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Welcome to The Ultimate Guide to Price Action Trading, your essential resource for mastering the art of trading based on the most reliable indicator there is: the price itself.
This guide is designed to teach both new and experienced traders the fundamentals of price action analysis, and provide practical strategies and techniques that can be applied across various financial markets.
Whether you’re trading futures, forex, or any type of financial instrument, the knowledge and skills you gain from this guide will help you make better-informed decisions which can, in turn, help you improve your overall trading performance.
Price action trading revolves around the belief that price movement is the ultimate reflection of all available information, sentiment, and market psychology. This powerful methodology helps you to focus on what really matters, filtering out the noise of complex indicators and allowing you to develop a keen sense of the market’s underlying dynamics.
By honing your ability to interpret price action, you’ll be better equipped to anticipate future price movements and identify high-probability trading opportunities.
So, let’s get started.
In other words, price action = price movements. The “characteristics” of price movements is subject to your personal interpretation.
With that said, price action trading is a method of trading that’s based solely on the movement of prices (meaning, no indicators, though traders might use one or a few, like volume bars).
When someone gives you a message, it sometimes helps to have another person convey it and perhaps even summarize it (that’s like being an indicator). But you can also have too many interpreters giving their own versions of the same message. This can often obscure the message.
If a market opportunity is fleeting, you’ll need to make decisions on the spot. This is where lagging indicators, or too many indicators, can put you at risk of missing a quick market opportunity.
Price action is the territory on which indicators draw various maps. Don’t Confusing the “map” wth the “territory”...It’s easy to do. Maybe technical indicators are simply overrated (or not). Some traders seem to think so.
What’s wrong with indicators? They’re useful for analyzing (read “shaping”) specific data. They’re not designed to give you a full 360-degree view.
And when you combine them, they can sometimes produce conflicting signals, slowing down your decision speed.
They also tend to create a visual mess. Worst case scenario, it’s easy to confuse the map with the territory. But here’s the point:
Seeing what’s right in front of you…If you trade based solely on the movement of prices, then you’re pretty much taking a Price Action Trading approach.
What’s the risk of using only price action? Indicators help you see the broader context. If you’re too fixated on the price, you can easily miss the big picture. Plus, interpreting price action can be just as subjective as interpreting and “interpretation” of price action via indicators. So, to use price action requires skill. And that takes time to develop.
Here’s a thought experiment that legendary trader Joe Ross would often mention in his books: take a look at a naked chart and try to figure out new setups might have been successful.
This way of thinking about charts probably led him to develop his “Law of Charts” method of trend assessment (one that didn’t rely on indicators). It might also have helped him develop his Ross Hook pattern which is another price action technique he developed. There are plenty more to discover and develop. The main point is that there’s more to a naked chart than meets the eye.
How can I begin reading charts in this way? We’ll present a few strategies in the coming sections/posts. For now, here’s what you need to become familiar with:
Price action can be an effective overall approach to trading markets using data that’s immediate and direct.
By working solely with price, you’re essentially using price as an indicator rather than using indicators to interpret the story that price alone might tell.
You’re working directly with the source.
With that said, interpreting price requires skill, patience, and experience. What you end up seeing is not one potential outcome, but several. Instead of being caged into a particular market bias (which indicators can do), you know can plenty of more angles, the risk being, of course, that you might see too much.
But with enough practice, you may find an approach that resonates with your own trading style, allowing you to see with greater clarity and efficiency.
It’s been around for a long time, and here’s a quick rundown of its history:
The first example of price action trading goes back to Japan in the 1600s when a rice trader named Munehisa Homma came up with candlestick charts. These charts made it easier to see how prices changed over time. Later, people started using these ideas in other markets, like stocks and commodities in the US and Europe.
Charles Dow, who co-founded Dow Jones & Company, came up with the Dow Theory in the late 1800s. This theory helped create modern technical analysis and focused on the importance of price trends and market phases. It said that prices already include all the important info, so studying price action could help make better trading decisions.
As markets got more complicated, traders started using different tools to figure out trends, reversals, and trading opportunities. Some of these tools, like moving averages and trendlines, came from the ideas of price action trading.
With digital computers and the internet, price action trading became more popular. Traders could access more data and create their own strategies. People like Al Brooks, Steve Nison, and Richard Wyckoff helped develop price action trading methods and shared what they learned through books, courses, and online.
