8.5 Price Action Trading Strategy

Price Action Trading Strategy - Text Version

In previous lessons, we talked about candlestick analysis and S/R. Now we are going to show how to apply these disciplines to some real historical Forex charts and identify some high-probability trades with a price action trading method.

Price Action Trading Strategy

Let's get practical by taking a look at how we could have used price action trading to trade the USD/JPY during the summer of 2013.
We begin with a 4 hour chart of the pair beginning on 12th July 2013. Looking at the chart, the first thing to notice is that there is no long-term trend. The price is ranging, or consolidating.

Therefore, it is a good idea to see if we can draw two major consolidating trend lines. The first one connects the two major lows with an upwards-sloping bullish trend line. The second one connects the two major highs in a downwards-sloping bearish trend line. Together, they form a consolidating triangle. We can look to fade – that is, trade against - touches of either line, or trade a retest from the other side after a breakout. The beauty of a consolidating triangle is that the price has to break out of it sooner or later.

Our next task within this price action strategy should be to identify any major areas of support that have become resistance, or resistance that have become support. Working from the bottom up, there is 93.78 and 96.95, but not really any suitable levels above us. So now we have our major trend lines and S/R levels drawn, we wait patiently for the price to approach one of them, and also watch to see if any new major S/R levels arise from subsequent price action.

Our first price action trading opportunity comes after midnight on 19th July, when the price approaches the upper trend line. Traders have two options here: the more aggressive option is to enter a short trade immediately upon a touch of the trend line. The conservative option is to wait for the close of a candle on at least the 1 hour time frame that has touched the trend line, and if the candle looks suitably bearish or produces a bearish price action pattern, enter a trade.
Here, either option works well, as the price taps the trend line exactly and falls. It is also possible to enter after the close of the 4 hour candle, which is a bearish outside bar. The obvious profit target is the nearest major support level at 96.95. This trade is a winner, hitting the profit target on 7th August.

As we hit the support level of 96.95, we have the option to either enter a long trade immediately, or wait to see if the candle striking the level closes bullishly. The 4 hour chart does not give us an entry, but the 1 hour chart gives us a bullish engulfing bar. Unfortunately, this trade does not win. As it did not work, we erase this support level and wait for the next opportunity.

On the 23rd of August, we have another price action trading short opportunity just like we had on 19th July. It produces a winning trade for both the aggressive and conservative trading styles.
On the 2nd of September, the price breaks up through the upper trend line. This is a significantly bullish development, as this trend line has held for a pretty long time. The safest way to trade trend line breakouts is to wait for the price to return to the trend line, and then enter in the direction of the original breakout. We have to wait until the 18th of September for the price to return to the trend line, where it forms a pin bar on the 4 hour chart. This gives an entry in both the aggressive and conservative styles. Although the trade does not go very far, by locking in profits or taking off risk when the price gets back to the previous swing high, we can ensure a small profit, or at least avoid a loss.

The price subsequently fell, but this bullish breakout of a long-term consolidating triangle did give a strong hint that the price would continue to move up, and it did so for the remainder of 2013.

That concludes our course on Candlestick Analysis and Price Action, showing how with a fairly simple price action trading strategy, you can identify trading opportunities with a high probability of success. We suggest that as well as moving onto our next course, you also take a look at our Strategy Simulations, which show real-life examples of Forex trades.