Price is the most brutally obvious thing in Forex trading. What do most profitable traders and indicators have in common? They both read price. I am trying so hard to hold back the urge of putting down indicators. I can do my best by describing it with one word, “harmful”. Success in Forex is about what works for you, but indicators do not work for a lot of traders I know (I’m included). Promise me one thing, if you have the ability to read price bar by bar on the charts for yourself, do not rely on indicators to do it for you. They either lag (reacting after the big move has taken place) or lead (producing a lot of false signals). If “price action” is an unfamiliar concept to you, then start here.
Price Action is what most traders tout as the “holy grail”; it is the observation of past price movements to predict future directions. The weather forecaster and the one who predicts the outcome of a football match have everything in common with the price action trader. They all go back in time in order to make a probable decision, so they seldom miscalculate. Price action works because when price is approaching a supply or demand zone, many traders are looking at those zones to make a probable decision. It works because it makes sense out of a seemingly senseless market. Price action can also be used to trade every symbol on the market and not currencies alone. It is the most respected technique when mention is made of technical analysis.
To access the content of this course click here or see the immediate right from this “Overview”, there’s the “Curriculum”. You can as well see below.
Price Action Charting.
Forex trading platforms offer 3 types of charting systems which are line charts, bar charts and candlestick charts. As price action traders, we have no business dealing with line and bar charts since they do not represent the history of price enough to our full satisfaction. Nonetheless, line charts can be of some help when looking out for support and resistance zones. Bar charts are okay to some extent but to fully understand price technically and visually, candlestick charts are the ideal.
Line Chart: This charting system helps a lot when market turning points become hideous with candlestick charts. It aids in plotting support and resistance lines before fine tuning them on candlestick charts.
Bar Chart: Traders seldom use this system when charting, it is kind of archaic.
Candlestick Chart: The ultimate for Price Action.
The Anatomy of a Candlestick.
The Candlestick is a Japanese invention and it tells the story of how price has reacted over a period of time. Candlesticks communicate 4 pieces of information to traders; the open price, the close price, the high price and the low price. Each single candlestick in a chart corresponds to the time-frame you are in, i.e, in a 1 hour time-frame every candlestick took an hour to form, in a 4 hour time-frame, every candlestick took four hours to form and so is it in the daily time-frame and the rest. The various candlesticks that can be found in a candlestick chart as grouped in this module are; Neutral, Bullish, Bearish, Inside bars and Uncommon Patterns. In the picture below, the white candlestick represents bullish sentiment and the black candlestick represents bearish sentiment. These colors are going to remain constant through this lesson.
Legend: Bullish- sentiment is positive so price must go up (buy)
Bearish- sentiment is negative so price must go down (sell)
Support and Resistance.
If you have ever bought something before, if you have ever sold something before, chances are that you bargained to buy at a low price in order to save some amount or you managed to sell at a reasonably high price in order to make realistic profits. Picture support and resistance as a room; the floor is support and the ceiling is resistance.
Now picture a basketball as price; when it is bounced it hits the floor, goes up to hit the ceiling, then down to the floor again and cycle repeats. These are market turning points that relates to the economical laws of supply and demand. You have come across tops and bottoms in the previous lesson; a market top is resistance and a market bottom is support.
They can be either horizontal, diagonal or even dynamic. To that effect, if a market is not ranging, it is trending. A market that is kept trading in a horizontal S and R is in a range and a market that is trading in a diagonal S or R or both is in a trend. This brings us to the construction of trend lines and channels.
The 3 states of a market are: i. Range (sideways) ii. Uptrend iii. Downtrend
A market in an uptrend consists of higher highs (HH) and higher lows (HL).
A market in a downtrend consists of lower lows (LL) and lower highs (LH).
In a downtrend, a trend line is constructed by connecting the lower highs and in an uptrend, it is constructed by connecting the higher lows. It needs at least, 3 touches to be valid.Some markets trend so nice that, instead of just a trend line, you’d need 2 trend lines to create a channel. Some markets are also run away markets in the sense that they trend steeply without obeying the concepts of trend lines and channels.
