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Forex Trading Strategy

The Price Action Forex Trading Strategy

https://www.forextradingrobotea.com

Have you ever wondered…

“How can I trade with a naked chart, without squiggly lines, without indicators, and without a mess?”

Well if you ask me, there’s one way to go about it…

Price action trading strategy.

Now, this isn’t the Holy Grail. But, if you devote time to learning price action trading, you’ll trade with cleaner charts, and can pinpoint your entries & exits with better precision.

This is powerful stuff, right?

This is why I’ve devoted 3000+ words to today’s post, teaching you the essence of price action trading.

Price Action Trading — Support & Resistance are the best levels to trade on your chart

Here are 4 things you must know:

  1. Support & Resistance
  2. Previous Support turns Resistance
  3. Dynamic Support & Resistance
  4. Trending & Retracement move

Let’s begin.

Support & Resistance

Support – An area on the chart, with potential buying pressure, to push the price higher.

Resistance – An area on the chart, with potential selling pressure, to push price lower.

Here are a few examples…

Support and Resistance on (EUR/USD):

Support on (USD/CAD):

Resistance on (GBP/JPY):

Remember…

Support & Resistance is not a single line, but an area on the chart

Next…

If price breaks below support, previous support becomes resistance.

If price breaks above resistance, previous resistance becomes support.

Here’s what I mean…

Previous Support turns Resistance on (GBP/AUD):

Previous Resistances turns Support on (NZD/USD):

Now:

You’ve just learned what are Support & Resistance, and their role reversal with one another.

These are “static” Support & Resistance, where their areas are fixed on the chart.

But wait… that’s not all.

Dynamic Support & Resistance

Because Support & Resistance can move along with price, which is called Dynamic Support & Resistance.

Dynamic support occurs in an uptrend and dynamic resistance in a downtrend.

They can be identified using moving averages. (I use 20 & 50 MA).

This is what I mean…

Dynamic Support on (USD/ZAR):

Dynamic Resistance on (NZD/USD):

You’re wondering:

Rayner, is there anything special about 20 & 50 EMA?

The answer is no. I use it because it fits my trading style. Ultimately you need to find something that suits you.

Indicators are simply trading tools. It’s how you use them that makes a difference.

Impulse & Corrective move

Here’s what I mean:

Impulse move – “Longer leg” on the chart, which points the direction of the trend. Candlestick size is usually larger, signaling momentum behind the move.

Corrective move – “Shorter” leg on the chart, which is against the current trend. Candlestick size is usually smaller because of traders taking profits, without strong selling pressure.

If you want to learn more, go read Impulse & Corrective move written by Chris Capre.

Here’re a few examples…

Impulse and Corrective moves on (XAU/USD):

Impulse and Corrective moves on (NATGAS):

Here’s a tip for you…

You can trade pullback on a corrective move, and breakout on the impulse move.

Depending on your trading style, both approaches let you get on board the trend.

Now, let’s move on to the next section…

The 4 stages of the markets every serious trader must know

The markets are always changing. It moves from a period of a trend to a range, and range to trend.

You can break it down further into 4 stages:

  • Accumulation
  • Advancing
  • Distribution
  • Declining

Stage 1: Accumulation phase

Accumulation usually occurs after a fall in prices and looks like a consolidation period.

Characteristics of accumulation phase:

  • It usually occurs when prices have fallen over the last 6 months or more
  • It looks like a long period of consolidation during a downtrend
  • The 200-day moving average tends to flatten out after a price decline
  • Price tends to whip back and forth around the 200-day moving average

It looks something like this:

Stage 2: Advancing phase

After price breaks out of the accumulation phase, it goes into an advancing phase (an uptrend).

Characteristics of advancing phase:

  • It usually occurs after price breaks out of accumulation phase
  • Price forms a series of higher highs and higher lows
  • Short term moving averages are above long-term moving averages (e.g. 50 above 200-day ma)
  • The 200-day moving average is pointing higher
  • Price is above the 200-day moving average

It looks something like this…

Stage 3: Distribution phase

Distribution usually occurs after a rise in prices and looks like a consolidation period.

