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The Price Action Trading Strategy Guide

Sebencapital

Published
06/10/23
The Price Action Trading Strategy Guide

You may be wondering:

"What exactly is Price Action Trading?"

Price action trading is an approach that relies on historical price data, including the open, high, low, and close, to assist you in making more informed trading decisions.

In contrast to indicators, fundamentals, or algorithms, price action provides insight into what the market is doing rather than what you might expect it to do.

It's important to note that this isn't a magic solution. However, if you invest time learning price action trading, you can analyze charts more effectively and accurately identify your entry and exit points.

That's why I've dedicated today's post to a comprehensive discussion of Price Action Trading, totaling 2873 words. In this post, I'll be sharing the following insights with you:

  • The Untold Truths About Support and Resistance
  • Secrets of market behavior: How the market truly operates
  • The key to interpreting Candlestick Patterns – Mastering precise timing for your trades
  • A handy Candlestick patterns cheat sheet – Understanding any pattern without memorization
  • The M.A.E Trading Formula – A straightforward Price Action Trading system suitable for everyone

Are you prepared to dive in?

Let's begin...

This post is extensive, and I recommend you download the PDF file below for future reference.

1. The reality about Support and Resistance that often goes unmentioned

First, let's clarify what Support and Resistance mean, ensuring that we all have a common understanding.

Support refers to a horizontal region on your chart where you can anticipate buyers stepping in to drive the price upward.

Resistance – Conversely, this denotes a horizontal zone on your chart where you can anticipate sellers coming in to exert downward pressure on the price.

Let's illustrate this with a couple of examples...

Support and Resistance on the EUR/USD Daily chart:

Support and Resistance on the EUR/USD

Support on (USD/CAD):

Support on (USD/CAD)

Resistance on (GBP/JPY):

Resistance on (GBP/JPY)

Support and Resistance can interchange their roles.

This signifies that when Support is breached, it can transform into Resistance. Likewise, when Resistance is breached, it can shift to become Support.

Let's examine an example...

Past Support evolves into Resistance on the (GBP/AUD) chart:

Past Support evolves into Resistance on the (GBP/AUD) chart

Previous Resistances turns Support on (NZD/USD):

Previous Resistances turns Support on (NZD/USD)

But why does this role reversal occur?

It happens because when the price breaks through Support, traders who are in long positions start incurring losses, finding themselves "in the red."

As the price subsequently rebounds to the Support level, this group of traders seizes the opportunity to exit their losing trades at breakeven, which generates selling pressure.

But there's more to it. Traders who missed the initial breakout often shorten the markets when the price revisits the former Support level, further intensifying the selling pressure.

This is the reason why Support often transforms into Resistance after being breached.

Does that make sense?

Now, you might be wondering...

"How do I draw Support and Resistance on my charts?"

That's a valid question.

Here are the guidelines I follow:

  • Zoom out your charts (I prefer at least 200 bars).
  • Identify the most obvious levels (if you need to guess second, it's likely not significant).
  • Adjust your levels to capture the highest number of "touches," whether on the body or wick of the candles.

If you're looking for a comprehensive tutorial on drawing Support and Resistance, I recommend watching the video below...

Next up,

let's talk about Dynamic Support and Resistance.

According to Classical Technical Analysis, Support and Resistance are typically depicted as horizontal areas on your chart. This approach is valuable when the market trades within a range or exhibits a weak trend.

However, in the case of robust trending markets, this conventional method may not be as effective. That's where you should turn to dynamic Support and Resistance.

Now, what exactly does "dynamic" mean in this context?

Support and Resistance levels adapt and move in tandem with the price action rather than remaining fixed.

For instance:

In a strong trending market, the 20-period Moving Average can serve as dynamic Support...

dynamic Support

Or, in the case of a healthy trend, the 50-period Moving Average can function as dynamic Resistance...

dynamic Resistance

Pro Tip:

Dynamic Support and Resistance can also manifest as Trendlines or Trend Channels.

Let's dive into some secrets of market behavior: How the market truly operates...

Here's the scoop:

The markets are constantly in flux (you've probably noticed this by now). They can be in an uptrend or downtrend, trading within a range, experiencing low, high, and more volatility.

But if you take a step back and examine the bigger picture, you'll realize that the market tends to fall into one of four stages...

1. Accumulation

2. Advancing

3. Distribution

4. Declining

Allow me to explain each one...

Stage 1: The Accumulation Stage

The Accumulation stage typically follows a price decline and resembles a range-bound market within a downtrend.

