The use of price action in trading is one of the best ways to monitor market conditions. But, how to use it as a trading signal?

The term ' price action ' may appear when you participate in a seminar or discussion about forex trading. The technical analysis based on the price movement looks very simple. However, did you know that the analysis accuracy requires a good understanding of the market that takes quite a long time to master?

Some say price action can 'project' the next price movement with high accuracy, but it is important to remember that price action uses price data from the past. In other words, relying solely on price action can't give you guaranteed accuracy. Yet, you can use it as a complementary method in your trading system.

Here's a step-by-step guide on how to read price action signals:

  • Understand reversal pin bars.
  • Watch for reversal pin bars in a false break scenario.
  • Identify long-tailed pin bar in a trend-following strategy.
  • Don't wait on breakouts.
  • Use long-tailed pin bar and doji as suppor resistance.

To demonstrate the interpretation of each step in reading price action signals, let's get to the next part.

 

1. A reversal pin bar with a very long tail is a fairly valid trading signal.

The tail factor on a pin bar is important. In a candlestick bar pattern, the tail indicates the strength of rejection from a certain price. The longer the tail is, the stronger the rejection is, meaning the market is reinforcing the price to reverse from where it is initially intended to go. It does not mean that every long-tail candlestick can be made as a reference for determining trading signals; you must look at the bar's position and several other supporting factors. However, a long tail is certainly more significant than the short one.

Here is an example of a reversal pin bar with a long tail. Added to the rejection at key resistance levels, this is surely a fairly valid trading signal with high probability.

Price Action Signal 4

 

2. Find the pin bar with a long tail that sticks out and indicates a false break.

Suppose we find a reversal pin bar accompanied by rejection at a certain support or resistance level, and the pin bar's tail appears to stick out of the line. In that case, it is usually a trading signal with high probability. The protruding pin bar tail shows the resistance at that level, so it has more weight than the other price action signals.

The rejection at the support or resistance level indicates that the market price movement cannot break the level, so the possibility of reversal is very high. The following is an example of a reversal bar that rejects the support level, indicating a false break condition. This condition shows a quite valid trading signal to buy from support.

Price Action Signal 2

In the next picture, you can see two reversal pin bars that become the trading signals. Both of them reject resistance levels. The difference is the first reversal pin bar is rejected from a minor resistance level, while the second pin bar goes down from a key resistance level.

Price Action Signal 3

In this case, the second pin bar reversal is more valid. Why? Because it occurs at a more important key resistance level which is harder to break than a minor resistance. If you want to use the first pin bar rejection as a trading signal, minimizing the risk as low as possible is suggested.

 

3. Long-tailed pin bar can also serve as a signal of trend continuation.

On the previous topic, it has been emphasized that a reversal pin bar is attached with a long tail that moves against the direction of the main trend. This characteristic leads to common consideration of a pin bar as a reversal candlestick.

Yet, a long-tailed pin bar can also help traders to find a good signal when the trend may continue. How so? To understand it better, you need to understand price corrections frequently happening in a trend. The corrections are generally temporary reversals that will revert to the original trend, especially when the momentum is still quite strong to carry out the trend.

A long-tailed pin bar is helpful to identify at which point the correction will return to the main trend. The following example shows a long-tailed pin bar when the price is downtrend. As the bar is formed in a (bullish) correction, the upper tail indicates that sellers strongly reject the price to move higher; they still have enough strength to continue pushing the price lower. The resistance level rejecting the long-tailed pin bar also validates the downtrend continuation signal. 

Price Action Signal 5

You can use this as a benchmark: if, in the following days, the price does not move from the 50% retracement level of the pin bar, this can be a trading signal, and you can make a trade from there. In this example, the stop loss can be set several pips above the resistance level.

 

4. Avoid getting your hopes up for a breakout.

Wait for clear confirmation. Avoid the breakout traps in the form of bull traps or bear traps; pay attention to the candlestick patterns and price action setup formations that are formed. Many traders are tempted to trade a breakout possibility quickly, a situation where the price moves past a support or resistance level. This is very risky, especially if you are playing in the area of a key support or resistance level.

Unfortunately, many traders consider the breakout trap a trading signal regardless of the price action setup. Remember that the price action setup reflects the psychology of the market.

