Price Action Trading Guide Notes
The Ultimate Price Action Trading Guide
Table of Contents
Chapter 1: Introduction (Page 4)
Chapter 2: What is Price Action? (Page 6)
Chapter 3: Mass Psychology in Trading (Page 15)
Chapter 4: Price Chart (Page 18)
Chapter 5: Trends (Page 32)
Chapter 6: Reversals and Continuation (Page 37)
Chapter 7: Understanding Market Swings (Page 40)
Chapter 8: How to Trade Support and Resistance Levels (Page 44)
Chapter 9: How to Trade Channels (Page 49)
Chapter 10: Nine (9) Chart Patterns Every Trader Needs to Know (Page 52)
Chapter 11: Nine (9) Candlestick Patterns Every Trader Needs to Know (Page 81)
Chapter 12: How to Trade Fibonacci with Price Action (Page 93)
Chapter 13: How to Trade Trendlines with Price Action (Page 98)
Chapter 14: How to Trade Moving Averages with Price Action (Page 103)
Chapter 15: How to Trade Confluence with Price Action (Page 110)
Chapter 16: Why You Should Use Multi-Timeframe Analysis (Page 116)
Chapter 17: Trade the Obvious (Page 124)
Chapter 18: Closing Remarks (Page 127)
Disclaimer
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Chapter 1: Introduction
Understanding price action requires studying the past, observing the present, and predicting the market's next move.
All traders are forecasters, similar to weathermen. Weathermen analyze wind direction, pressure systems, and temperature variations to predict the weather.
Similarly, traders analyze past data and current market conditions to predict market direction. Getting the direction right leads to profit, while getting it wrong leads to loss.
Some common terms:
Long = Buy
Short = Sell
Bulls = Buyers
Bears = Sellers
Bullish = Market is up (uptrend)
Bearish = Market is down (downtrend)
Bearish Candlestick = Opened higher, closed lower
Bullish Candlestick = Opened lower, closed higher
Risk : Reward Ratio = Risk $50 to make $150, the ratio is 1:3.
Chapter 2: What is Price Action?
Price action trading involves making decisions based on repeated price patterns that indicate the likely market direction.
Tools used include chart patterns, candlestick patterns, trendlines, price bands, market swing structure (upswings, downswings), support and resistance levels, consolidations, Fibonacci retracement levels, pivots, etc.
Price action traders generally ignore fundamental analysis, believing everything is already reflected in the market price. However, major economic news announcements (interest rate decisions, Non-Farm Payroll, FOMC, etc.) should not be ignored.
Economic news can be both a friend and an enemy:
Trading in line with news can yield quick profits due to increased volatility.
Trading against the news can lead to wiped-out profits or significant losses; Markets can move so fast during news release that stop loss orders may not be triggered.
Always check the news calendar (e.g., forexfactory.com) before placing a trade.
High impact news is color-coded in Red.
Recommendations:
Check forexfactory.com for major news before trading.
Avoid trading until after the news release, or trade with small contracts during volatile periods.
If a trade is already running in profit before a news release, consider tightening the stop loss or taking profits.
Three reasons to trade price action:
Price action represents collective human behavior and market psychology, creating chart patterns when traders react to specific situations.
Price action gives structure to the forex market, which helps predict potential market movements to some extent.
Price action reduces noise and false signals, which are common with indicators. Larger timeframes minimize market noise.
Multi-timeframe trading involves using setups in larger timeframes to trade in smaller timeframes for better price points and tighter stop losses.
Price action is applicable to all markets.
Price action trading is about trading with an edge, which includes:
Trading with the trend
Trading with price action using reliable chart and candlestick patterns
Trading using support and resistance levels
Making winners larger than losing trades
Trading only in larger timeframes
Waiting patiently for the right trade setups
What price action trading is not:
It will not make you rich quickly, but with proper risk management, it can make you a profitable trader.
It is not a holy grail, but it is better than using lagging indicators.
It will not make you an overnight success; it requires hard work and observation.
Chart time is necessary to understand price action.
Trend lines, candlestick patterns, chart patterns, Fibonacci retracement levels, and support and resistance levels are essential tools.