Here are the key characteristics to watch for:

  • It occurs after the price has declined over the past five months or more (on a Daily timeframe).
  • It resembles a range-bound market with clear Support and Resistance zones, all within the context of a downtrend.
  • The 200-day Moving Average begins to level off.
  • Price movements exhibit back-and-forth swings around the 200-day Moving Average.

Let's take a look at an example...

The Accumulation Stage

Stage 2: The Advancing Stage

The Advancing Stage is characterized by an uptrend marked by a sequence of higher highs and higher lows.

Here are the key indicators to keep an eye on:

  • This stage typically follows a price breakout from Resistance in the Accumulation stage.
  • You will observe a series of higher and lower highs in the price movement.
  • The price will be positioned above the 200-day Moving Average.
  • Additionally, the 200-day Moving Average will begin to slope upwards.

Here's a visual representation to illustrate this stage...

The Advancing Stage

Now, here's a crucial point to remember...

No market can sustain an upward trajectory indefinitely. Eventually, it becomes "fatigued," leading it into stage 3...

Stage 3: The Distribution Stage

The Distribution stage typically follows a price ascent and appears as a range-bound market within an uptrend.

Here are the key characteristics to keep an eye on:

  • This stage occurs after the price has risen over the past five months or more (on a Daily timeframe).
  • It resembles a range-bound market featuring clear Support and Resistance zones, all within the context of an uptrend.
  • The 200-day Moving Average tends to level off.
  • Price fluctuations exhibit back-and-forth movements around the 200-day Moving Average.

Here's a visual representation to help you grasp this concept...

The Distribution Stage

At this point, the market is still in equilibrium, with buyers and sellers on equal footing.

However, the tide is turned if the price breaks below Support, and that's where we enter the final stage…

Stage 4: The Declining Stage

The Declining Stage is a downtrend with a series of lower highs and lows.

Here are the things to look for:

  • Occurs after the price breaks out of Support in a Distribution stage
  • You see a series of lower highs and lows
  • The price is below the 200-day Moving Average
  • The 200-day Moving Average is starting to point lower

An example…

The Declining Stage

And if you find it challenging to determine the direction of the trend, consider watching this training...

Now, you might be pondering...

"What's the significance of understanding the four stages of the market?"

Here's the deal:

Recognizing the current stage of the market empowers you to adopt the most suitable Forex price action strategy or trading approach.

Here's how it works...

If the market is Advancing, consider being a buyer, not a seller. This implies that you can explore buying breakouts or pullbacks.

Alternatively...

If the market is in a Distribution stage, it's crucial to acknowledge the potential downside if the price breaks below Support. In this scenario, consider shorting the Support breakdown or waiting for the breakdown to occur, then selling during the pullback.

Once you grasp the four stages of the market, you'll clearly understand which Price Action Trading strategies to apply in specific market conditions, ensuring you never feel "lost" again.

Now, let's delve into the secret of reading Candlestick Patterns and precisely how to time your trading entries.

At this stage, you've gained insight into the broader scope of Price Action Trading. You've learned where to initiate your trades (Support and Resistance) and what actions to take under varying market conditions (the four stages of the market).

However, one missing piece of the puzzle is knowing when to enter a trade.

This is where candlestick patterns come into play.

Let's explore...

What exactly is a candlestick pattern, and how does it function?

A candlestick pattern comprises four essential data points:

  • Open: The opening price
  • High: The highest price within a specified period
  • Low: The lowest price within a specified period
  • Close: The closing price

Here's a visual representation to clarify...

candlestick pattern

For a Bullish candle, the open is consistently lower than the close, creating an upward-looking candle.

Conversely, for a Bearish candle, the open is consistently higher than the close, resulting in a downward-looking candle.

Now, let's move on to understanding a few potent candlestick patterns that can enhance your entry timing:

  • Hammer
  • Shooting Star
  • Bullish Engulfing Pattern
  • Bearish Engulfing Pattern

Allow me to elaborate...

1. Hammer

Hammer

A Hammer is a bullish reversal pattern consisting of just one candle, typically forming after a prior decline in price.

Here's how you can identify it:

  • The upper shadow is either very small or non-existent.
  • The closing price is in the top 25% of the candle's range.
  • The lower shadow is approximately 2 or 3 times the length of the candle's body.

Now, let's break down what a Hammer signifies...

  • Initially, when the market opens, sellers take charge and drive the price lower.
  • At the point of the selling climax, significant buying pressure enters the market, propelling the price higher.
  • The buying pressure becomes so robust that it closes the candle above the opening price.

In essence, a Hammer represents a bullish reversal candlestick pattern demonstrating a rejection of lower prices.

