Risk Disclosure

"Forex trading can involve the risk of loss beyond your initial deposit. It is not suitable for all investors and you should make sure you understand the risks involved; seeking independent advice if necessary"

Binary Options

Tuesday, August 11, 2009

Price Action trading

Price Action

An alternative to using indicators to enter trades is price action. As most indicators lag the market we often only enter trades late and leave a large slice of the profit on the table. Using price as our guide we can often get earlier entries with much tighter stops.

One of the more common methods is to use inside bars as an indicator of where price might go next. Inside bars are not necessarily reversal bars and can just as easily be the precursor to a continuation of the trend.

Pin Bar

A pin bar is any bar with a long shadow or candle wick where the open and closing prices are close together leaving a long tail or spike. (See more on candle stick patterns)

Inside Bar
An inside bar is any bar who’s high is lower than the previous bars high; and who’s low is higher than the previous bars low.

Once the inside bar has formed we cannot be certain if we will get a reversal or a continuation of the trend. If the inside bar is a pin bar or is followed by a pin bar then this is an added indication of where price might go next.

For the purpose of this exercise we will call the bar preceding the inside bar the control bar. Once an inside bar is formed the high of the control bar becomes our resistance and the low of the control bar becomes our support.

When price breaks the support or resistance of the control bar we enter the trade in the direction of the break. Our stop loss can be either the low of the entry bar or the low of the control bar on a long trade. On a short trade the stop loss is either the high of the entry bar or the high of the control bar depending on your money management and how tight a stop you want.

Alternately we can exit the trade if we have another inside bar and a reversal prior to our target being reached. The profit target on the trade should be at least two to three times the risk which is the difference between the stop loss and entry points.

If we examine the above GBP/USD 1 hr chart we see that we have six entries. The blue shaded areas represent the range of the control bar. On the first entry a buy at 1.6042 we had a bullish pin bar as our inside bar. The following bar was our breakout bar where price broke the resistance of the control bar and we entered long at 1.6042. Our stop loss was placed at the low of our entry bar; a 25 pip stop.

Aiming for three times the risk; required making 75 pips on the trade. Before reaching our target we had another entry and were able to scale in with an additional trade at 1.6102; then again at 6209 before we had the reversal at 1.6341.

The only possible losing trade was the second short trade where we would have been stopped out at the high of the entry bar prior to hitting our target if that was our stop as opposed to the control bar. With a good risk to reward ratio of 3 to 1 even a 50 percent winning ratio will mean coming out ahead.

Not every inside bar is followed by a pin bar but the method works equally well without it. The method works well as both a trend follower and reversal signal.


Wait for inside bar to form.
Establish the range of the control bar.
Place your orders at least 10 pips above and below the high and low of the control bar.
Once trade is entered, place stop loss and take profit orders.
If a reversal pattern appears before target is reached close trade rather than wait for stop loss to be hit.
In a tending market use this method to scale in with additional orders.
Don’t trade this method in flat market conditions.

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