Price action trading is still a popular way to analyze and trade in financial markets. People often mix it with other methods, like fundamental analysis or technical indicators, to make well-rounded trading strategies. The rise of computer-driven and high-speed trading has also made it more important to understand and take advantage of short-term price movements.
Price action trading has come a long way since its early beginnings in 17th century Japan. As markets have evolved and technology has advanced, traders have continued to refine and adapt price action techniques to better understand and exploit market trends.
Today, this approach remains a popular and widely-used method for making informed trading decisions, often combined with other tools and strategies. The enduring success of price action trading highlights the importance of studying historical price movements to navigate the ever-changing world of finance.
Price action trading is all about analyzing past price changes to forecast what might happen next. While it’s got a few incredible advantages, it’s not perfect, nor is it for everyone.
Let’s chat about a few ups and downs of this trading style to see if it’s the right fit for you.
It’s Relatively Simple: One of the main advantages of price action trading is its simplicity. Instead of getting bogged down by countless technical indicators, you can focus on what really matters: the price. By studying how prices have moved in the past, you can make more informed decisions about future trends.
It’s Very Flexibile to Use: Price action trading can be applied to various markets, including stocks, forex, commodities, and cryptocurrencies. This flexibility means that you can use the same basic principles across different assets, making it easier to diversify your trading portfolio.
It’s adaptable to different timeframes: Whether you’re a day trader or a long-term investor, price action trading can work for you. It can be applied to various timeframes, from minutes to months, allowing you to tailor your approach to your specific trading style and goals.
It Can Be Highly Subjective: One of the main challenges with price action trading is its inherent subjectivity. While some traders may see a specific price pattern as a bullish signal, others may interpret it differently. This subjectivity can lead to inconsistent results and makes it harder to develop a standardized, rule-based trading system.
It’s Hard to Find Confirmation: Unlike other trading methods that use multiple technical indicators to confirm a signal, price action trading often relies solely on price movements. This means that you might not have the same level of confidence in your decisions, as there’s less supporting evidence to back up your analysis.
It Requires Dedication,Experience and Skill: To be successful with price action trading, you’ll need to develop a keen eye for spotting patterns and understanding the market’s underlying psychology. This takes time and experience, which means that beginners might find it challenging to get started with this method.
Price action trading is a pretty straightforward, versatile, and customizable way to tackle the financial markets.
But, like anything, it’s got some hurdles too. You’ll need a bit of experience and skill to really nail it, and since it can be kinda subjective, you might find it a little inconsistent.
If you’re thinking about giving price action trading a shot, make sure you think about the good and the bad, and maybe even blend it with other techniques to create a solid, all-around trading plan.
Suppose you have strong technical and fundamental skills. Chances are that you’re going to use both skills when the situation calls for it.
There’s no point in ignoring half of the tools in your toolbox. Same principle applies to price action and indicators.
Is the “lagging” indicator a myth?…It’s true that a 200-day moving average will lag behind a 3-day moving average.
And a 3-day moving average will always lage behind, say, a pin bar. But that pin bar, no matter how quickly it unfolds, may be part of a much larger trend, or a slower supply and demand (read: fundamental) context.
Immediacy is important, when necessary. But the broader context ultimately defines the engagement.
Do indicators provide clear-cut signals?…Yes, they do, but to multiple and potential outcomes.
An “oversold” reading on the RSI or Stochastics indicator means “oversold relative to the broader context.” If you miss the context, you misread the signal. It doesn’t mean “pullback,” but the possibility of a pullback that may come in different forms.
The same goes for a pin bar. It indicates the potential for a pullback. But when, how far, and what it might look like depends solely on the context.
If you can see both (with and without indicators) in addition to understanding the fundamental context, and if you have enough experience to make trading decisions without getting stuck in analysis paralysis, then you’re in better shape than a trader who has a limited context of understanding.
Don’t confuse the tools of observation with the object under observation… Take a look at the following indicators:
All of these can be helpful if they don’t conflict with what price action is indicating. Sometimes indicators help filter price action, and sometimes they’re add-ons to other messages that price may be indicating.
Conflicting indications…For instance, suppose a stochastics reading is hovering at the oversold range for an extended period of time.
So, you look at the RSI, and notice that it is falling back from oversold levels, indicating a pullback. Yet, on the price action front, we’re seeing the formation of a symmetrical triangle, which can go either direction.
Finally, you realize that the latest PCE report is due, and that if it indicates, say, that inflation is easing, the likelihood that the Federal Reserve may further ease interest rates may be bullish for the market. In the near term.
