that relies on chart analysis, not on working with indicators.