Characteristics of distribution phase:

  • It usually occurs when prices have risen over the last 6 months or more
  • It looks like a long period of consolidation during an uptrend
  • The 200-day moving average tends to flatten out after a price decline
  • Price tends to whip back and forth around the 200-day moving average

It looks something like this:

Stage 4: Declining phase

After price breaks down of the distribution phase, it goes into a declining phase (a downtrend) and consists of lower highs and lows.

This is the stage where traders who do not cut their loss become long-term investors.

Characteristics of declining phase:

  • It usually occurs after price breaks out of the distribution phase
  • Price forms a series of lower highs and lower lows
  • Short term moving averages are below long-term moving averages (e.g. 50 below 200-day ma)
  • The 200-day moving average is pointing lower
  • Price is below the 200-day moving average

It looks something like this…

So, you’ve learned what are the 4 stages of the market, and the key characteristics to look out for.

Now, let’s move onto the next section…

How to tell when the market is trending

There’s a famous Wall Street saying that goes like this…

Question: What is the trend of the market?

Answer: What is your time frame?

You’re wondering:

What does it mean?

This means there are trends in different time frames. You can have a downtrend on 5 minutes chart and an uptrend on a daily chart.

Here’s an example…

Lower Timeframe on (AUD/CAD):

Higher Timeframe on (AUD/CAD):

So, you’ve understood that trends can exist in different time frames.

Now… let’s learn how to define a trend objectively.

There are two ways you can go about it:

  • Structure of the markets
  • Moving average

Structure of the markets

The market is in an uptrend when there’s series of higher highs and higher lows.

Likewise, in a downtrend, there’s a series of lower highs and lower lows.

Uptrend Structures on (USD/CAD):

Downtrend Structures on (USD/JPY):

Moving average

Alternatively, you can use a moving average to define the trend.

Here’s how you can do it:

  • 20 ma – Short-term trend
  • 100 ma – Medium-term trend
  • 200 ma – Long-term trend

If 20 ma is pointing higher, and the price is above it, then the short term trend is up.

If 100 ma is pointing higher, and the price is above it, then the medium-term trend is up.

If 200 ma is pointing higher, and the price is above it, then the long-term trend is up.

Now, let’s learn how to identify a range market…

How to tell when the market is ranging

A range market is contained between Support & Resistance.

A textbook example looks something like this:

Now, before the light bulb in your head goes off with “buy low and sell high”, I want you to see the reality of trade range markets.

Because in the real world, you get variations like:

  • Range expansion
  • Range contraction

Range expansion

This occurs when the market does a false breakout and trades back into the range. Thus expanding the “space” between Support & Resistance.

Selling at resistance would get you stopped out, as price breaks above the resistance, only to trade back into the range.

An example:

Range contraction

This occurs when the market enters a period of low volatility, usually due to an impending major news release.

Looking to “buy low sell high” would put you on the sidelines as the markets went into a tighter consolidation.

Here’s what I mean:

Personally, I find range expansion and contraction one of the hardest markets to trade, and I usually stay out of it.

Now, let’s move onto something interesting…

How to read the price action of any markets (and determine the strength and weakness of it)

Here are the things I look out for:

  • The slope of impulse moves getting flatter
  • Candlestick bodies getting smaller on impulse move
  • The slope of corrective move getting steeper
  • Candlestick bodies getting larger on a corrective move

Here’re a few examples to walk you through…

Example 1:

a – Impulse move higher which looks normal in an uptrend

b – Corrective move lower, but candle bodies size are increasing compared to previous corrective move. This is something unusual

c – Impulse move which is short lived. Possible complex pullback setting up

d – Corrective move tested the previous low

e – Impulse move higher which should lead to the resumption of trend

f – A false breakout. The corrective move has large bodied candles and is getting steeper. This doesn’t look good

g – A weak attempt by the bulls to regain control

Overall:

The uptrend is getting weak. Support comes in around 175 which is a strong line of defense for the bulls.

I will look to long or stay on the sidelines. No shorting at this point.

A break and close below 175 would be bearish with the completion of a head & shoulders pattern. If it happens, I’ll look to short or remain on the sidelines.

