The principles of price action pattern formation and trading with these patterns are discussed. Both novice and seasoned traders may benefit from learning about the finest indicators for trading price action patterns and trading methods.
Topics discussed in the article are as follows:
What is Price Action?
- The price action trading strategy analyzes price changes in investments. Indicators for entering and leaving trades are generated by analyzing price action patterns. One kind of technical analysis that has gained widespread acceptance among traders is known as the “Price Action” technique.
- The price action method is self-explanatory: it is based on analyzing price movements and making a trading choice only based on the study of the price chart. Precisely what methods exist for assessing changes in market value?
- The Japanese candlestick chart is one representation of the price changes. According to this strategy, each candle should represent a discrete time interval, such as an hour. Only chart patterns or candlestick formations will be considered when using a price action trading strategy. They may also use price action indicators as an addition to their existing toolkit.
- Many short-term traders, known as “day traders,” rely on price action trading tactics to turn a profit in a hurry. H4-D1 time series are often used for trend analysis since they include the most recent four to one-day periods. In a shorter time period, the market’s noise grows due to random price fluctuations. There are times when the price action approach gives you the best possible entry opportunity in shorter periods.
Why do traders use price action?
Studying the patterns established by Japanese candlesticks over time makes it possible to gain insight into the future. Furthermore, the right strategy may exploit these patterns for financial gain.
Because of their consistency and independence from technical indications, price action techniques stand out. Forex price action is a technical analysis since it ignores fundamentals in favor of looking at past price data. Instead of relying on values gleaned from price history, as with most other types of technical analysis, price action analysis analyzes the relationship between the current price and the performance of a trading instrument. Highs and lows of price swings, trend lines, and support and resistance levels are all taken into account by price action.
Traders new to the market will appreciate the clarity and simplicity of price action’s recognizable patterns.
Most trading techniques don’t call for any extra programs (indicators);
- As the previous day’s closing prices determine the patterns in price action, they do not re-draw themselves.
- They are an accurate depiction of price changes with no indications to muddy the picture;
- When trading at solid levels, price action patterns may be quite effective;
- A trader using price action may pick and choose from a broad number of patterns to implement their preferred trading technique.
Price Action in Forex
- Medium- and high-volatility assets, such as the GBP/USD, EUR/USD, and other major currency pairs, are best suited to Price Action Forex techniques. Trading some of the central cross rates may be very profitable with the help of the price action trading technique.
- Minor cross rates and exotic currency pairings are not suitable for use with the Price Action patterns. Often caused by factors like central bank intervention or economic penalties against a nation, exotic currencies are prone to wild swings.
- Picking highly liquid assets is crucial when trading price action patterns in equities. Find the highest-volume stocks with a stock screening tool.
- There are unique aspects to using Price Action techniques when trading cryptocurrency or commodities. First, price action patterns tend to materialize only when instrument liquidity is low. Therefore, it is crucial to choose very liquid instruments, as suggested before. The price action strategy may be less effective for cryptocurrencies that are not in the top 100 by market capitalization, unlike the BTCUSD pair.
Price Action signals
- Trade at the flat borders, rebounding from intense channel levels/Fibonacci levels, trading reversal patterns, and fractals are some of the most prevalent examples of Price Action signals.
- Before looking for Price Action indications, you should label the chart with the foundations of your trading approach. By this, I refer to factors such as significant horizontal support and resistance levels, Fibonacci retracement/expansion levels, the edges of price channels, and reversal patterns.
- Then, after keeping an eye on how the price is fluctuating, you may look for a Price Action pattern that can help you figure out where to enter the trade and where to stop.
- An illustration of a price action indication on the EUR/USD exchange rate at the horizontal level. Between June 16th and June 30th, 2022:
The trading method is laid forth in the preceding graph:
- Based on those two considerations, I arrive at the top limit of the shrinking range.
- Using those two positions, I establish the bottom bound of the converging range.
- On June 22, I saw a pattern of inner bars forming at the top of the flat range.
- Additionally, the price breaks down through the inner bar on June 22 at 19:00 terminal time. So it’s time to make a short trade with a target around the flat’s bottom when I get this signal.