The market may pull back, but the Fed’s decision will ultimately have the final say, and fundamental traders will be buying, not selling.
But you’re moving with the herd…It’s true that a Fibonacci retracement is blatantly obvious. So is a double top or double bottom chart pattern.
Are you going to get “squeezed” by the professionals? Maybe, if you’re on the wrong side of the market. If you’re on the right side of the market, then professional traders will likely join you.
How do you know if you’re on the right or wrong side of the market? You have to know the economics behind your market. And that’s something that neither technical indicators nor price action alone can tell you.
There’s no point in approaching price action trading as an exclusive discipline. It’s better you think of it as a tool; a tool among many tools. And like with all situations in life, you use the right tools to match the right context.
These lines actually show where the price hit a roadblock or bounced back before, which helps them make sense of what’s happening in the market.
A lot of traders look to price action signals like pin bars and engulfing bars when prices touch these horizontal lines, but we’re talking about something different here.
It’s like trading these levels “blindly,” without waiting for those price signals to show up.
This method, called “blind” or “touch” trades, is pretty effective because you can get in on the action closer to the support or resistance level itself.
It’s different from the usual price action signal trades where you’d wait for a pin bar or engulfing candlestick to close, which can actually put you farther away from the source of support or resistance.
As much as this trading style might catch your eye, let’s be clear: trading horizontal support and resistance levels without waiting for price action confirmations like obvious candlestick patterns is definitely more aggressive.
It needs a deep understanding of how prices move and how the market behaves, so it’s better for traders with more experience and skills in technical analysis.
If you’re new to trading, it’s a good idea to practice this style a lot before you try it out in real-time trading situations.
Just make sure you’re ready and comfortable with it before diving in, especially in a live market environment. For more basic concepts surrounding support and resistance levels as well as some actionable tips, read this article: How to Trade with Support and Resistance Levels
Now, let’s get to the meat of the content.
The first step in this strategy involves identifying key price points on your chart that show where prices have previously been supported or resisted. These are important because they help you and other traders understand what’s going on in the market.
Make sure to choose clear and accurate price levels that have acted as support or resistance recently. It’s important to know the difference between two types of support and resistance levels and why one is more important than the other.
Here’s an example of a chart with unclear support and resistance levels. You can see that the price reacts in a “zone” instead of at a specific price or a small group of prices. Now, compare this to another chart with a clearer and more precise resistance level.
If you had to pick between the two types of support and resistance levels to make a trade, which would you choose?
This strategy lets you enter trades closer to the source, but with more risk because you’re not waiting for additional confirmation.
So, it makes more sense to use the clearer support and resistance levels like in the second chart, rather than the vaguer zones from the first example.
The last touch point of the resistance level marked with an asterisk could have been a safe entry for a short trade since the market reacted precisely at that level three times recently.
It’s also important to choose support and resistance levels that have a proven track record, meaning the market has reacted at those levels multiple times in the recent past.
The resistance level in the second chart is a great example of a reliable support and resistance area.
We began by explaining that the biggest advantage of touch trades is being able to act quickly and enter a trade near the starting point without waiting for a price action confirmation. This might make the title of this section seem confusing.
What we mean by supporting price action isn’t specific candlestick patterns, but the overall price action and flow as the market approaches your target area.
In general, we want the price to move quickly toward our target area, rather than slowly trending toward it.
This sudden movement towards the crucial support and resistance area often shows a temporary lack of opposing order flow, which may then build up at the actual support and resistance level.
We won’t go into detail about this common market behavior since it’s not the main focus of our strategy, but if you’re still confused or need more information, you can check out our dedicated article on the topic HERE.
Looking at the chart, pay attention to the price action rhythm at point 1.
See how the market quickly approaches the resistance level and then quickly drops, as it bounces off the significant swing high. You should notice that the sudden sharp rise doesn’t create new highs, which makes it easier for the price to drop down from the resistance level.
In contrast, look at Point 2 on the chart. This time, the price quickly moves toward the resistance level, but not before creating a small swing high during the uptrend.
You’ll see that when the price drops, it finds support at the previous small swing high, giving buyers a chance to enter and push the price higher again for a third test of the resistance level.
This should clarify why we prefer the price to move quickly toward our target area, rather than trending toward it.
Lastly, Point 3 on the chart shows a situation we want to avoid. The downward pin bar followed by congestion at the resistance level can be risky for a trader expecting a bounce off the resistance level.
The main idea behind aggressive touch trading and getting closer to the support or resistance source is to enter the market more quickly, resulting in very low drawdowns.