Learn how to plot Support, Resistance, Trendline and Channels in the video below.
Warning: I hate to be the bearer of bad news but prices do not bounce off support and resistance forever. If it were so, trading would be simple because markets would range forever or trend forever. These levels break eventually and when they break, they either run away or retest. Retests are based on the theory that previous support can turn into resistance on a breakdown and previous resistance can turn into support on a break up. Conservative traders wait for retests and aggressive traders just jump in.
The arrows signify the areas of S and R that have been retested. Conventionally known as support turned resistance or resistance turned support.
As we come to the end of this lesson one thing you should note down is to never force a trend line!
Price action consolidation
Over the charts, you’d see all the messy stuff that doesn’t make any form of sense and makes trading so much of a headache. What if they made sense? After strong trends you’d realize a market pause to take a breather; out of this breather we get chart patterns which come in the form of various consolidations. They signal the end of a trend or the continuation of a trend. In 3 groups, we have Reversal, Continuation and 2 way chart patterns.
Reversal Charts Patterns: End of a trend. An uptrend tumbles down and a downtrend turns up.
A market in an uptrend, hits resistance twice and price reverses. The idea is to wait for a break of the neckline and go short. Stop loss goes above the neckline and target is obtained by measuring the height of the double top to the neckline.
The opposite of the double top. A market in a downtrend finds support twice and reverses. On the break of the neckline, go long. Stop loss goes below the neckline and target is obtained by measuring the height of the double bottom to the neckline.
NB: There are triple tops and triple bottoms as well and I believe you have a fair idea of what it should look like.
Head & Shoulders:
An uptrend should be in place; market then finds resistance which makes up the left shoulder, breaks through it falsely to form a head and falls back within the range. Go short on the break of the neckline; Stop loss goes above the neckline and target is obtained by measuring the height of the head to the neckline.
Inverse Head & Shoulders:
Mirrors the head and shoulders A downtrend should be in place; market finds support to form the left shoulder, breaks through it falsely to form the head, only to fall within range again. Go long on the break of the neckline and stop loss goes below the neckline whilst target is the height of the head to the neckline.
Price consolidates and trades within an uptrend channel that forms with the trend already in place in the form of a wedge. Go short on break of wedge support; stop loss goes above wedge resistance and target is the height of the trend with the wedge area inclusive.
This is the inverse of the rising wedge. Price consolidates and trades within a downtrend channel that forms with the established trend in the form of a wedge. Go long on break of wedge resistance and stop loss should go below wedge support. Target is the height of the trend and wedge.
Continuation Chart Patterns: An uptrend takes a break only to move higher and a downtrend takes a break, and then moves lower. Just like the reversal chart patterns above, stop losses go below and above marked support and resistance and targets are still obtained by their measured objectives. Same is true for the 2-way chart patterns.
Flags: In an uptrend the market tends to weaken, thereby causing price to slope down in the form of a flag. The opposite is true for a downtrend with a slope up.
Rectangle: The established trend should be in place but the market comes to a pause and trades in a tight range (box).
Wedges: These wedge patterns form against the established trend, unlike the ones in the reversals which form with the trend
2-way Chart Patterns: These patterns are approached with no directional biases until significant breakouts occur; since they can break either way. Buy and sell stop orders can be used simultaneously for entries.
Ascending triangle: Price moves in such a way that a firm horizontal resistance is met; however the support comes in the form of higher lows.
Descending triangle: The exact opposite of the ascending triangle. A firm horizontal support is respected but resistance comes in the form of lower highs.
Symmetrical triangle: Both support and resistance are formed diagonally as prices makes higher lows and higher highs. The levels then converge at a point.
- Broadening formation (more or less like the inverse of symmetrical triangle), Diamond Top and Cup & handle are other consolidation patterns are really rare but they can be very profitable when correctly identified and traded accordingly.
- Pennants are very small and tight ranged symmetrical triangles and they are strictly continuation patterns.