- We close the trade with a take profit at the flat’s bottom line on June 23.
Other price action patterns illustrating trading near the flat channel boundaries might also be highlighted in this chart. There will be entry signals on June 23, 27, and 28, 2022.
Here’s another case: Price action forms inside a double-bottom reversal candlestick pattern. The currency pair used for trading is XAUUSD. The range of dates is from December 15 through December 28, 2021.
- I first established a short-term trend, and it’s an upward one. Then, on December 17th, a new downward turn will begin.
- In this correction, I see a double-bottom candlestick, which I have highlighted in purple.
- Third, I pinpoint the level of price resistance that must be overcome before the double bottom pattern can be considered complete and traded to the upside.
- I see the railroad track price action pattern on the corrective move towards the previously-resistance level turned support level.
On December 22, once the train track configuration has solidified, I make a purchase trade. The trade is closed with a take profit on December 28 when the December 17 low is broken.
Price Action Trading Patterns
- Price Action charts may display a wide variety of patterns. However, because utilizing them requires making trading judgments based on analyzing price charts and comprehending the rationale of chart movements, they will always be helpful. Learn the unique price action patterns I utilize in my trade and expand your trading knowledge.
- Consistent retracement and expansion, or the pin bar pattern
- Several price action patterns exist, but the pin bar pattern is the most significant. “Pinocchio Bar” is an abbreviation for “Pin Bar.” The name comes from the way it looks. The “nose” of the design represents the candlestick’s wick, and the “body” is the rest of the candlestick.
- The design emphasizes the head and shoulders, with a long nose and short torso. On the price graph, we see:
Commonly seen near the trend’s conclusion, this formation signifies that the trend is about to change direction. This represents the last assault by buyers or sellers and a dramatic shift in market mood. So, they get out of transactions they made during the last swing and get into trades during the current trend at the best possible price. This causes the bar’s wick to be very lengthy. The lack of a significant body suggests that the opening and closing prices are close. Neither buyers nor sellers significantly changed the market condition at that time.
How to trade a pin bar setup
When a turning point in a trend has been predicted in advance, we may sit back and relax. Before drawing a pin bar, we watch for the price to move into a reasonable price range. If you want to test the assumption, you should wait to enter a transaction after a pin bar appears. It is incumbent upon you to anticipate confirmation of its integrity. For example, suppose a trader believes an uptrend will reverse. In that case, they may wait until the following bar to place a trade based on this setup, while those expecting a downtrend to reverse up would initiate long positions as the pattern’s high was broken through.
Your stop-loss order should be farther out when entering a trade than usual. An important reason this is so is that you could set orders without factoring in the possibility that the price might go beyond the high or low owing to market noise and random swings. For each instrument and period, an appropriate distance is chosen at which the trade is entered; this distance, however, must be greater than the spread. Of course, having a little offset is preferable, but you still need to time your entrance well.
You’ll find some sample pin bar pattern-based entries in the following:
Immediately upon the candlestick opening that follows the pin bars in the instances above, the price moves in the anticipated direction, reinforcing the price action signal.
Railway Track chart trading pattern
To add to the list of helpful price action chart patterns, we have the railroad track. Together with margin zones, it’s one of my go-to tools. What we see on the pricing chart is:
- Since it is a reversal pattern, it shows up when the current trend is about to terminate. The first pattern bar extends the current trend in the same direction. Despite moving in the other direction, the point spread of the second bar is about the same as that of the first. In many cases, the second bar completely engulfs and covers the first. Candlesticks swallowing each other are standard while studying the train track arrangement.
- To forex traders, an engulfing pattern is a very reliable indication. An opportunity to initiate a trade in the direction of a new trend in its infancy is signaled when it occurs at critical levels. The pattern also indicates that the correction has ended, and the market will likely continue the impulse triggered by price action.
How to trade a Railway Tracks pattern?
When one bar emerges after another whose range in points is the same as the one that came before it but in the opposite direction, it indicates a setup. To mitigate losses, we wait for the price to break above the setup’s high to trade with a bullish trend or below the setup’s low to trade with a bearish trend. Then, an order to cut losses is placed beyond the pattern’s extreme.