If the market doesn’t seem to reverse sharply from your expected support and resistance area, it may be time to act quickly to avoid losses. This leads us to the final aspect of touch trading.
Your success as a touch trader will depend on how well you manage your trades based on your trading personality and mindset. However, there are some general guidelines that can be helpful due to the aggressive nature of this strategy.
Even if you identify the best support and resistance levels for your reversal touch trades, you can’t beat the extra confirmation provided by a price action signal from a candlestick pattern.
This strategy is high risk, high reward. By entering trades closer to the source, you have the potential for more profit, so you should use this to reduce your risk per trade for these aggressive trades.
Traders may need to closely monitor their trades, especially in the beginning, when the market is near the support and resistance levels. This is different from more conservative, set-and-forget methods that don’t require as much attention.
Keep in mind that prices won’t always behave exactly as you expect them to. Adjusting your risk appetite and trade management techniques can make a big difference between a successful and unsuccessful trade.
As long as you adapt your risk appetite to match the aggressive nature of touch trading and have a good understanding of how the market behaves, especially at key support and resistance levels, you might benefit from adding touch trading to your trading strategies.
It’s one of the most popular high risk, high reward methods out there, but be aware that it requires time and experience to master.
Touch trading is an aggressive strategy that allows traders to enter trades closer to support or resistance levels without waiting for price action confirmations.
This high-risk, high-reward method is popular among experienced traders with a deep understanding of market behavior. Keep in mind that practicing this style and adjusting risk management techniques are essential for success in touch trading.
We specifically mention “trend trading” because moving averages become less useful when the market moves sideways and prices stay close together.
In these situations, the moving average and the price are close, causing more false signals as the price keeps touching the moving average.
Many traders use more than one moving average, usually a mix of slow and fast ones. In this section, we’ll explore a new way to use moving averages in your trading to give you a fresh perspective.
The main reason for using a short-term moving average along with a long-term one is to get different perspectives for better decision-making.
A short-term moving average stays closer to the price and provides more signals, while a long-term moving average touches the price less often during a normal trending market. It’s often used as a target in trading systems or as a signal for trend reversal when the long and short-term moving averages cross over.
However, there’s another way to look at slow and fast moving averages in relation to price action, called the constriction principle.
This principle can be applied to most combinations of slow and fast moving averages, but in this article, we’ll focus on the interaction between the 21 and 50 exponential moving averages (EMA) to determine price direction.
The constriction principle is based on the popular Bollinger Bands indicator.
Instead of focusing on moving averages crossing over, this principle looks at the distance between the two moving averages to show the strength of the trend.
In a strong trend, the price will pull the 21 EMA away from the 50 EMA, creating a larger gap between them.
When the price moves sideways or pulls back, the moving averages will come closer together, forming a “constriction” that works like a tightening spring. The price will often bounce off the constriction zone or break out into a trend.
Remember, the constriction principle is derived from the Bollinger Bands indicator, which also measures market volatility and expands or contracts based on market activity.
The chart above shows how the two EMAs behave in a strongly trending market.
In this example, there’s a strong downtrend with frequent, short pullbacks. Notice that the distance between the two EMAs stays fairly consistent, reflecting the smooth and steady nature of the trend.
When the market pulls back, it often bounces off the 21 EMA, which is common during strong trends.
Towards the bottom right, there’s an extended pullback. Observe how the moving averages act in this situation.
The EMAs come closer together, creating a “constriction” due to the longer pullback in the downtrend.
The 21 EMA is pulled back up with the price, getting closer to the 50 EMA and narrowing the gap between them. If the trend is strong enough and other factors allow it to continue (such as the absence of clear support areas below), we can expect the EMAs to release the price back in the direction of the trend.
However, keep in mind that moving averages, like all technical indicators, are lagging.
This means they respond to price changes rather than causing price changes themselves. The constriction of the EMAs isn’t the reason for the downtrend resuming; instead, it’s a result of the price resuming the trend. Watching the constriction phenomena can help you understand price action due to the visual cues it provides.
Let’s look at an example to further explain this point.
We’re looking at an uptrend that gradually changes into sideways market movement. Each pullback in the uptrend causes a slight constriction of the EMAs, resulting in the price jumping back up quickly.
However, when we get close to a potential key resistance level around the important 1.200 round number, an extended pullback does NOT lead to a sharp price increase.
