Price is king but what does it take to trade price action successfully and why do so many traders struggle with it? The answer is often surprisingly simple and you can often improve your price action trading with just a few tweaks. This is no rocket science.
In this article, I share six of the best Forex price action trading tips that I have learned after over 15 years of trading price action. The tips could help the majority of traders to finally stop repeating the same old mistakes that keep them from realizing much better trading performance.
During this article, we will take a deep dive into advanced price action concepts that will help you gain a deeper understanding of price action principles. By the end of this article, you will be able to "look behind the scenes" at price action charts and fully understand what drives the price action.
Accumulation into A New Trend
When a trend unfolds, you will see an interplay between impulsive (trending) phases and corrective (against the trend) phases. The trending phases are generally longer and steeper than the corrective phases.
The screenshot below shows a bearish trend that started with extreme selling on the left. The corrective phases were very short and shallow in the early trend stages.
However, this changed and the price traded sideways for an extended period of time. The trend was not continued as effortlessly as before.
The distance between the two lows that I marked at the bottom is also very small, further indicating a loss of bearish momentum. During a healthy downtrend, you generally want to see that the price is making new lower lows quickly.
Although the previous signals already strongly indicated a shift in market sentiment, it is essential to wait for the market to provide a bullish signal before considering long trading opportunities.
The screenshot below shows that the price pushed through the blue resistance area with strong momentum. This marks the first time that the price was able to make a higher high.
For a breakout trader, this would most likely qualify as a long trading signal.
Just after the initial breakout, the price formed a corrective pattern with a horizontal resistance level. Taking re-entry positions after the breakout of this pattern is another common trading strategy.
The two horizontal arrow lines mark import supply areas that were formed during the initial downtrend on the left. Such supply areas will often act as resistance going forward and traders can use such price levels for target placement.
- Long corrections often lead to reversals
- Weak lows during a downtrend are a good indicator of a power shift
- Higher lows are a first bullish signal
- A momentum break into higher highs is often used as a breakout signal
The breakout buildup can be part of any price pattern and it then acts as an add-on, improving the overall pattern quality. Some traders may refer to it as a pressure pattern, but the idea is the same.
In the screenshot below, the price formed a double or triple top underneath the dotted resistance level.
The slightly upwards-sloping trendline on the right marks the breakout build pattern. Whereas the price was previously able to sell off aggressively after hitting the resistance level and moved lower substantially, during the breakout buildup, the price was pushing into the resistance sooner and sooner.
A faster return into a resistance level indicates that fewer sellers are willing to sell for that price and buyers are buying up the lower prices sooner each time. Both are confirming a shift to a more buyer-dominated market.
The breakout from a breakout buildup pattern often happens with strong momentum. As the selling interest has been consumed steadily pre-breakout, the strong buyer surplus leads to a strong reaction once the sell side disappears and only buyers are left.
- The buildup can be seen in most conventional chart patterns
- The buildup can improve pattern quality due to the added information content
- The key to the buildup is the continuously faster approach to a resistance (or support) level
- During the buildup, the selling interest is fading steadily, resulting in quicker returns back into the potential breakout level
Stop Run - Liquidity Run
The stop run is another add-on pattern and many traders use it as a trading method to get into trend-following trades after an initial breakout entry. This can be especially beneficial if the first breakout signal leads to a loss, but then the price chart develops favorably and presents the stop run signal.
In the screenshot below we see a downtrend in which the price traded sideways for an extended period of time. This is identical to the first accumulation example. We can also see the buildup component as the price keeps returning to the resistance level sooner and sooner.
The breakout occurs and the price is pushed into a new bullish trend wave. A tip that helped me in my trading is to ask myself how the average trader would approach such a breakout situation.
Traditionally, Forex price action trading books will tell traders to place their stop loss orders just underneath - or right at the breakout level for a breakeven stop - at this point.
The price shortly after falls back below the breakout level into the stop zone. Interestingly, as the market approaches the previous breakout level, the price accelerates to the downside and the red candles are getting larger. This is probably caused by the price hitting a lot of stops from traders who bought the market - in this case, those stops will be selling orders.
What we see in the screenshot below is the effect of the stop-run pattern. As the price pushed into the stop zone, more and more traders were forced out of their trades, leading to a lot of volatility. At this point, trading can be quite risky because the price is moving back and forth erratically.
A common approach is to wait for the price to break into a new high, as indicated by the horizontal dotted line. At that point, the price started making higher lows already and the price pushed through the resistance with extreme strength.
The danger of the stop-run pattern is to get involved too soon. As the price hits the stop zone, volatility generally increases. It is best to wait until the dust has settled and you can see clear signs that the bullish participants have regained control.