Listed here are a few illustrations:
From each of these charts, we can see that the creation of the pattern is not complete until the reversal candlestick of a different hue appears, signaling a suitable entry opportunity to trade in the other direction. The pattern’s two candlesticks are similar in size and color, making them easy to see on a chart.
Saloon With a Discrete Interior
An inside bar (IB) can signal a breakout or a reversal in price. Depending on the context, it can indicate either a trend reversal or a continuation. Like any candlestick chart pattern, the IB is best traded around significant support and resistance levels.
This is how an indoor bar is usually set up:
- The IB pattern is a two-bar price action pattern, as seen in the examples. The first and largest bar is called “the mother bar.” The second bar, called the inner bar, comes behind it and is smaller than the first while still falling within the same high-to-low range as the first bar.
- A small number of inner bars satisfying the criteria above may develop. Inside bars are numbered like I2B, I3B, etc., and the whole thing is evaluated as a unit.
How do I trade an inside bar pattern?
A frequent strategy is to place a pending order at a little farther distance after the breakout of the mother bar. A buy-stop and sell-stop are ideal for trading an IB setup.
Where is a stop loss?
- However, setting a stop loss beyond the mother bar’s polar opposite is not a failsafe strategy. The mother bar may be too massive. Therefore, your stop-loss will be farther away, and your take-profit will be less. Occasionally, the benefits won’t outweigh the dangers. In this scenario, an action trader should place a stop loss order right above the next strong level. This alternative for placing a stop loss is rational; if the price returns to the level, the judgment is likely erroneous, and the level breakout is fake.
- The second strategy for placing a stop loss relies on the trader’s ability to evaluate and locate reliable support and resistance levels accurately. I suggest the first approach if you are starting to trade. Stop losses are often relatively far away, but they provide more security.
- In the case shown in the image below, an IB acts as a reversal pattern.
An IB continuation pattern:
Pivot Point Reversal (PPR) Forex pattern
For traders, the benefits of price action trading patterns lie in their accessibility and ease of use. The subsequent pattern may be found with little effort and traded relatively quickly. For example, the Pivot Point Reversal, or PPR, is a forex setup based on price action.
Count three bars in this pattern. It relies heavily on critical support and resistance levels. After a rapid trend, it tends to emerge.
When prices are climbing and reaching new highs, that’s a negative sign. The subsequent bar then makes a lower high and low and closes below the previous day’s low.
The price drops to a new low in a bullish situation. The low of the next bar must not be lower than the low of the preceding bar, and the bar must close higher than the high of the preceding bar.
Thus, an invitation to enter is present. After closing the signal bar, you may join the trade since you know the market has given you a warning that it will reverse. This is a pattern of reversal. Trading near the conclusion of a pullback in the opposite direction of an extensive worldwide trend may be profitable.
The pattern’s peak or low point is a stop-loss point, respectively. Here are some real-life examples of trading charts:
Sometimes, you need to wait for quite a long time:
The following illustration shows a PPR pattern forming in the $1.0020–$1.0010 price range, a resistance area. After that, a steep drop in price results in a windfall for investors. An identical pattern is known as an “evening star” in candlestick analysis.
Shooting star pattern
- One traditional take on Japanese candlesticks is the shooting star design. The use of Japanese candlestick patterns predates the use of price action patterns in technical analysis. Since their definitional processes are comparable, Candlestick patterns may be categorized with other price action patterns. The similarities between candlestick patterns and price action patterns are substantial.
- A shooting star might signal the conclusion of an upswing when it emerges at its apex. However, when a shooting star appears in the market, it usually signals a downward trend.
- This is the pattern of a shooting star:
That is how a shooting star pattern looks in a real chart:
shooting star pattern features
- One must be familiar with the essential characteristics of a shooting star pattern to recognize it appropriately.
- It begins to take shape at regional peaks.
- The candlestick casts a very lengthy upper shadow.
- The body of the candle is relatively tiny.
- The bottom shadow of a shooting-star candlestick is relatively brief.