Notice that when the price tried to resume the trend after the last pullback, it stalled at the crossover point of the two EMAs and actually reversed back down. This is usually a strong indication that we are either entering a longer sideways phase, preparing for a deeper pullback into the dominant trend, or completely reversing the trend.
A major critique of many moving average-based trading systems is that they often struggle to predict broader market sentiment. In other words, traders who rely on moving averages often do well in trending markets but might face a few losses before realizing the market has shifted to a range rather than a strong trend.
This refined approach can potentially provide a clearer view of price action.
Observing how the price behaves when it pulls back to a constriction zone can give you valuable insights into the momentum of the current move. Keep in mind that when the price pulls back to the constriction zone, we’re actually looking for a sharp move back in the direction of the trend.
It’s also helpful to include other technical indicators in your analysis. As mentioned earlier, when looking for a trend resumption at the constriction zone, it’s useful to assess if the trend has room to continue.
Does the constriction zone align with a round number or a horizontal support and resistance zone?
Is the trend approaching a key swing high/low? Answering these questions will help you gain a better understanding of the market, while following the patterns can assist in fine-tuning your entries and exits.
In the chart above, we highlighted a bullish engulfing candlestick pattern. Can you see why this could have been a great trade?
Not only do we have the constriction of the moving averages (MAs) and the candlestick pattern forming right at the constriction zone, but we also have a breakout play happening out of the wedge pattern, indicated by the two angled red lines.
With any effective trading approach, your trigger should come from a single source. However, some trade setups have multiple factors supporting them. Watching for constriction zones on these two EMAs is just one of those factors.
The wrap it all up, the constriction principle offers a fresh approach to using moving averages in trading.
By focusing on the distance between slow and fast moving averages, traders can gain actionable insights into market momentum in order to better understand and, eventually, trade the price action environment.
These patterns usually serve as reliable cues for entering trades.
However, as you grow in your trading career and gain a deeper grasp of price behavior and how buying and selling orders affect it, it might be beneficial to delve deeper into price action.
In other words, you should look beyond just the basic chart and candlestick patterns. This involves understanding the actual data that these setups provide and how you can use this information in your analysis, without having to wait for a clear pin bar to show up to make a trade.
Let’s discuss two specific examples of how you can apply common information in unique ways to enhance your understanding of price action and improve your chart analysis.
If you’ve devoted some time to learning about candlestick patterns, chances are you’ve encountered the pin bar candlestick pattern, which is also known as the hammer pattern.
This pattern is one of the most frequently traded and is highly sought after by traders who use technical analysis.
However, the title of this section mentions an “inverted pin bar” – a term you might not be very familiar with. Let’s begin by unpacking what a typical pin bar tells us:
The chart above displays a typical bearish pin bar in the Gold futures market.
The wick at the top of the candlestick shows that even though the price was pushed higher during this period, sellers strongly resisted this, resulting in the price closing near the opening price at the end of the period.
So essentially, this period saw both buying (following the current trend to the left of the pin bar) and selling happening in the market.
If you look closely, you’ll see that while the pin bar itself is a distinct candlestick pattern that traders actively seek and track, the information it reveals is actually pretty common in market dynamics: Price moving towards a significant support or resistance level, and then the opposing party stepping in to reverse that movement.
As long as you understand the dynamics of support and resistance, and know when to highlight sellers coming into a bull market and buyers coming into a bear market, you might be ready to start looking at your charts beyond just the standard candlestick and chart patterns.
Now, let’s examine an inverted pin bar:
Usually, we look for bullish pin bars at swing lows, where a wick sticking out at the bottom shows us that buyers seem to be entering a bear market, possibly signalling a good time to enter a long trade.
But does the same pin bar at a swing high give us the same information? Actually, it might be conveying something quite different, which aligns more with the information given by a bearish pin bar at the same spot.
Observe that even though we have a wick at the bottom of the pin bar mentioned above, unlike the top wick you’d usually expect from a typical bearish pin bar at a swing high, the message is more or less the same: sellers are having an effect in a bull market.
The real difference between the appearance of a regular pin bar and an inverted pin bar lies in when the buyers’ and sellers’ actions occur within the period. For the inverted pin bar above, selling happened first during the period, followed by bullish activity, leaving a wick at the bottom.
If this were a regular bearish pin bar, we would likely have seen a similar back-and-forth between buyers and sellers, except that buying would have come before selling during the period, leaving a wick at the top of the candlestick.
Regardless, whether it’s a regular or inverted pin bar at a swing high or low, you’ll find that the information presented by the pin bar is more or less the same.
