Breaking down the price action system

How many tools do you use in trading? What if we tell you that there is an effective trading system that requires nothing but candlestick patterns?  This approach is called price action, and it is extremely popular among professional traders. Let us find out what are the basic elements of price action and what you need to master to trade this system.

What is price action?

The price action system describes a change in the price of a given currency pair.  

The origin of this approach begins from the good old times of Charles Dow – the founder of technical analysis. According to his words, the price includes all the necessary information and fundamental facts. Everything that happens across the markets is encrypted in the price. Therefore, price action shows the essence of price movement. If you know how to do it right, you don't need to understand complicated calculations and read thousands of news headlines. The price will do everything for you. Thus, the main advantage of price action is that a trader frees his mind from unnecessary information and has a clear vision of what is happening in the market.

To conclude our introduction, we can highlight the three main reasons for price action's attractiveness to traders:

• it is universal;
• it is relatively simple;
• it is very popular.

To trade the price action system, you need to know how to draw trend lines, identify support and resistance levels, and be familiar with candlestick patterns.

When it is recommended to consider price action?

If you are a day trader with ambitious goals who adores technical analysis and trend trading, this trading system will suit you. You won't deal with unnecessary market noise and stick to a bigger market picture.

Why don't price action traders use oscillators?

Apart from many traders' beliefs about the universal oscillator, oscillators are just formulas of price analysis. You should not interpret oscillators' signals (i.e. RSI leaving the overbought/oversold zone) as an undoubtable truth and always confirm them by additional facts. Price action allows a trader to operate with the price, not with its derivatives. When you work with a price action system, you can use some oscillators as filters, but don't rely on them entirely.

Price action algorithm

If you know price action, you can manage all the changes of the price near important levels. Let's consider the make steps you need to do before entering the game of price action.

1. First, you need to identify support and resistance levels.

This is an important step for any trader who wants to master price action. If you trade on the H1 timeframe, use H4 or daily ones for identification of the main levels. You need to draw the lines between the points on your chart where the price changes its direction or stops most of the time.

For example, let's take the daily chart of NZD/USD and find the most important support and resistance levels. Do not place too many of them, only the most important ones. After marking the most important levels on the bigger timeframe, you need to switch to a smaller one (H1) and, again, draw horizontal lines through the important points. We recommend you use another color for them.

2. Secondly, you need to determine your entry.

Here, you need to remember about reversal and continuation candlestick patterns. You can find the most popular ones in FBS Guidebook. At first, it is hard to find them right away, so we advise you to print out this article and train your eye. If some of those patterns appear near the marked levels - prepare to buy or sell depending on the pattern. If you have doubts, use an oscillator as a confirmation.

3. Finally, do not forget to place stop loss and take profit levels.

When you operate with a price action system, you need to place stop loss 3-4 times further from the candlestick pattern with an entry. As for take profit, it should be placed at the next significant support/ resistance level.

Conclusion

Those traders who try to determine their actions in the market according to indicators' readings have very dependent thinking. On the other hand, those who trade using primary data (price movements), concentrate only on one important element. Of course, you need to spend a lot of time practicing price action, but if you develop good skills and intuition you will likely succeed in the future.

Shooting star trading strategy

A shooting star pattern is really popular among traders because of its simplicity and effectiveness. Elsewhere, this pattern has a significant advantage – it occurs on the charts quite often, so it won’t take too much time to find it. In this article, we will discuss what the shooting star pattern is, how to recognize it, and how you can use it in your trading. Let’s get started!

What is a shooting star?

1. A shooting star is a candlestick with a long upper shadow and a little lower shadow.
2. As a rule, it has a small body, which should be close to the low of the session.
3. A shooting star only appears after an upward price movement. It is important! The pattern occurs after a swing higher in price action and not after a swing lower.
4. The color doesn’t matter!

Look at the picture below – it is the shooting star!

What does a shooting star signal?

A candlestick roughly represents the tug-of-war between buyers and sellers. If a candlestick grows up, it means that there are more buyers or bulls on the market. Therefore, the price rises. On the flip side, if a candlestick goes down, there are more sellers or bears on the market. As a result, the price moves downward. 

The long upper tail of a shooting star shows that bulls (buyers) were trying to push the price higher, but by the end of the session more bears (sellers) appeared, and they pulled the price lower. In other words, higher prices were rejected, so the price moved down. That’s why the price is likely to go down in the next session as well. 

How to trade a shooting star?

Great! You’ve learned what a shooting star is and how to identify it. Now the time to know how to use it! There is a simple trading strategy. First of all, you open the chart and try to find a shooting star. Once you’ve noticed the formation of the shooting star, you should wait for the next candlestick to move below the low of the shooting star you’ve just found. You need to do that to make sure the candlestick pattern confirms itself. The perfect market entry will be exactly at the time when this confirmation happens. You can use a sell stop entry to do this automatically.

Example

Let’s try this strategy on the EUR/USD chart.

