Price action trading describes the practice of making trading decisions largely based on pure price movement on a chart, with minimal use of complex technical indicators.
Price action traders primarily use the raw data of price movement and chart patterns to form their decisions.
They do however often use basic support and resistance levels, which may be derived from a prior high or low, a trend line or moving average.
In this guide we’ll cover several classic price action strategies that you’ll be able to get started with right away.
Above: a bearish reversal pin bar on the H4 GBP/JPY Chart
Pin Bars are perhaps the most famous of price action trading patterns – for good reason, as they are highly accurate when properly identified and occur at a support or resistance level.
Pin Bars are reversal patterns. They appear at the top of an uptrend or at the bottom of a downtrend and are candles with long wicks and short bodies. At the top of an uptrend, price probes higher, but then makes a hasty retreat closing near the open. This reveals the psychology of the market, reflecting a lack of confidence among the bulls.
In a down trend a pin bar appears when price reaches down to a lower level but reverses and closes near where it opened. In this scenario we see a lack of confidence among the bears.
Pin Bars have a very high accuracy rate in trending markets and especially when there is a confluence of indicators. We see confluence when the pin bar reaches up to a resistance level (in an uptrend) or a support level (in a downtrend).
Pin bars are generally traded as follows:
In the event of a pin bar at the top of an uptrend, sell entry takes place in the following bar when price trades below the low of the pin bar. Stop loss can be placed just above the high of the pin bar.
In the event of a pin bar at the bottom of a downtrend, buy entry takes place when price rises above the high of the pin bar. Stop loss can be placed just below the low of the pin bar.
Your profit target can be set at 2 to 3 times the amount of your stop loss. For example if your stop loss is 10 pips from your entry level, your profit target can be placed at 20 to 30 pips from your entry level.
Inside Bar Pattern on the Daily GBP/USD Chart
An inside bar is a two candlestick price pattern which can signal a trend continuation. An inside bar is a candle completely contained within the range of the previous candle (also called the mother bar). The inside bar should have a higher low and lower high than the mother bar.
Like Pin Bars, Inside Bars tell us about the psychology of the market. Inside bars reflect indecision and uncertainty.
Inside Bars can be traded as follows:
When an inside bar occurs in the context of an uptrend you enter long when price breaks out above the high of the mother bar. Your stop can be placed below the low of the mother bar. Profit target can be placed at 2-3 times the distance of your stop loss.
When an inside bar forms in the context of a downtrend you enter short when price breaks out below the low of the mother bar. Your stop loss can be placed above the high of the mother bar. Profit target can be set at 2-3 times the distance of your stop loss.
Inside bars are best traded on longer term time frames, such as the 4 hour, daily and even weekly charts.
Declining Momentum on the EUR/USD Daily Chart
The size of the body of a candle reflects momentum. Like inside bars and pin bars the size of the body tells us something about the psychology of the market. Long bodied bullish (green) candles reflect that the buyers are confident and in charge. Long bodied bearish (red) candles indicate the the bears are in control.
Looking at the change in the size of a candle’s body tells us something. When the body of candles get progressively smaller when approaching a support or resistance level, this signals slowing momentum and indicates a possible reversal at the inflection (support or resistance) level.
Meanwhile, if you see long bodied candles approaching a support or resistance level, this signals that price is more likely to break through that level.
Let’s take a look at how to use this insight in your trading.
When price is falling and the bodies of candles are getting progressively smaller when approaching a support level, this tells us that price is more likely to bounce at that level. You can trade this by placing your buy order at or just above the support level. Your stop loss can be placed below the support level. In this instance your profit target could be larger in relation to the stop loss, placing it at 3-5 times the amount of the stop loss. The chart example pictured above shows candles getting progressively smaller before reaching the support level of the 200 period moving average, where price indeed reverses.
When price is rising and the bodies of candles are getting progressively smaller when approaching a resistance level, this tells us that price is more likely to reverse at that level. This can be traded by placing your sell order at or just below the resistance level. Your stop loss can be placed above the resistance level. Place your profit target at 3-5 times the amount of your stop loss.
The logic of price action trading is similar to the logic behind technical analysis itself – news and other complex data are not necessary to follow, because everything is reflected in real time in the price action of the charts. Price action traders avoid what is called analysis paralysis from using too many indicators and getting confused by conflicting signals. Ultimately, understanding price action and support and resistance levels can provide all the signals necessary to develop a profitable trading strategy.