Another innovative way to analyze price action is by merging trading periods – or visually speaking – combining candlesticks to get a better understanding of a potential trading opportunity or general price movement.
Since we’re discussing pin bars, we’ll use this common candlestick pattern to illustrate the idea.
We’ve mentioned that a pin bar is formed when sellers come into a bull market and buyers come into a bear market within the same trading period. We also discussed how the order of buying and selling can actually flip the pin bar around, providing a less conventional but equally valuable perspective on market sentiment at that moment.
But what if we’re really looking for strong selling in a bull market that’s quickly nearing a resistance area, potentially forming a pin bar? Can we try ignoring time period divisions and look at the market as a continuous moving force, which is more accurately what it is?
Some traders often skip trading a pin bar simply because it doesn’t look too promising due to less favorable trading activity in the final minutes of the trading period that completes the candlestick itself.
But is that necessary if you understand the impact of new buying or selling at a clear support or resistance area, and you know that price action on the chart is intentionally being divided into customizable time slots (or in some cases, tick)?
Let’s try to examine the bulk of the information that a pin bar typically holds – as part of continuous trading activity or multiple candlesticks:
The chart above presents a 2-candlestick bearish pin bar. We’re looking at the daily chart for Euro currency futures from mid-October.
Essentially, the highlighted pattern is a 2-day bearish pin bar. You’ll see that the typical information a bearish pin bar shows is clearly visible on the two candlesticks that poke through the major resistance, as marked on the chart.
However, we don’t have a traditional bearish pin bar that would have shown both bullish and bearish activity on the same day.
Instead, we have the bullish and bearish activity spread out over two trading periods. As you can see, this doesn’t really matter for a market that’s continuously moving, and perhaps for a trader who knows exactly what they’re looking for.
The main issue with expanding your analysis to include unconventional methods, such as creating your own candlestick patterns or merging trading periods, is that it can easily become excessive.
You could potentially start spotting too many intriguing possibilities, which could lead a novice trader towards lower profitability and possibly excessive trading.
The reason to look beyond candlestick patterns is to grasp their actual dynamics and understand why they’re so well-known and popular.
It’s about applying the basic information these patterns offer in a wider, more practical way. We encourage our readers to thoroughly test all ideas and strategies before using them in real-time trading.
The techniques mentioned above aren’t proven trading methods but merely tools for analysis to deepen your understanding of the technical aspects of financial markets. They’re intended to foster creative and thoughtful thought processes for potentially better trading results.
In the end, expanding your analysis beyond conventional candlestick patterns allows you to gain a deeper understanding of price action and order flow dynamics.
By exploring patterns like the inverted pin bars, or by combining different trading periods, you can extract valuable information from the market to make more informed decisions.
However, it’s essential to be cautious not to overextend your analysis, leading to overtrading and reduced profitability.
Always thoroughly test any new ideas and strategies before applying them to real-time trading. The techniques mentioned here are not proven trading methods but aim to promote creative and thoughtful mental processes to potentially improve trading results.
In this section, we focus on a few simple but often overlooked principles of price action that can help you understand when a trend is ending and likely to change direction.
After a prolonged period of trending, the presence of wicks can indicate a weakening of the trend. In the provided screenshot, several wicks pointing downwards followed a significant sell-off, which served as an early indication of an upcoming bullish reversal.
The wicks represent instances where sellers attempted to drive the price lower to sustain the downtrend.
However, due to insufficient selling pressure, buyers intervened by absorbing all the sell orders and preventing the price from dropping further.
Eventually, sellers relinquished their efforts entirely, leading to a subsequent upward movement of the price driven by the buyers.
The outside bar is a great 3-candlestick price pattern and it can offer reliable information if a trader can analyze it in the correct context.
An outside bar is a candlestick that completely covers the previous candlestick. The final signal then comes after the outside bar, when price moves into the direction of the outside bar.
In the screenshot below, you can see that the first arrow points to a bearish outside bar that completely covers the previous bullish candle.
This shows that buyers tried to move price higher but were rejected and sellers drove price lower. The second arrow highlights a candlestick with a long wick which, as we learned previously, shows rejection as well.
Together, those two clues could have provided information to exit any long trades very close to the top.
When you notice a trend starting to flatten out, it’s usually a sign to close positions in line with the trend.
In the provided screenshot, after a prolonged upward movement, the price clearly demonstrated a flattening pattern in its structure.
