Price action analysis refers to technical analysis that is solely based on naked price movement; it does not include exotic indicators but may include Fibonacci levels, trendlines or wedges/triangle formations.
In this article we are going to take a look at the major tools of price action trading that include swing analysis, trendlines, Fibonacci levels, candlestick pattern and horizontal levels.
Swing analysis is the most powerful tool to identify the existing trend. If the current wave prints a Lower Low or Lower High as compared to the preceding wave, then we say the trend is bearish.
Similarly, if the wave prints a Higher Low or Higher High compared with the previous wave, then we term the trend as bullish.
For example, consider the above monthly chart of Euro/Dollar. The waves are constantly printing Lower Lows and Lower Highs on the chart, indicating consistent bearish trend for the Euro/Dollar in the long run.
In this scenario, price action traders would prefer the “Sell on Rally” strategy unless the price prints a Higher High or Higher Low.
The use of trendlines is another very effective price action strategy. Consider the following weekly chart of gold.
The lower trendline, known as Channel Support, is drawn by joining the swing lows of candles.
Similarly the upper trendline, known as Channel Resistance is drawn by joining the swing highs of candles. A daily closing above/below the trendline results in breakout. The channel resistance acts channel support in case of an upside breakout while opposite is the case with downside breakout.
Calculating support and resistance levels with the help of Fibonacci ratios is also one of the widely used price action strategies. Key Fibonacci ratios include 23.6%, 38.2%, 50%, 61.8%, 76.4%, 100%, 161.8% and 261.8%.
Price action traders mostly use Fibonacci levels in conjunction with other strategies. The 50% fib level is believed to be the most important Fibonacci ratio.
Another famous price action strategy is the assessment of charts with the help of the candlestick pattern. Traders use various reversal candles and patterns to identify the potential change in trend.
For example, bullish pin bars, hammers and bullish engulfing candles indicate potential reversal in an ongoing bullish trend, while bearish pin bars, shooting stars and bearish engulfing candles show potential change in the ongoing bullish trend. These candles signal continuity of trend if they appear within the same trend.
Identifying support and resistance with the help of horizontal levels is another famous price action tool.
As demonstrated in the following chart, horizontal support consists of levels that acted as level somewhere in the past. Likewise, horizontal resistance consists of levels that acted as resistance in the past.
This was a brief account on various tools of price action analysis.
Using the combination of price action tools is always good to optimize results. Price action analysis is generally considered reliable on four-hour and higher timeframes.
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