Example 2:

a – Impulse move lower with a huge spike down (possibly due to news event). Price continues trading towards the low

b – Corrective pullback with small-bodied candles, which looks normal in a downtrend

c – Weak impulse move lower. Where did the sellers go?

d – Strong corrective move higher with large-bodied candles. The trend is possibly over and could transit into a range market

e – Sellers came in and tried to push price lower. If it breaks below the previous low, the trend could resume. But it couldn’t

f – Bulls taking control once more an attempt towards the resistance area

Overall:

Bulls and bears are in equilibrium at the moment as both bullish and bearish candles are of similar size.

I’ll look to short or stay on the side. No longs at this point.

If price breaks above the resistance area at 0.6900, then I’ll look for longs or stay on the side.

Example 3:

a – Impulse move higher which broke and close above resistance. Candle bodies are largely showing strong bullish momentum. Expecting the trend to continue

b – False breakout as price trades back into the range. Candle bodies are largely showing strong bearish momentum. It doesn’t look good here. The last line of defense comes in at 91.00 support area

c – A weak attempt by the bulls to push the price higher. The small-bodied candles show the lack of strength by the bulls

d – Bears regain control and push price lower, breaking 91.00 support (this is an impulse move lower). Large-bodied candles show signs of strength by the bears

e – A weak attempt by the bulls to push the price higher. Again it shows lack of strength, with small-bodied candles and flatter slope

f – One bearish candle wiped out the gains of the last 14 candles, with previous support now turned resistance

Overall:

The bears are clearly in control now and I’m looking to short or stay on the sides. No longs for me at this point.

For further readings, I would recommend the works of Lance Beggs.

Now, let’s move onto the topic of candlesticks…

Stop memorizing candlestick patterns, you only need to know these 4 things

They are:

  1. Wick
  2. Length of the wick
  3. Size of the body
  4. Close of the candle

Wick

The wick of the candle represents price rejection. If you see a longer wick, it represents greater price rejection.

Here’s what I mean…

Price rejections on (USD/JPY):

Price rejections on (EUR/USD):

Length of the wick

In general…

When you see wicks “flying” all over your charts, you’re probably in a “choppy” condition (usually in a range market).

And when you get little to no wicks, you’re probably in a “cleaner” condition (usually in a strong trending market).

Choppy and Clean market conditions on (CAD/JPY):

Choppy and Clean market conditions on (USD/JPY):

Size of the candle

The easiest way to identify momentum in the markets is, to look at the size of the body.

A large body shows greater momentum, and a small body shows a lack of momentum.

An example:

Close of the body

To identify who’s currently in control, you’d want to see where the candle closes.

If it closes near the highs, the bulls are in control.

If it closes near the middle, the market is undecided.

If it closes near the lows, the bears are in control.

So, are you pumped right now?

Because you’re going to learn something really cool…

Advanced candlestick knowledge (that nobody talks about)

I used to get excited when I spot a candlestick pattern that I memorized.

“Look, a shooting star! The market is heading lower for sure!”

And it rallied 300 points.

Now…

Instead of “copy-pasting” what individual candlestick means, I’ll go deeper into it.

I’ll explain to you how not to trade them, how to trade them, and other variations of it.

Here’s what you”ll learn:

  • Pinbar
  • Inside bar
  • Rising three method
  • Wide range candles
  • Narrow range candles

Pinbar

A Pinbar is a reversal pattern, which was first introduced by Victor Sperandeo, in his book, Trader Vic: Methods of a Wall Street Master.

The key takeaway about this pattern is price rejection.

Bullish Pinbar – A small-bodied candle with a long lower wick, showing rejection of lower prices.

Bearish Pinbar – A small-bodied candle with a long upper wick, showing rejection of higher prices.

Now:

Just because you see a bearish Pinbar, doesn’t mean price is going to trade lower.

In fact, it’s usually just a retracement within a trend.

Here’s what I mean…

Bearish Pinbar on (EUR/AUD):

Lower Timeframe Bearish Pinbar on (EUR/AUD):

Do not “blindly”  go short when you see a bearish Pinbar or go long when you see a bullish Pinbar.

Chances are, it’s a retracement within a trend.