- There shouldn’t be any other bars below the upper shadow.
How do I trade the shooting star pattern?
- Trading on a shooting star is similar to trading on a pin bar. Be sure the design is a shooting star before proceeding. Check the specifications, as mentioned above.
- Once the candlestick forming the shooting star has closed, a transaction may be entered if it is a genuine shooting star. The high of the candlestick is used as a stop loss. The take profit target is twice as far away as the possible stop loss. In addition to using a resistance level or the price level recommended by your trading method to trigger a take profit, you may use any of these to trigger a sale.
The above illustration shows that the pattern is simple to trade, even for novices.
Important notes
- It is recommended that a trader enter the market at a strong resistance level close to the shooting star pattern.
- You shouldn’t trade a shooting star if it forms within a rising wave or a swing high inside an uptrend. Most of the time, a signal like that won’t be accurate and won’t lead to a profit.
- The shooting star candlestick is easily recognizable among the other Japanese candlesticks since it only appears at the peak of a price chart.
Hammer pattern
- The hammer is the polar opposite of the shooting star in terms of candlestick patterns. It indicates a change in trend from bearish to positive when it emerges during a decline. There are other similarities between a hammer and a shooting star.
- The pin bar formation in the price action analysis is a cross between a shooting star and a hammer.
- Here is what a hammer might look like on a real-world pricing chart:
Conditions of the hammer pattern:
- It develops at regional troughs.
- The bottom shadow cast by the candlestick is consistently lengthy.
- I reduced the size of the candle’s body.
- The top shadow is small or nonexistent.
- Those preceding bars are only some of what is blocking off the darkness below.
How to trade the hammer pattern
- might make a buy trade after the chart’s price pattern mentioned above is complete your stop loss should be below the pattern’s bottom price
- . Your take profit should be at least twice as large as your possible stop. Setting the take profit at a significant resistance level or following your trading plan is another viable option.
Important notes
- The support level should validate the hammer pattern. To clarify, the pattern should increase the support level at which you start a trade. If this occurs, there is a higher probability of the price moving in the anticipated direction. Previous pivot points in price action will serve as a guide for potential support zones.
- Things will become apparent after we draw the support and resistance levels in the examples above and find the hammer pattern.
Since the hammer candlestick casts a lengthy lower shadow beyond the surrounding bars, it should be easily distinguished from the others. In addition, I’d like to emphasize those hammer candlesticks can only form at the chart’s lows, so you shouldn’t trade a hammer if it appears amid a growing downtrend or a swing low.
Tweezers pattern
- Tweezers are a reversal Price Action pattern. A tweezer is often made up of two Japanese candlesticks. Additional candles may be present between the first and second candlesticks.
- A tweezers pattern forms when buyers or sellers encounter resistance and cannot push the price in their favor.
- The end of a bullish or negative trend might trigger this pattern. If you see a tweezers pattern during trading, you can buy or sell, depending on the direction of the market.
- This is what the pattern might look like in a diagram:
Tweezers aren’t the only thing that may produce candlestick patterns in Japanese culture; other objects, such as candlesticks, are fair game. For instance, when analyzing a sell pattern, the engulfing pattern may be used in tandem with the tweezers if the bearish candlestick is longer than the bullish one.
Conditions for a buy pattern:
We look at candlesticks with two different designs.
The first candle reaches a local minimum.
The local low is repeated in the second candlestick.
The market turns around, and the price breaks the peak of the second candlestick.
Conditions for a sell pattern:
- We look at candlesticks with two different designs.
- The first candle marks the highest point in the market.
- The peak point in that area is shown again in the second candle.
- A reversal occurs, and the price drops below the low of the second candlestick.
It makes no difference how long the shadows are or how tall the candlesticks are. Therefore, the price should reverse its direction after reaching new highs and lows at around the same levels.
How to trade the bearish tweezers pattern
It’s common for the tweezers pattern to appear after an upswing has ended.
The best time to sell is after the second candlestick’s price has broken below the low.
Place Stop Loss above the pattern’s high.
The take-profit target is placed above a significant support level.