However, it's essential to note that spotting a Hammer doesn't guarantee an immediate trend reversal. To enhance the likelihood of a successful trade, you'll need further "confirmation," which I'll delve into in more detail later.

Now, let's move forward to discuss the Bullish Engulfing Pattern...

2. Bullish Engulfing Pattern

Bullish Engulfing Pattern

A Bullish Engulfing Pattern is a bullish reversal candlestick pattern that involves two candles and typically forms following a prior decline in price.

Here's how you can identify it:

  • The first candle closes bearishly.
  • The second candle's body completely "engulfs" the first candle's body, disregarding the shadows.
  • The second candle closes with a bullish tone.

Now, let's unravel the significance of a Bullish Engulfing Pattern...

  • During the first candle, sellers exert control as the closing price is lower for that period.
  • However, in the second candle, robust buying pressure emerges, pushing the price to close above the high of the preceding candle. This signals that the buyers have temporarily gained the upper hand.

A Bullish Engulfing Pattern indicates that the buyers have overwhelmed the sellers and taken control of the market direction.

A Hammer is a Bullish Engulfing Pattern on a smaller timeframe, as candlestick formations can appear differently across various timeframes.

Here's a visual representation to illustrate this concept:

Bullish Engulfing Pattern

Make sense?

3. Shooting Star

Shooting Star

A Shooting Star is a bearish reversal pattern consisting of a single candlestick that typically forms after a price has advanced.

Here's how you can identify it:

  • There is little to no lower shadow.
  • The closing price falls within the bottom 25% of the candle's range.
  • The upper shadow is roughly 2 or 3 times the length of the candle's body.

Now, let's break down the significance of a Shooting Star...

  • When the market opens, buyers initially take control, increasing the price.
  • However, substantial selling pressure enters the market at the peak of the buying frenzy, forcing the price lower.
  • The selling pressure becomes so pronounced that it leads to a close below the opening price.

In summary, a Shooting Star represents a bearish reversal candlestick pattern that indicates a rejection of higher prices.

As a contrasting pattern to the Shooting Star, remember that a Hammer is its bullish counterpart.

Now, let's move on to discuss the Bearish Engulfing Pattern...

4. Bearish Engulfing Pattern

Bearish Engulfing Pattern

A Bearish Engulfing Pattern is a bearish reversal candlestick pattern that involves two candles and typically forms following a price advance.

Here's how you can identify it:

  • The first candle closes with a bullish tone.
  • The body of the second candle completely engulfs the body of the first candle without considering the shadows.
  • The second candle closes with a bearish sentiment.

Now, let's decode the meaning of a Bearish Engulfing Pattern...

  • During the first candle, buyers have control as the closing price is higher for that period.
  • However, significant selling pressure enters the market in the second candle, leading to a close below the low of the preceding candle. This indicates that sellers have temporarily gained the upper hand.

A Bearish Engulfing Pattern signifies that sellers have overwhelmed the buyers and are dictating the market direction.

You've just learned some of the most potent reversal candlestick patterns. But it's worth noting that numerous variations make it impossible to cover all of them in a single blog post.

The good news is that you don't need to commit all these patterns to memory to comprehend what the market is conveying. Here's how you can do it...

Candlestick patterns cheat sheet: How to decipher any candlestick pattern without memorizing one.

This is a critical concept, so let's focus...

1: Trending Move

You might be wondering:

"What exactly is a Trending Move?"

A Trending Move represents the "longer" leg of the trend.

If the candles are sizable (in an uptrend), it signifies strength, indicating that buyers are in control.

On the contrary, if the candles are small, it signals weakness, suggesting that buyers are becoming exhausted.

Let's take a look at an example...

Trending Move

2: Retracement Move

A Retracement Move represents the "shorter" leg of the trend.

If the candles during this phase are substantial, it indicates that counter-trend pressure is mounting. In other words, the retracement could be significant, potentially challenging the prevailing trend.

On the contrary, if the candles are relatively small during a retracement, it suggests a healthy pullback within the trend. In such cases, the trend will likely resume its previous direction, as the retracement doesn't exhibit excessive counter-trend force.

Here's an illustrative example of a Retracement Move...

Retracement Move

3: Swing Points

Swing Points encompass swing highs and lows – readily discernible "points" on the chart where the price reverses.

Let's examine an example...

Swing Points

Understanding swing points is crucial because they provide insights into whether the market is in an uptrend, downtrend, or trading within a range.