The structures used to represent consolidation patterns are pretty simple and easy to identify. Identifying them on a real chart comes out a bit tedious, at least for noobs. It would be intimidating in the beginning, but it gets better with time and practice. Below is a candlestick chart with some consolidation patterns. Do well to identify them on your own.
- Head & Shoulders
- Symmetrical triangle
- Descending triangle
- Bearish flag
Fibonacci is a theory propounded by renowned Italian Mathematician, Leonardo Fibonacci. It is a sequence of ratios that have a quiet complex calculation formula but our tool does it for us and that is as far as we need to know. Its ratios are evident in nature but that is not much of our concern as price action traders. What we are looking forward to is how to use that famous tool to profit from the markets. We are going to learn about the Retracements and Extensions only. Fibonacci simply works! And it complements price action.
Fibonacci Retracement levels: 0.236, 0.382, 0.500, 0.618, 0.764, 0.886, 1.000….
Fibonacci Extension levels: 0, 0.382, 0.618, 1.000, 1.382, 1.618, 2.236….
It is not so common for markets to run away! There is the theory of mean reversion which says that a trending market will revert to its mean before the resumption of its trend. Reverting to the mean means pulling back for a while, otherwise termed as retracement and this is where the Fibonacci retracement tool comes in handy. When it retraces, it falls back on one of those retracement levels listed above. A 100% (1.000) retracement signals a change in direction of a trend.
To use the retracement tool if in a downtrend, first identify the most previous swing high, press and hold to the most previous swing low. If in an uptrend, first identify the most previous swing low, press and hold till the most previous swing high.
The fib tool can be used with support turned resistance or resistance turned support, with candlesticks (or on its own) and with trend lines.
In this video, you will learn how to use the Fibonacci tool judiciously.
Fibonacci Extension levels come in pretty handy when there is no near term support or resistance level; after a deeply informed analysis. It is used to set take profit orders.
There’s an advanced form of a really profitable trading strategy which fully utilizes the retracement and extension tool. It is called Harmonic trading which consists of the ABCD, 3- drive and Gartley patterns. I do trade them once in a while only if I spot them easily. All the same practice makes simple so if you’re interested you can read on them; if you want the full package here’s the book from a pro.
The timeframes in MT4 can be found in Window 3
When trading price action in the proper way, anything below the 1-hour would not produce effective returns. Proper application of price action trading is operated from the daily TF mostly and sometimes the 4-hour. In the lower timeframe exists a lot of waves and confusion. Trading price action with 5 minutes or 1 minute charts produces a lot of false signals and you’d be better off, trading with indicators that way. The reason higher timeframes work with price action is because; there’s so much volume that goes into a single candlestick on say a 1D or a 1W and that reduces the probability of false signals. Also, that is the timeframe we look at most of the time when plotting support and resistance levels.
Establishing the difference.
A bullish reversal candlestick on the 1D TF is likely to push prices up than one on a 30-minute TF. In conventional candlestick trading knowledge, a hammer is a signal to go long on a pair. If you find six hammers on a 5-minute chart, only two might be able to push price up after its occurrence. On a 1D chart, only one might be insignificant after its occurrence because price went down later. That is what we term as noise and false signals with respect to the 5-minute chart instance.
The higher the timeframe, the more potent the signal. The big money is also in the higher; of course, that’s where the big industry players are also located. You stand a high chance of succeeding if you trade along the big boys. Even those who trade from small timeframes look at a higher timeframe before doing so (Multi timeframe trading). And no! you do not need to have $100,000 to trade from the daily timeframe. With a small capital, all you need is a reduced lot size to do so…
If you love price action well enough; the lowest you should be looking at is the 4- hour whilst you conduct most of your analysis on the 1D.
Closing in on this price action module, I want you to know that you can base your strategy on mastering the sections of this module, one at a time. Once you start seeing improvements, you need to combine the theories in finding trade entries to become a proficient trader.
See how all the price action concepts are added up to formulate live trading ideas from posts in this section.
The preferred chart for price action traders.
Supply and Demand.
Support & resistance variations.
Price action consolidation.
Understanding the fib tool.
The favorable timeframes for trading price action.