How to trade the bullish tweezers pattern
- After a downward trend, a tweezers pattern sometimes forms.
- It’s an excellent time to purchase if the price has broken above the peak of the second candlestick.
- Your stop loss (loss limit) will be established below the pattern’s bottom point.
- The take-profit target is placed just above a significant barrier.
How does the tweezer affect other candlestick patterns?
The tweezers’ pattern helps reinforce pattern reversals. If there is a tweezer, even a faint reversal pattern will become robust. A powerful reversal pattern with confirmation is visible if the chart shows a reversal pattern between the tweezers’ candlesticks.
Trading flat with a tweezers pattern
Price ranges always have a ceiling and a floor, even when the price is trading sideways in the middle. For this reason, the tweezers and other reversal patterns are closely examined by traders in this area.
Maintaining distinct boundaries between trade zones is essential. If this is the case, then the supply and demand around these levels and the potential for a trend reversal may be inferred from the candlestick shadows that touch or extend beyond the boundaries.
The pattern of price increases known as a bullish Harami
The power of the harami pattern is around average. A reversal pattern known as a “harami” appears when a downturn finally ends.
The Japanese term for pregnancy is harami. You’ll need two candlesticks to create the harami pattern. The size and prominence of the first candlestick set it apart from the rest. The second candle is located inside the first’s trading range. For this reason, we may compare the first candlestick to a pregnant woman and the second to a kid.
To see a bullish harami toward the tail end of a downtrend is a good sign that the price may soon level out or reverse direction. In addition, other technical analysis tools, such as high support and resistance levels or a different candlestick pattern, should confirm the harami pattern. On the other hand, the market may reach the accumulation zone after a harami and continue plummeting. That’s why looking for more evidence supporting the haram pattern is essential.
This is the appearance of a harami:
For example, the preceding chart shows that the bullish candlestick inside the bearish one’s range started with a gap. Unlike the foreign exchange (FOREX) market, the stock market is prone to this phenomenon. The efficiency of this formation is unaffected by the existence or absence of a gap; nevertheless, the presence of a gap might aid stock traders in recognizing the pattern.
The bullish harami is reminiscent of the inner bar price action pattern, often known as a “day with a shrinking price range” candlestick pattern.
Bullish harami conditions:
- It shows up after a downward trend has ended.
- Both candlesticks must point upward for the pattern to be considered a bullish harami. Over time, the varying dominance of bulls and bears renders the candlesticks’ colors irrelevant. The most crucial factor in a trend reversal is a heightened fight between sellers and buyers inside the candlestick’s range.
- The first candlestick in the pattern should be much larger than the others.
- The peak and low of the second candlestick should be, at most, those of the first.
- The second candlestick should have a noticeably smaller body than the first.
- The stock market may or may not be where the gap occurs.
How to trade a bullish harami
- The pattern often appears near the bottom of a downward trend.
- When the second candlestick completes, you may buy on the breakout of its high.
- The low of the candlesticks is used as the Stop Loss.
- I am setting a Take Profit at the level of closest resistance.
Important notes
- Given the pattern’s average strength, as stated above, waiting for further confirmation signals is advisable if there is no movement in the predicted direction immediately after creating the pattern.
- A harami cross, which may also be traded, forms if the second candlestick in the pattern is a Doji. A harami cross has the same significance as a regular harami pattern; the Doji only adds the idea that the market remains unsettled after a trend shift and that bulls and bears are equally represented.
Bearish Harami
At the peak of an upswing, a bearish harami appears, signaling the possible end of the trend or its reversal. Due to its moderate reliability, it often has to be backed up by other chart patterns or indications.
Two candles forming a bearish harami are called a harami yomi. The first candlestick is the mother bar; its body is significant. When a second candlestick appears, its highs and lows stay within its original range.
A bearish harami may be represented graphically as follows:
Steve Nison defines a harami as “when the second candlestick with its shadows goes beyond the first candlestick in both height and width.” These harami patterns, however, are not advised for beginners because of the higher stakes they entail.
Bearish harami features
- At the peak of an upswing, it makes an appearance.