During this type of price action, you typically observe diminishing candlestick sizes, indicating a decline in buyer enthusiasm for the trend.
Additionally, in the given scenario, there is a candlestick with an extended rejection wick, which further confirmed the end of the upward trend.
The inside bar can either be a trend continuation or a reversal pattern and, similar to the outside bar pattern, it’s also a 3 candle pattern: the inside bar is the second candle and it falls completely into the previous candle.
The third candle is then the confirmation candle when price breaks out above or below the inside bar.
The screenshot below shows the small inside bar that completely falls into the previous green bar and it signaled that buyers were not pushing price higher anymore.
The following candle was then a huge bearish candle that then foreshadowed the upcoming downtrend.
An inside bar is usually not enough to exit a trade, but it serves as a warning signal. The direction of the candle after the inside bar then shows where price is likely to go.
Double bottoms and tops are patterns that occur over a longer time period and offer valuable context for exiting trades at favorable prices.
A double bottom indicates that the price made multiple attempts to break a support level but failed due to insufficient momentum and support from sellers.
If you are in a short trade and observe price struggling with a double bottom pattern, it’s generally wise to exit your trade to secure your profits and avoid potential losses.
In the provided screenshot, there were several indications for the trader to exit their short trade. Firstly, when the price initially broke below the low, it was immediately rejected, suggesting a lack of selling pressure.
Subsequently, the price retraced and formed a double bottom pattern, leaving a long wick that once again indicated rejection.
Furthermore, after the double bottom, the price even reached a higher high with long wicks, signifying that sellers were completely withdrawing from the market. These multiple clues served as compelling signals for the trader to exit their short trade.
Charts Courtesy of TradingView
Of course, price won’t always give you clear signals to exit your existing trades, but once you start paying more attention to those subtle clues you should be able in our opinion to make much better trading decisions.
To wrap up, knowing when to exit trades is important for traders who want to maximize profits and avoid big losses. By looking closely at price action signs like wicks, outside bars, rounding price formations, inside bars, and double bottoms, traders can figure out when a trend might be “on the bend.”
These patterns give useful information about how buyers and sellers are leaning in the markets.
Even though a single pattern or sign can’t always tell you the best time to exit a trade, noticing these small hints and knowing what they mean in the bigger picture can help traders make smarter decisions. As traders get better at spotting and understanding these patterns, they can improve their trading results and avoid leaving a trade too early or staying in too long.
Using these price action ideas in your trading approach can lead to more steady outcomes and long-term success in trading.
Timing your market entries is critical to trading success. Price action, which is all about studying past and current price movements, can really help you fine-tune your entries; making your buys and sells more accurate and effective.
In this section, we’re going to explore different techniques that you can use to make the most of price action.
The goal is to improve your market entries and, ultimately, boost your chances of success.
Support and resistance levels are significant price points where the market has previously experienced a bounce or reversal.
These levels act as psychological barriers where buyers and sellers face off, and they can be identified by analyzing historical price action.
By entering trades near these key levels, traders can achieve better risk-reward ratios, as price movements often reverse or stall at support and resistance levels.
Moreover, these levels can also be used to place stop-loss orders, further mitigating potential losses.
Candlestick patterns provide valuable insights into the market’s sentiment and can help traders anticipate potential reversals or trend continuations.
Some common candlestick patterns that can be used to time entries more effectively include pinbars, hammers, and engulfing candles.
These patterns represent a snapshot of the ongoing struggle between buyers and sellers and can provide traders with an edge when used in conjunction with other price action techniques.
For example, a bullish engulfing candle that forms near a support level may indicate strong buying pressure and signal an optimal entry point for a long trade.
Understanding the strength of a trend is essential for timing market entries. By examining the size and formation of candlesticks, as well as the sequence of highs and lows, traders can gauge the strength of a trend and identify potential entry points.
Entering trades during strong trends can improve the chances of success, as the momentum is more likely to continue in the direction of the trend.
Additionally, recognizing weakening trends or early stages of a reversal can help traders capitalize on potential shifts in market sentiment.
Price action traders can also look for breakouts from consolidation patterns, such as triangles or wedges, as potential entry signals.
These patterns indicate a period of indecision in the market, and a breakout often signals the start of a strong directional move.
Alternatively, traders can wait for pullbacks to key support or resistance levels within a trend to enter trades with a more favorable risk-reward ratio.
This approach allows traders to take advantage of temporary market retracements before the trend resumes its course.