Here’s what you should do instead:

  • In an uptrend, only trade bullish Pinbar at an area of support
  • In a downtrend, only trade bearish Pinbar at an area of resistance

Following these simple rules, you’ll greatly increase the odds of your trade working out.

Look at this:

Recall:

The Pinbar shows price rejection on the charts.

But, there are more than one ways to show price rejection, and it may not come in the form of Pinbar.

So…

In case, you haven’t realized…

Another variation of Pinbar is the Engulfing pattern.

If you think about it, Pinbar is actually an Engulfing pattern on a lower time frame.

Remember…

Price rejection can come in many forms. You should focus on price, not the pattern.

Inside bar

It can be both a continuation and reversal pattern (I’ll focus on continuation pattern).

The key takeaway about this pattern is low volatility. Thus, you can get an entry with tight stops on this pattern (and improve your risk to reward).

Inside bar – Small candle contained within the previous bar highs and lows

How not to trade it?

Most traders would trade the break of the Inside bar, hoping to capture a quick profit.

But…

In a choppy market, the lack of momentum usually results in many losses (so it’s best to avoid choppy markets).

Here’s an example:

The best Inside bar setups occur when:

  • Price breaks out of a range with strong momentum
  • It’s a strong trending market
  • Trading in the direction of the trend

It’s when the Inside bar breaks out in one direction, only to reverse and close in the opposite direction (otherwise known as a false breakout).

Moving on…

Price action patterns — Rising three method

This pattern was first introduced by Steve Nison, in his book, Japanese Candlestick Charting Techniques.

The main idea of this pattern is trend continuation.

Rising three method – This is a bullish trend continuation move, with three bearish candles as a retracement in an existing trend. Then a bearish candle closes lower, signaling the bears are back in control.

Falling three method – This is a bearish trend continuation move, with three bullish candles as a retracement in an existing trend. Then a bullish candle closes higher, signaling the bulls are back in control.

Here’s the thing:

By waiting for this precise pattern to occur, you’ll not get many trading setups (following an exact 3 candles pullback).

So… what other patterns can you trade?

If you think about it, another variation of this pattern is the flag or pennant formation.

Here’s what I mean…

Bullish Pennants on (GBP/JPY):

Bearish Flags on (EUR/USD):

Next…

Price action patterns — Wide range candles

A wide range candle is formed due to an imbalance of buying/selling pressure.

This represents “hidden” Support & Resistance in the markets (known as Supply & Demand by Sam Seiden)

Here’s what I mean…

Supply and Demand Candles on (SPX):

Supply and Demand Candles on (EUR/USD):

There are traders who swear by Supply & Demand, and some who do just fine, with Support & Resistance.

Here’s the thing…

You don’t want to trade them in isolation, but use them with other technical tools, that add confluence to your trades.

Price action patterns — Narrow range candles

If there is a sudden range expansion in a market that has been trading narrowly,  human nature is to try and fade that price move.

When you get range expansion, the market is sending you a very loud, clear signal that the market is getting ready to move in the direction of that expansion. – Paul Tudor Jones

You’re wondering:

What does it mean?

Simply put, when you get a series of narrow range candles (volatility contraction), get ready for an explosive move. (These findings can be validated by the works of Adam Grimes, Tony Crabel, and Mark Minervini.)

So, what’s the best way to enter such trades?

You can look to trade the initial breakout or the pullback after the breakout.

The last thing you’d want to do is trade against the breakout.

Let’s move on…

A price action trading strategy that works

Here’s what you need to do:

  1. Mark your areas of Support & Resistance (SR)
  2. Wait for a directional move into SR
  3. Wait for price rejection at SR
  4. Enter on the next candle with stop loss beyond the swing high/low
  5. Take profits at the swing high/low

You can consider taking half your position off at the nearest swing low, and the remaining at the further swing low.

This depends on your trade management.

This is important…

You must understand the trading strategy isn’t the holy grail.

In fact, you’re going to have both winners and losers. And the only thing that will keep you in this game is proper risk management. My advice is to risk no more than 1% of your account on each trade.

So, what’s next?

You’ve just learned what price action trading is all about, and how you can use it and to get a “feel” for the markets.

If you learn it well, it will improve your entries, exits and trade management.

Now… it’s time to put these techniques into practice.

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