Price action is the backbone for all technical analysis of currencies, commodities or stocks. By definition, price action is the behavior of a security’s price over a period of time plotted on a chart.
Price action traders rely on specific price patterns, such as a pin bar or a head and shoulders reversal pattern to trade the forex market. These price action patterns are known to be quite accurate and showing a success rate of more than 75%. Not bad!
For that, I will show you a few price action patterns that you can add to your supply and demand trading system.
A pin bar is a candlestick that has a long tail or wick and a small real body. When a pin bar is formed on a price chart, it usually shows a clear sign of reversal and rejection of price.
The ideal situation is to have a pin bar formed after price tests a supply or demand zone during the first retracement. This shows that market sentiment is shifting and a reversal is about to happen. It also gives us a confirmation that our supply or demand zone has higher chances of winning.
Let’s look at the following chart:
Here we have a pin bar formed at the first retracement of the supply zone on the daily chart. This is a clear indication that momentum is about to shift and is a good place to go short.
Not all pin bars work, it depends on where the candlestick is formed. For instance, a pin bar that is formed within an uptrend might not be a good reversal signal to trade.
Pin bars are accurate signals to trade when formed near reversal levels.
An inside bar is basically a candlestick that is engulfed entirely by the previous candlestick. Here’s what an inside bar looks like:
There are two ways to trade an inside bar: against the trend when formed at or near a reversal level and within the trend.
Let’s take a look at this chart:
The first inside bar is formed right where the reversal happened near the demand zone. This is a confirmation that the trend is changing direction to the upside and that our demand zone has higher chances of giving us a profitable trade.
The second inside bar is located within the trend. We can use it to enter the market if we missed the first reversal signal. This is the same as the rally-base-rally structure.
The third inside bar is also a valid continuation pattern. But as price is getting closer to the supply zone, we better wait for more confluence like a pin bar to show us price rejection or an inside bar formed inside the supply zone to go short.
Head and Shoulders
A head and shoulders pattern is a chart pattern represented by three peaks, the outer two peaks are close in height and the middle one is the highest.
The head and shoulders pattern is formed at the end of an uptrend move.
The inverted head and shoulders pattern is formed at the end of a downtrend move.
The head and shoulders pattern is considered to be one of the most reliable trend reversal patterns.
If these price action patterns are located at or near supply and demand zones, the probability of a trend reversal to happen is high.
In this example, we have an inverted head and shoulders pattern formed at the demand zone. The way we could trade this structure is to wait for price to complete the inverted head and shoulders pattern and break above the neck of the pattern to go long.
Another aggressive method is to wait for price to created the head and place a pending order at around the same level of the left shoulder. When price goes down to complete the pattern, our pending order gets filled with a stop below the demand zone.
Double top and bottom patterns are trend reversal price action patterns that form two consecutive tops or bottoms.
A double top pattern is a chart pattern where price forms two consecutive highs (at almost the same level) at the end of an uptrend move.
A double bottom is a chart pattern where price forms two consecutive lows (at almost the same level) at the end of a downtrend move.
The chart below shows an example of a double bottom formed at the demand zone.
Price tested the demand zone forming the first bottom then retraced back down for the second time to the zone completing the double bottom pattern before moving up in a nice uptrend.
Price action is simply how a security’s price changes over a period of time. It is easily observed in highly liquid and volatile markets.
Traders rely on price action to predict future price movements using chart patterns and candlestick patterns to find trading opportunities.
By adding price action techniques to our trading arsenal will help us fine-tune our entries/stops or adding more confluence to our trading ideas.
But one thing to keep in mind, there is no such a thing as a perfect trading strategy or system. Our job is to use all the available tools to help us stack the odds in our favor and profit from the market.