Breakouts can happen, but the market will usually test the support or resistance level before eventually reversing, leaving the situation as a false breakout or a false break. It is not always the case, but the stronger the support or resistance level, the higher the possibility. If you happen to trade in the stock market, it will be easier to anticipate it with the volume indicator. The higher the volume trading at the main support or resistance level, the bigger opportunity is for a breakout because of a clear boost to the market sentiment.

Unfortunately, the forex market does not have a reliable volume indicator reflecting the size of transactions from all the players. One way to figure out the possibility of a real breakout and a false breakout is to pay attention to the psychology of the market sentiment, which can be observed from the candlestick patterns and price action setup formations.

The daily chart below detects a bull trap when a false break happens at a resistance level.

Price Action Signal 6

Don't bet your position on a false break. When the resistance is broken, wait until the previous price is closed above the resistance level. The breakout is not confirmed in the previous example because no closed price is above the resistance level. It is only the tails of the candlesticks that pierce the level.

 

5. Using a long-tailed pin bar without the help of support resistance levels.

A long-tailed pin bar can also be inferred as a Doji pattern when the opening and closing price is almost at the same level. Usually, this trading signal is quite valid in the daily time frame. A support or resistance level is unnecessary if this long-tailed pin bar is formed, as the Doji's tail will independently form a new support or resistance point.

Price Action Signal 7

 

The Basic Application of Price Action

Price action is the study of historical price movements to predict future price movements. It is a popular trading strategy among both beginner and experienced traders.

There are many different ways to use price action analysis, but some of the most common methods include:

  • Identifying trends: One of the most basic uses of price action analysis is to identify trends. A trend is a general direction in which the price of an asset is moving. Trends can be either uptrends (prices are rising) or downtrends (prices are falling).
  • Identifying support and resistance levels: Support and resistance levels are price points where buyers and sellers will likely come into balance. Support levels are areas where buyers are likely to step in and prevent the price from falling, while resistance levels are areas where sellers are likely to step in and prevent the price from rising.
  • Identifying candlestick patterns: Candlestick patterns are a type of chart pattern that can be used to predict future price movements. There are many candlestick patterns, but some of the most common include the bullish engulfing pattern, the bearish engulfing pattern, and the hammer pattern.

Price action analysis can be a powerful tool for predicting future price movements, but it is important to remember that it is not a perfect science. There will always be times when the price does not move in your expected direction.

If you are new to price action analysis, it is a good idea to start by learning about the basics of trends, support, and resistance levels, and candlestick patterns. Once you understand the basics well, you can start developing your trading strategies.

Here are some additional tips for using price action analysis:

  • Use multiple time frames: It is important to use multiple time frames when analyzing price action. This will help you to identify trends and support and resistance levels on different time scales.
  • Use multiple indicators: In addition to price action, you can use other technical indicators to help you make trading decisions. Some of the most popular technical indicators include moving averages, Bollinger bands, and the Relative Strength Index (RSI).
  • Backtest your strategies: Once you have developed a trading strategy, it is important to backtest it on historical data. This will help you to see how your strategy would have performed in the past.
  • Start small: When you are first starting, starting with small trades is a good idea. This will help you to reduce your risk and learn from your mistakes.

If you are new to price action analysis, starting by learning the basics is a good idea, and slowly developing your trading strategies.

 

What to Watch Out For in Price Action Trading

Once again, price action cannot guarantee 100% accuracy. It is influenced by various factors, including:

  • Time Frame. Candlestick formations are influenced directly by the time frame you choose. For example, the H4 time frame will display a bar every 4 hours, while the daily time frame will only carve the bar once a day. As a result, the lower the time frame is (below H4), the higher the risk of fake signals.
  • News Impacts. News releases can be a "double-edged sword" for price action traders. The price movements will usually fluctuate after the impact of a news release but return to normal as the market discerns the news carefully. Therefore, as a price action trader, you must always monitor the news and keep yourself current.

Although price action looks simple, its application in live trading needs high awareness. You must consider several factors before reacting to a signal from chart patterns. From there, you can develop a trading strategy based on the dynamics of Price Action.

 

Another interesting price action method to get a trading signal without any indicator is by interpreting price patterns. What are they, and what sets them apart from simple analysis using candlestick patterns? Find out in Introduction to Forex Technical Analysis with Chart Patterns.