- Ask yourself where most traders will place their stops on a pattern breakout
- Wait for the market to push back into the stop zone
- Volatility should increase during the stop run
- Don´t get involved too soon and wait for the volatility to settle
- Wait for the price to break resistance with strong momentum
Divergence and Exhaustion
Many Forex price action trading strategies will make use of price divergences. Generally, a trader would choose a momentum indicator such as the STOCHASTIC or the RSI to determine whether a price divergence has really formed. However, by understanding the underlying market principles, we can pick up the divergence signal by only looking at the price chart.
Let´s get an understanding of the divergence characteristics by exploring the screenshot below.
The market was initially in a strong uptrend but the price then showed clear signs of weaknesses:
- The higher high just barely made it above the previous high. Observing the highs and the distance between highs can help you identify market weakness effectively.
- The sell-off before the last higher high was also stronger than usual. A change in the size of corrective waves is another key component of a price divergence
After the highest high, the price went into a long sideways phase. As in your first example of this article, the long correction leads to an accumulation where a continuation is much less likely.
Just prior to the breakout, there were signs of a breakout buildup. The price initially sold off into the dotted support, but the following bounce was much weaker. The price also returned back to the support quickly.
The candle sequence leading into the breakout also showed extreme strength.
Various confluence signals come together to improve the quality of the pattern. Generally speaking, the more criteria you can identify in a given chart situation, the higher the likelihood of a successful follow-through.
After the pattern was broken, a new downtrend started.
The divergence and the accumulation top provided clear evidence that the bullish market period was likely to be over. However, a trader should still always wait for the price to break into the new trend direction with a higher level of momentum.
- A divergence shows a weakness in trend strength
- Weaker highs and longer-than-usual corrective phases are the criteria for a valid divergence
- On its own, a divergence should not be traded without further confirmation
- An accumulation phase after a divergence is another clear sign that the market powers are shifting
- However, waiting for the price to break previous support with strong momentum is an absolute must-have signal before engaging in short trades
Flags are classic trend continuation patterns and are used within many Forex price action trading strategies.
A flag is a corrective wave with a specific shape as shown in the screenshot below. The flag occurred within a downtrend and after a strong bearish trending phase. If you are able to place a trendline along the lows without cutting through the candle body, then you have found a valid flag pattern.
But there is more to the flag than just a correction with a trendline.
The difference in steepness is another critical component to understanding this pattern. In the initial bearish trend wave the price fell a lot within a short amount of time. But during the flag, the price was not able to advance much higher. This difference in steepness is pointing to an overall seller-dominated market.
My tip for identifying flags: add the weekly Pivot point to your charts. Often, the price will pull back into the central Pivot point during a corrective phase. The central Pivot is a strong support and resistance tool during trending markets.
After the price broke the trendline, the next trend wave started and the price continued trending into the overall trend direction.
- A flag is a continuation pattern during trending markets
- A valid flag has a trendline that defines the outline of the pattern
- A flag should have a lower steepness than the previous trending phase
- Pivot points are often the endpoints for flag pullbacks and act as strong support/resistance
- The flag is triggered when the price breaks the trendline
The triple tap is another exhaustion pattern that comes with a divergence. Some triple taps even have a double divergence when the last two higher highs show weakness in a trend.
The example below shows a triple tap with three consecutive higher highs. However, the height between each subsequent high is lower than the one before, resulting in a double divergence.
Furthermore, the sell-off after each high shows much more selling interest than what was observable previously. When corrective phases become steeper and stronger, it is often a clear sign that a shift in sentiment is taking place.
Applying the RSI indicator to the chart confirms the double divergence. However, by understanding the principles of what forms a divergence, we can spot divergences just by looking at a price chart alone.
The price is breaking the last support level with a strong selling sequence. Note that the price has also shifted the Pivot structure. Whereas during an uptrend, the price will typically trade above the central Pivot point, in a downtrend the price will stay below the Pivot.
During the following downtrend, the price moved lower and pulled back into the central Pivot point during the corrective pullback phases. As mentioned earlier, using the Pivot point indicator can be a great addition to a trend-following trading approach.
- A triple tap is a trend exhaustion pattern
- The pattern confirms that the present trend is losing momentum
- Strong corrective phases are a clear indication of a shift in sentiment
- The break into a new low is a very important criterion because it shows the first lower low
- The central Pivot point may help in understanding the trend context
Summary and final words
I put a lot of emphasis on understanding exhaustion, momentum weakness, and reading the shifts in the power dynamics because such knowledge allows traders to exit their trend-following trades while getting ready to anticipate the new trend direction in the most effective way.
Furthermore, being able to read the power dynamics between the buyers and the sellers from your chart allows traders to trade with higher conviction and gain a deeper understanding of price charts in general.
Whereas most Forex price action trading guidelines just provide a surface-level understanding of the different pattern names and formations, being able to look behind the scenes by interpreting the buyer and seller distribution can help traders lift their chart reading to a new level. Then traders are not limited to trading the textbook patterns but can apply their knowledge to all kinds of situations.