Price action in forex is the movement of currency prices over time without being affected by any external indicators or tools. It’s the analyzing process of raw price changes as displayed on a chart based on historical price patterns and chart behavior. Price action trading relies on reading and interpreting the market's language through candlesticks, chart patterns, support, and resistance levels.
In simpler words, if forex trading were storytelling, price action would be the narrative. Since it reveals what buyers and sellers are doing in real time, traders can aim and predict where the market might move next by studying these past movements.
In this article, we will delve into the real meaning of price action and thoroughly analyze the price action trading strategy.
What is Price Action Trading in Forex?
When traders choose to make decisions solely based on past price movements without relying heavily on technical indicators or algorithms, this minimalist trading approach is called price action in forex. In this strategy, traders study price action patterns in forex, trends, and analyze market psychology through chart formations. For example, if you observe that EUR/USD bounces multiple times from 1.0500 but can’t seem to break above 1.0600, it’s an obvious signal for price action trading of a trading range. This helps traders to decide whether to buy, sell, or wait.
Consider a trader monitoring GBP/USD and notices a bullish engulfing candlestick pattern at a key support level. This pattern, when a bullish candle fully engulfs the previous bearish candle, signals a potential reversal. Based on this reading of the price action patterns in forex, the trader enters a long position, betting on upward momentum. This strategy is more approachable, especially for retail traders due to its simplicity. This strategy is also popular because it’s available for anyone willing to learn how to read chart patterns, unlike other strategies that involve complex algorithmic trading systems or heavy setups of indicators.
Key Elements of Price Action Analysis
1. Support and Resistance Levels
These are the zones where the price tends to pause or reverse due to increased buying or selling pressure. Support is a price level where buying interest exceeds selling and the price eventually bounces. Conversely, resistance is a price level where selling pressure overtakes buying, causing the price to drop. These levels help traders determine entry and exit points.
2. Candlestick Patterns
Candlestick patterns are essential for price action patterns in forex analysis. Each candlestick shows a different signal about the market’s mood within a specific time frame. For instance, doji is a candle where the opening and closing prices are almost identical, reflecting indecision in the market, or when a candle fully engulfs the previous one, it indicates a potential reversal, and it’s called engulfing patterns. There are more candles like this, and each one tells a different story.
3. Trendlines
Trendlines help traders identify the market’s direction. These lines are known as dynamic support or resistance, whether it’s up, down, or sideways. A break of a trendline can signal a shift in market sentiment.
4. Market Context and Risk Management
Economic events like central bank rate decisions or geopolitical tensions can influence price movements. A trader using price action should be cautious of these events and interpret how they can shape the market while relying on chart signals.
Who Uses Price Action Trading?
Both professional and retail traders use price action in forex trading; however, there’s a slight difference in how they imply it. For example, many institutional traders, including those working at hedge funds and banks, embody price action strategy principles in their strategies to either confirm signals from algorithms or refine large-scale trades. Professional traders may use a breakout above a key resistance level as a trigger to increase their position size. On the other hand, price action trading is quite popular among retail traders because of its simplicity and cost-effectiveness. In addition to that, most retail traders prefer price action strategy in forex because it’s just a solid understanding of price charts and patterns, unlike most indicator-based strategies that require subscription services or expensive tools. Needless to say that all of the indicators are derivatives of the price itself, so indicators might have delays but the price itself won’t.
Tools Used for Price Action Trading
Since price action in forex trading is focused on charts and patterns, traders using this strategy keep their setup minimal. For instance, Candlestick charts are the backbone of price action trading especially because they provide a visual representation of market sentiment, showing open, high, low, and close prices, such as a series of bullish candlesticks on GBP/USD suggests strong buying interest. Furthermore, we have horizontal lines on the chart that mark critical support and resistance levels. Traders use them to highlight zones where price tends to reverse or consolidate. Some traders on the other hand use complementary tools, even though the price action strategy avoids indicators. For instance, traders use price action indicators in forex like moving averages and a 200-period moving average can act as dynamic support or resistance, aligning with price action indicator in forex.
How to Predict Price Action?
Reading price action patterns in forex is a key element when a trader wants to predict price action trading movement in the forex market. Patterns like head and shoulder or double top give the trader clues like potential market reversals. For example, if EUR/GBP forms a double bottom, traders could expect an upward move.
Another important factor traders should take into consideration is understanding market sentiment. Let’s suppose, the Federal Reserve rates hikes, USD pairs often strengthen as traders assume tighter monetary policy. To understand it better let’s take a look at a real-life example of price action in forex trading.
A trader analyzes the USD/CAD daily chart notices a clear resistance zone at 1.3800. After multiple failed attempts to break this level, the price forms a bearish pin bar, indicating rejection. The trader enters a short position with a stop loss just above 1.3800. USD/CAD drops over the next few days to 1.3600, yielding a 4:1 reward-to-risk ratio. This example highlights how price action trading combined with proper risk management, can lead to consistent profitability.