Analyzing price action on multiple timeframes can offer a more comprehensive view of market dynamics and help traders fine-tune their entries. Higher timeframes can be used to identify the overall trend, while lower timeframes can provide more precise entry points.
For example, a trader might use a daily chart to determine the overall market direction and a 1-hour chart to pinpoint an optimal entry point within that trend.
This multi-timeframe approach can help traders align their trades with the broader market context and minimize the impact of short-term price fluctuations.
Whereas indicator traders are constantly looking for ‘leading’ indicators that can predict what is going to happen next, price action traders follow a different approach.
Price action traders anticipate what they see on their charts and don’t try to predict. Traders use price action information to read sentiment from their charts because trading behavior is stored in a price formation. For example, a pinbar (hammer) shows that traders tried to push price higher but then other bearish traders came in and brought price down again.
Or, an engulfing candle shows extreme strength when the new candlestick completely engulfs the prior one. And, finally, a double top formation tells you that traders moved price into a certain level twice but they couldn’t find enough buyers to break the level.
Thus, you should not only look for certain patterns or formations on your chart, but put them into context and understand what price action tells you about the underlying behavior or traders moving the markets.
“Whenever you find yourself on the side of the majority, it is time to pause and reflect.”
– Mark Twain
This quote should be your mantra as a price action trader. A reason why traders often struggle with price action is because following the textbook examples makes you a victim to the experienced traders.
Experienced traders always know where the average amateur trader enters a trade and where they place their stops.
How? It’s not hard and we show you why.
For example, whenever you see an obvious pinbar candlestick you can be very sure that traders enter on a break of the pinbar and place their stops on the other side.
When you see a double top, traders will usually enter right at the level and place their stop on the other side of the resistance level. On a head and shoulders pattern, traders will enter on a pullback to the neckline and place their stop just above the neckline.
If you are a price action trader, you probably know what we are talking about. Next time you see a very obvious pattern on your chart, think where the average trader will put his orders and then observe how price reacts.
Here are some simple tips on how to understand and use price patterns better. Instead of just memorizing what patterns look like and tracking price changes without understanding why, it’s important to know what’s really happening behind these price changes.
When you know what’s driving the market, you can make smarter trading choices.
When trying to make sense of price patterns, there are three key ideas that can help you understand pretty much any price change you see on your trading charts:
How highs and lows form on your charts is the most used concept in price action and price formation. Remember a healthy trend is defined by higher highs or lower lows and a break of a trend is indicated by lower highs and higher lows.
Thus, a double top shows two highs at the same level where the second high failed to break the prior one, indicating missing strength and conviction behind the move.
The head and shoulders pattern shows 2 higher highs followed by a lower high and finally a lower low – a clear reversal pattern indicated by the sequence of highs and lows. Highs and lows will help you understand the majority of price movements and formations.
How candlesticks form is another important factor to understand price dynamics.
Are the candlesticks small and does it take long for the trend to move higher or are the candlesticks large and a large price move occurs with only a few candlesticks?
The size of candlesticks, in relation to previous price action is an important tell.
Wicks are another important concept. Can you see a lot of wicks to either side or are the candlesticks mainly made up of the body?
Missing wicks and large candles usually show greater strength. On the other hand, candles with long wicks and small bodies show indecision and greater volatility.
This ties in with the previous point. Candlesticks which become smaller in size show a contraction in volatility. This pattern is used in a variety of price formations such as wedges, triangles or pennants.
A contraction and narrowing of volatility eventually results in a breakout. A contraction signals indecision about the current state or the anticipation of an upcoming price movement.
Putting it all together
As you can see, understanding how to read price action can help you significantly really see what is going on on your charts and what traders are up to. But, instead of remembering formations you should aim to understand how to decode patterns and formations by using the 3 principles we described.
Incorporating price action techniques into trading strategies can significantly enhance a trader’s ability to time market entries effectively.
By identifying key support and resistance levels, observing candlestick patterns, analyzing trend strength, monitoring breakouts and pullbacks, and using multiple timeframes, traders can improve their market entries and increase the likelihood of successful trades.
By mastering these techniques and applying them consistently, traders can leverage price action to make more informed decisions, optimize their risk management, and ultimately, achieve long-term success in the markets.
Price action trading is a powerful and versatile trading strategy that can be used in a variety of markets. By understanding the basics of price action and how to identify key support and resistance levels, traders can make informed decisions about when to enter and exit trades.
However, it is important to note that price action trading is not without its risks, and traders should always use proper risk management techniques.
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.
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