As a rule of thumb:

  • If the swing highs/lows trend higher, the market is uptrend.
  • Conversely, if the swing highs/lows are trending lower, the market is in a downtrend.
  • The market is in a range if the swing highs/lows aren't exhibiting an upward or downward trend.

Now, if you're interested in uncovering the secrets of chart patterns, you can click here to learn more.

Moving on...

To grasp any candlestick patterns, you only need to consider two essential factors:

  • Where the price is close to the range.
  • The size of the pattern relative to other candlestick patterns.

Let me elaborate...

  • Where did the price close relative to the range? This aspect informs you about the current dominant force in the market.

Take a look at this candlestick pattern...

Swing Points

Let me pose a question to you...

Who's calling the shots here?

In this case, the price has closed near the upper end of the range, indicating that the buyers are firmly in control.

Now, consider this other candlestick pattern...

Swing Points

So, who's the one calling the shots in this scenario?

Despite it being a bullish candle, it's the sellers who are asserting control.

Why, you ask?

Because the price closed near the lower end of the range, signifying a rejection of higher prices.

Hence, remember this key question to gauge control:

Where did the price close relative to the range?

Now, let's move on to the next crucial aspect...

What's the size of the pattern compared to other candlestick patterns?

This aspect helps you determine whether there's any significant strength or conviction behind the move.

You aim to compare the current candle's size with the preceding candles.

If the current candle is considerably larger, around two times or more significant, it signals substantial strength driving the move.

Here's an example to illustrate this concept...

candlestick patterns

However, if there isn't much strength propelling the move, you'll observe that the size of the current candle is quite similar to the earlier ones.

Here's an illustrative example...

candlestick patterns

It all makes sense!

Now that you have the tools to read any candlestick pattern without memorization, let's delve into The M.A.E Trading Formula, a proprietary trading technique designed to help traders consistently and profitably identify high-probability trading setups.

Here's how it functions...

1: Market Structure

Recognizing the market structure is the initial step in navigating a blank chart and providing clear direction.

Ask yourself:

"Is the market currently in an uptrend, downtrend, or range?"

In essence, identifying the market structure helps you align your trades with the path of least Resistance.

For instance:

  • In an uptrend, focus on buying opportunities.
  • In a downtrend, concentrate on selling opportunities.
  • In a range-bound market, consider both buying and selling.

Next...

2: Area of Value

Identifying the market structure alone isn't sufficient; you must also pinpoint where to enter your trade.

Now, you might be wondering:

"With so many potential entry points, how do I choose the right one?"

Your goal is to trade from an area of value, enabling you to buy low and sell high. This could involve areas such as:

  • Support and Resistance
  • Respected Moving Averages
  • Trendlines

Moving on...

3: Entry Trigger

Now that you know what to do (identify market structure) and where to enter (area of value), the final piece of the puzzle is determining when to enter.

I prefer to enter when the market provides signals of reversal, thereby confirming my trading bias. These signals can manifest in the form of reversal price patterns like:

  • Hammer
  • Shooting Star
  • Bullish Engulfing Pattern
  • Bearish Engulfing Pattern

Now, let's explore a few examples of The M.A.E Formula in action, starting with

GBP/USD on the daily chart...

GBP/USD on the daily chart

GBP/USD Daily: Wait for the price to reach an area of value

GBP/USD Daily: Wait for the price to reach an area of value

GBP/USD Daily: Enter upon receiving a valid entry trigger

entry trigger

Another example…

T-Bond 4-hour: Identify the market structure

T-Bond 4-hour: Identify the market structure

T-Bond 4-hour: Wait for the price to approach an area of value

T-Bond 4-hour: Wait for the price to approach an area of value

T-Bond 4-hour: Enter on a valid entry trigger

T-Bond 4-hour: Enter on a valid entry trigger

It's all coming together now!

You've gained a comprehensive understanding of price action trading, reading candlestick patterns without memorization, and applying The M.A.E Trading Formula to identify high-probability trading setups.

So, what's the next step?

It's time to put these techniques into action.

The first step in this journey is to click the link below and download The Ultimate Guide to Price Action Trading.

By doing so, you'll access a beautifully crafted PDF file containing the trading strategies and techniques we've covered here and additional content that wasn't space to include in this discussion.

Happy trading!

Written by Sauravsingh

Techpreneur and adept trader, Sauravsingh Tomar seamlessly blends the worlds of technology and finance. With rich experience in Forex and Stock markets, he's not only a trading maven but also a pioneer in innovative digital solutions. Beyond charts and code, Sauravsingh is a passionate mentor, guiding many towards financial and technological success. In his downtime, he's often found exploring new places or immersed in a compelling read.

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