Start learning to trade naked price action.
Chapter 3: Mass Psychology in Trading
Price action represents collective human behavior or mass psychology.
Human beings respond to situations in certain ways, forming repetitive price patterns.
For example, a 'shooting star' bearish reversal candlestick pattern at a major resistance level indicates a likely downward price movement.
This is because many traders are watching that resistance level and recognize the bearish reversal formation.
They react by:
Placing sell orders.
Taking profits around resistance levels, reducing the number of buyers, and shifting the balance to sellers.
The market is moved by the activities of traders.
Pure price action trading means using only price action without indicators.
Not-So-Pure Price Action Trading uses price action with indicators such as moving averages or oscillators like stochastic and CCI.
Charles Dow is credited as the father of technical analysis, with the DOW Theory, which explains market behavior and focuses on market trends. The theory states that the market price discounts everything.
Chapter 4: Price and Charts
Price is the value given to an instrument in monetary terms, dependent on supply and demand.
Higher demand leads to increased prices.
Demand zones are around support levels.
Oversupply leads to decreased prices.
Supply zones are around resistance levels.
Charts reflect the forces of supply and demand.
Rising market = high demand.
Falling market = low demand, high supply.
Price has a time component; supply and demand over time drive price changes.
Price bars, candlesticks, and line charts graphically represent price over time.
Three Main Ways to Represent Price:
Bar Chart: A "stick" with knobs on each side. The knob on the left is the opening price, and the knob on the right is the closing price. The wick ends represent the highest and lowest prices reached during that period.
Candlestick Chart: Similar to a bar chart but with a "body." The candlestick chart has a body, and the bar chart does not.
Line Chart: Connects closing, high, or low prices; it can be useful for looking at the "bigger picture" and finding long term trends but they simply cannot offer up the kind of information contained in a candlesticks chart.
Red color indicates a bearish candlestick (price opened high, closed lower).
Green candlestick represents a bullish candlestick.
Candlestick charts are the most popular.
The Candlestick: The candlestick chart had its origins in Japan and can also be referred to as the Japanese candlestick chart.
The color indicates price movement during a timeframe (bullish or bearish).
A Bullish candlestick means the price opened lower and closed up higher after a certain time period.
The candle body represents the distance price has moved from the opening price to the closing price. The longer the body, means price has moved a great deal upward after opening. The shorter the candle body means the exact opposite.
The high is the highest price that was reached during that time period.
The low is the lowest price that was reached during that time period.
A bearish candlestick means that the candlestick opened up at a high price and closed lower after a certain time period.
Each candlestick tells a story about the battle between bulls and bears.
The length of the candlestick body and shadow (wick) indicates buying and selling pressure.
Long upper wick = significant selling pressure.
Longer lower wick = significant buying pressure.
Short upper wick = minimal selling pressure.
Short lower wick = minimal buying pressure.
Length of Body
Long body = strong buying or selling pressure.
Short body = little price movement, less pressure.
Sometimes the candles will have no upper or lower shadows but with very long bodies. These are interpreted the same way as standard candlesticks but are an even stronger indication of bullish or negative market sentiment.
Multiple candlesticks can show the strength or weakness of a move and indicate momentum. Momentum describes such a situation
Decreasing length of bearish candlesticks in a downtrend signals weakening downward trend; watch for bullish reversal signals near support levels.
Decreasing length of bullish candlesticks in an uptrend signals weakening upward trend; watch for bearish reversal candlestick patterns near resistance levels
Wicks indicate a change in market sentiment.
Upper wick forms when price moves up but is pushed down by sellers.
Lower wick forms when price moves down but is pushed up by buyers.
Longer wicks indicate increased change in market sentiment.
Long upper shadows occur when an uptrend is losing strength.
Long lower shadows occur when a downtrend is losing steam.
Chapter 5: Trends
Price movement over time, due to supply and demand, creates trends.
Understand a trend's structure using price action to identify if a trend is up, down, or sideways.
Three Types of Trends:
Uptrend: Price is moving up.
Downtrend: Price is moving down.
Sideways Trend: Price is moving sideways.
