If you’ve been trading currencies for a while you may have heard the term forex price action.
In fx, many people associate the term “price action” with price movements.
And they are right. But did you know forex price action trading is a whole trading style on its own?
I cover the basics in this page, so read on.
In forex, price action trading means paying attention to price only.
You don’t wait for your moving average indicators to cross, and you don’t pay attention to Fibonacci ratios, Bollinger bands, or any other indicator.
Armed with a price chart and a system (a collection of rules to follow), an fx trader will look for opportunities to profit based on the movement of price itself.
Some call forex price action “naked” trading, since you’re not relying on an army of indicators to tell you when to enter or exit a trade.
Does that sound exciting? There’s more.
Price action traders believe price doesn’t lie.
Most technical indicators are based on past price action, so why would you bother with distortions of past prices when you have the current price?
Similarly, price action traders don’t believe in analyzing market fundamentals, after all, price has the last word, right?
Everything that should affect price, will be reflected in price.
Note: I personally agree with their position on technical indicators, but not when it comes to fundamentals.
Based on their own logic, why should I look at present price if fundamental analysis tells me where price will go? I don’t know about you, but I prefer knowing where price will be instead of where it is right now.
Forex price action traders would
Analysis can err, but price doesn’t lie.
Regardless of my position, there are many successful traders who use this approach.
If it sounds interesting to you, learn more by scroll down.
One aspect I like about price action trading, is the emphasis most experts place on back testing your system, and keeping a log of your trades, particularly your losing trades.
First, let’s step back and define back testing.
Backtesting means trying out a trading system on past data.
In other words, you’re going to simulate trades.
Trading simulations help you get comfortable with your trading system, make sure it is generally profitable, and help you gain expertise without risking money.
Ok, but isn’t it better to use a demo account?
The advantage of backtesting is speed.
You can log many training hours with your system faster than you would trading on a demo account.
This is because you have to look for moments in which trading opportunities occur.
Your trading platform will allow you to go forward quickly in order to identify such spots.
In contrast, you will have to actually wait on a live demo account for potential trade setups to occur.
This is a much less efficient way to gain expertise.
By backtesting, you also get the advantage of going slower, and moving back in time.
This allows you to study your trading with much ease.
However, be warned: be careful while going back in time while backtesting.
If you accidentally see where price ended up before simulating a trade, you will forfeit the benefits of the simulation.
You just allowed the hindsight bias to taint the experience of trading without knowing what will happen.
Ok, so if I can log many hours of practice by backtesting, why do I even need an error log?
Believe it or not, many of the mistakes we make are repetitive.
This is what we call systematic mistakes. Because you keep repeating them under the same circumstances.
But there is no way of catching these mistakes unless you force yourself to study your trades.
A great way do so is by writing down your trade setup, the entry price, the exit price, whatever you were feeling while the trade was on, and why you think the trade failed (don’t cheat here).
With time, you will be able to see commonalities.
You repeat the same type of mistake.
For example, it’s possible that you don’t properly follow the rules of your system when you feel like price will continue to go against you.
Know you know you do so, and can work on improving.
Imagine yourself doing this process with hundreds of trades, and slowly, but surely reducing the systematic mistakes you make.
You will get closer and closer to luck being the only possible thing which could go against you.
This is a great place to be.
Ok, so we have talked a lot about forex price action trading, but we still haven’t gone about how to do it.
The first and most important concept is that of support and resistance zones.
I go about these in forex technical analysis since it’s also paramount to technical traders.
In a nutshell, you have to get good at drawing zones in your chart.
Zones where price is likely to move back from.
Price action trading is all about support and resistance zones.
It is in these places where magic happens and you get to make profits.
If price moves down and gets close to the support zone, then you expect price will move back up, as it has in the past.
Similarly, if price moves up and gets close to the resistance zone, then you expect price will move back down, as it did in the past.
But you don’t enter your trade blind like that, no, you have to wait for an entry catalyst:
Depending on the forex price action system you have chosen, you will wait for a particular catalyst to appear near a support or resistance zone you drew.
What is a catalyst?
It is a pattern price action draws on the chart.
If the particular patter that triggers your trade occurs in a zone, you will enter the trade, per the rules of your system.
Phew. That’s a mouthful.
A simple, but not representative example:
You’re trading the double bottom and double tops pattern.
If price gets down and touches the support zone twice, your system indicates price will move up, and you enter the trade long.
Beware, I oversimplified to get a point across.
There are many different entry catalysts, some of these are the big shadow, the last kiss, and the kangaroo tail.
Describing these is beyond the scope of this article.
Exit strategies also vary. But most of them have to do with support and resistance zones.
If you buy price after it bounced from a low near the support zone, you will wait to sell when price gets close to the resistance zone (before it presumably comes back down).
Wow, that’s it for an introduction. And we haven’t even touched on the psychology of trading.
However, if you want more information, you can get it from an expert price action trader.
Since I am an expert on forex fundamental trading and not on forex price action, I can only recommend you get more information elsewhere.
A good place to start might be at Nial Fuller’s site http://www.learntotradethemarket.com/price-action-trading-forex.
But if you’re not convinced by forex price action, and you wish to know where what is driving price right now, and where price is likely to go, check my pages on forex fundamental analysis or better yet, sign up to Forex Economist Daily below.
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