- It includes a pair of candle holders. Since either bulls or bears may gain control of the market at any moment, it doesn’t matter what color the candlesticks are. The most crucial aspect of the candlestick range is the lively competition between sellers and buyers.
- When the first candlestick is relatively large compared to the others, it sends a more robust signal.
- A second candlestick appears inside the first’s confines.
- Compared to the first candlestick, the second one should have a substantially smaller body.
- Not having the gap is preferred in the stock market, even if nonexistent.
How to trade a bearish harami
- When an upswing finally ends, the pattern should be considered complete.
- Please put in a sell order when the second candlestick closes below its low point.
- The pattern’s peak point is used to place a stop-loss order.
- The closest level of support is chosen as the target for a take profit.
Important notes
- If you see a harami pattern, you may join a trade in a few different ways. For example, you were opening trade after the closure of the second candlestick (high risk) or after forming a confirming candlestick (low risk, but quite a significant stop loss).
- The above example illustrates one possible entry strategy for a trade after the second candle closes. Of course, my stop-loss level is higher, but the higher risk is worth it.
- The deal is closed off in the support zone rather than at a specific price. For charts with many weak levels that may be grouped into a zone, this technique is used when pinpointing a single level proves too challenging.
- Bearish haramis are only a medium-strength pattern. Therefore, it’s important to supplement them with other indicators from technical analysis, such as solid resistance levels or oscillators. The harami cross pattern is also tradable if the second candlestick is a Doji.
Dagger Price Action pattern
In terms of price action patterns, the dagger is a newcomer. Although this signal only shows up rarely, it has a high chance of being correct. There is a continuation of the trend indicated by the pattern. With the dagger pattern, traders use two different periods to make decisions. W1 and D1, D1 and H4, H4 and H1, and so on are all viable options. When looking at shorter time frames, more dagger patterns will arise, but most will be bogus due to market noise.
Conditions of a buy pattern
The more considerable period generates a bullish candlestick.
Second, the next candlestick finishes higher than the preceding candle’s 50% Fibonacci retracement level. There should be no gap between the two closing candlesticks.
The second candle’s shadow mustn’t exceed the 61.8 percent mark of the exact Fibonacci retracement.
The bottom shadow of the candlestick is as long as or longer than the body of the candlestick.
The “rebound” candlestick’s high is broken, and trade is entered.
A stop loss is placed below the 50% retracement level for the lengthier period.
Your trading strategy or a significant level of resistance should be used to determine where to place a take profit. One alternative is to place the take profit twice or thrice as far from the market as the stop loss.
Conditions of a sell pattern
- Firstly, a vast bearish candlestick appears in the more extended period.
- The next candle closes below the preceding candle’s 50% Fibonacci retracement level. There should be no gap between the two closing candlesticks.
- The second candle’s shadow mustn’t exceed the 61.8 percent mark of the exact Fibonacci retracement.
A candle indicates a shorter period with an upper shadow at least as long as the candle’s body. Finally, we see here what I will refer to as a “rebound candlestick,” since it indicates that the price has recovered after encountering resistance.
To enter the trade, wait for the price to break below the low of the rebounding candlestick.
A stop loss is placed above the 50% retracement level for the lengthier period.
Seven, a take profit is predetermined by your trading system or placed at a significant support level. Another strategy is to place the take profit twice or thrice as far from the market as the stop loss.
Important notes to trade a dagger pattern
- This occurrence of the pattern is quite rare. That’s why it’s essential to proceed with caution and filter patterns in the chart so they fit the criteria mentioned earlier.
- For the shorter period candlestick to act as a signal, it must develop within the same range as the following bar in the larger timeframe. If the larger timeframe is D1, for instance, the signal candlestick in the smaller timeframe H4 should develop six candlesticks (64 = 24 hours) after the requirements in the more significant period is satisfied. For example, a signal candlestick in the H1 period should take four hours to develop if the H4 timeframe is larger. If not, the pattern becomes meaningless. Additionally, if there is a solid overall trend in the trade you want to join, it further indicates that you have made the right decision (e.g., an uptrend for a buy trade).
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