Whether you are a season trader, newbie, or someone with some level of trading experience, price action analysis should always be the first type of study one should use.
Why is Price Action Important?
Price action allows you to see the general price behavior and momentum in the market.
You’ll see the swing highs and lows, major key levels of support and resistance, and determine whether the market is in a trend or range.
As mentioned above, price action should be the first technical analysis a trader should conduct. It should also be use to confirm what the indicators are projecting.
For example, you see the stochastic oscillator cross from the 20% zone upwards. So you place a buy entry right? WRONG!
What you do next, is go back to the charts and try to spot confirmation. There must be a confluence between what the indicator is showing, and what price action is telling you.
As you can see from the example above. Stochastics crossed the 20% to the upside.
So here is the right steps to enter this trade. (Keep in mind, this is the Daily chart.)
- Zoom out a little and see if price is at or near a level of key support.
- Look at the monthly and weekly charts and see if price is at or near a key level of support and plot the necessary support lines.
- Spot the general direction of the trend. (e.g. Purple line drawn on the chart) The trend line tells us its in an upward trend. (In the example above we looked at the weekly charts to gauge the direction of the trend, since we were using the daily charts.)
- Since prices are below the plotted moving average, we wait for a confirmed break of the dynamic resistance.
- By observing the candle sticks, we can predict market behavior and momentum change based on the patterns/formations of the candlestick.
- Price breaks dynamic resistance.
- Now we watch to see if price respects the new level of support, and if there is any bullish candle stick patterns emerging informing us that the bulls have entered the market.
- We spot a higher high, and lower high, now we look to spot a bullish candle on the pullback that tells us the the swing low is coming to and end, and that prices are continuing in the general direction of the trend.
- Only when all these steps are confirmed, then an entry order can be placed.
Remember, this is just general step-by-step guide, there is still more that has to be done to confirm the entry, but this is just to give you a general idea.
Using Indicators Along with Price Action
When ever you use indicators, you must avoid letting it determine the trade. As a trader, you must only use indicators to reference direction, measure momentum, and confirm your trade plan. Most traders will use a cross over from an oscillator to enter a trade. For example, the Stochastic Oscillator.
New traders are thought to buy when the oscillator crosses upwards from the 20% level, and sell if the stochastic crosses the 80 % level heading down.
Now this type of trading may get you a few wins every now and then, but majority of your trades will end up losing you a lot of money.
Stochastic, like the RSI and MACD indicators, measures the momentum of price movement.
In order to be successful in trading with these indicators, you would have to pair them up with price action, moving averages, and other indicators.
It only took me about 7 days to get use to trading with indicators. I don’t know if it was because I was dedicated to learning a profitable trading strategy, but the concept came natural to me.
I practiced with a demo account for about a week using the 4-hour timeframe and the 15-minute time-frame. I placed about a total of 12 trades in one week, looking at 28 currency pairs.
At the end of the week, was truly amazed with my results. My win to lost ratio was 50%, but due to my risk to reward ratio, I managed to pull in profit, even though I lost 6 of the trades.
I will continue to trade the strategy, and once I get some free time, I’ll post up those trades here so others can see them.