Dow Theory Of Trends Summarized
when price is in an uptrend, prices will be making increasing higher highs and higher lows until a higher low gets intercepted, then that signals the end of the uptrend and the beginning of a downtrend.
For downtrend, prices will be making increasing lower highs and lower lows until a lower low is intercepted and that signals an end of the downtrend and a beginning of an uptrend.
Structure of An Uptrend (Bull) Market: Prices will be making higher highs (HH) and Higher Lows (HL).
Structure of A Downtrend (Bear) Market: Prices will be making Lower Highs (LH) and Lower Lows (LL).
Skillfully judge when a trend is still intact or potentially reversing by observing price intersecting highs or lows.
Structure Of A Sideways/Ranging Market: Price moves in a range between support and resistance levels.
Chapter 6: Reversals & Continuation
A reversal is when a trend changes direction.
Reversals can happen:
Support levels
Resistance levels
Fibonacci levels
Continuation means that the main trend will continue. For instance, if there is an uptrend and price slows down and consolidates for a little while then that ends and price resumes in the beginning uptrend direction then that is called a continuation.
Spot trend continuity by recognizing specific chart and candlestick patterns.
Top 3 reasons for knowing reversal points/levels and trend continuity patterns:
Avoid buying near resistance (reversal point).
Avoid selling near support (reversal point).
Trade with the trend using continuation charts and candlestick patterns. (Exceptions exist, such as trading channels).
Chapter 7: Understanding Market Swings
Market price moves in swings with an uptrend making higher highs and higher lows.
A downtrend makes lower highs and lower lows.
Understand market price swing for trend and swing trading.
Without understanding swings:
Execute trades at the wrong spot.
Get stopped out or use a large stop loss.
Wait longer for profits.
In an uptrend, buy on downswings. In a downtrend, sell on upswings. Use Price Action (reversal candlesticks).
Chapter 8: How to Trade Support and Resistance Levels
Support and resistance levels are noticeable on any chart because finding effective support and resistance levels on your charts is the core to successful price action trading.
Three Types of Support and Resistance:
Horizontal support and resistance.
Broken support becomes resistance, and broken resistance becomes support.
Dynamic Support and Resistance.
Horizontal Support and Resistance: They look like peaks and troughs. Fairly easy to spot on your charts.
Support: Price hits a level and bounces up.
Resistance: Price hits a level, reverses, and cannot continue upward.
Expect price to get rejected again when heading back to a support or resistance level. Reversal candlestick trading is very handy.
Not all support and resistance levels are created equal and significant support and resistance levels are those levels that are formed in the large timeframes like the monthly, weekly and daily charts.
Significant support and resistance levels form in larger timeframes, causing long-lasting moves.
Technique: Switch to smaller timeframes (4hr, 1hr, etc.) and wait for a reversal candlestick signal for trade entries for to get in at a much better price level as well as reducing my stop loss distance.
Support turned Resistance and Resistance Turned Support:
In a downtrend, broken support often acts as resistance. Look for bearish reversal candlesticks to go short.
In an uptrend, broken resistance often acts as support. Look for bullish reversal candlesticks to buy.
Chapter 9: How to Trade Channels
The path price follows and the area enclosed within it is called the price channel.The fundamental principle of how a channel form is based on support and resistance.
Three Channel Types:
Uptrend channel
Downtrend channel
Sideways/horizontal channel
Sideways/horizontal channels are different because you can start trading at point #2, unlike uptrend and downtrend channels that require waiting for trendlines to be touched.
Look for reversal candlesticks to buy or sell when you see such setups happening.
General Rules for Trading Channels:
If buying or selling on one side, wait for the other side to take profit.
Place stop loss just outside the channel, above the candlestick high (sell) or below the candlestick low (buy).
Consider taking partial profits in the middle of the channel for a profitable trade.
Chapter 10: Nine (9) Profitable Chart Patterns Every Trader Needs to Know
Chart patterns are geometric shapes found in price data that help traders understand price action and predict future movements.
Candlestick patterns involve one or a group of candlesticks, how they form in terms of body length, opening/closing prices, and wicks/shadows, etc."