1. After the price moves higher it forms a shooting star.
2. The next candlestick goes below the low of the shooting star, confirming the pattern.
3. This low is the perfect entry to the market!
4. It’s better to put stop loss just above the long upper shadow of the shooting star to minimize possible risks.
5. After that, the price moves down, as expected.
6. The profit target should be at the support level (for example, the recent lows).

Catch a wave with swing trading strategy

While trying to find a perfect balance between day trading strategy and scalping, traders may discover an attractive in-between style. The name of the article speaks for itself: today we are going to talk about swing trading. So, what is swing trading?

Swing trading is a specific approach to trading, which combines fundamental and technical analyses. Trading swings reminds of surfing: you catch the swings when the price changes direction. If you choose this trading style, you hold your position for several days. Therefore, you should be familiar with the main principles of position size management and the mechanism of swaps.

You’ve probably guessed that swing trading works perfectly during sideways markets, as in that situation the price fluctuates within certain levels. At the same time, “swing-catching” is also possible when a price makes corrections within a trend.

If the swing trading sounds too complicated for you, we will be happy to reassure you with a good swing strategy called “H4 crossover”. Its rules are as simple as its name! Let’s look at the details.

First of all, let’s consider the basic conditions for the strategy. They are, as follows:

• Timeframe: H4
• Indicators: 89-period SMA, 21-period EMA (with application to close prices), and MACD oscillator with standard settings (12, 26, 9).
• Currency pairs: EUR/USD, GBP/USD, AUD/USD, USD/CAD, EUR/GBP, EUR/AUD, EUR/JPY, GBP/JPY, USD/JPY, GBP/CHF, USD/CHF, EUR/CHF.

Don’t forget about money management. Your maximum risk and profit target per trade should equal about 1-2% of the account balance. 

The steps for the strategy will be, as usual, presented for both “sell” and “buy” scenarios.

Algorithm for the “buy” scenario

1. Firstly, we wait for the 21-period EMA to cross the 89-period SMA to the upside.
2. Price should go higher but then retrace with MACD going down.
3. We place the “entry” order on the closing price of the first green candle after MACD turns back upwards. (Important notice: the price should be higher than the 21-period EMA. If it is not, you need to skip the trade.
4. Stop Loss goes 4-10 pips below the previous significant support level.
5. Take Profit is placed at the same distance as a Stop Loss.

 Below we provided an example of the strategy on the H4 chart of EUR/USD.

In the chart, we can see that the 21-period EMA (yellow line) broke above the 89-period SMA (grey line) on October 6. The price jumped higher, but then corrected downwards. At the same time, MACD was going down. We waited for the price to rise back above the moving averages and for MACD to go up. After that, we opened a position at 1.1776 (closing price of the bullish candlestick). We placed Stop Loss 5 pips below the support at 1.1728. The level of Take Profit was placed at the same distance between the “buy” order and the Stop Loss, which is 48 pips.  As a result, our Take Profit went to: 1.1776+48=1.1824.

Algorithm for the “sell” scenario

1. Alternatively to the “buy” scenario, we wait for the 21-period EMA to cross the 89-period SMA to the downside.
2. Here, we expect the price to fall but then correct to the upside with MACD going up.
3. We open a “sell” position on the closing price of the first red candle after MACD starts going down again. Important notice: the price should be lower than the 21-period EMA. If it is not, you need to skip the trade.
4. Stop Loss goes 4-10 pips above the previous significant resistance level.
5. Take Profit is placed at an equal distance as a Stop Loss.

In the same chart of EUR/USD, we saw that that the 21-period EMA (yellow line) broke below the 89-period SMA (grey line). The price then moved down and up. MACD was moving higher as well. We waited for the oscillator to reverse and opened a “sell” order at the closing price of the red candlestick. Stop loss was located above the resistance level at 1.0899, while take profit was put at 1.0811 (1.0855-0.0044=1.0811).

This strategy seems pretty easy, right? By following the simple rules explained above you can master swing trading quite effectively. We recommend you to try it out on the demo account first for backtesting and then implement it in the real market environment.

How to trade on central bank decisions?

What is a central bank?

It is worth starting with a small definition. A central bank is a sovereign national bank that operates independently of the government and influences the monetary policy. It also acts as a bank for other nations’ commercial banks.

The main aim of the central bank is to maintain price stability by controlling inflation and create the stable economic environment of the country.

The central bank has an important feature. It is the only legal financial institution that is allowed to print money as a legal tender. Printing money the central bank has opportunities to control the money supply, the total amount of money available in the economy. Using this feature the central bank regulates the inflation level and the economic environment.

Monetary policy of central bank and Exchange Rates

Let’s talk about the monetary policy that central banks use to control the inflation rate.

To control the level of inflation banks can use one of two monetary policy types: accommodative or restrictive.

Accommodative/ loose/ expansionary monetary policy

If GDP growth is low, the central bank increases the money supply in the country. Moreover, the central bank decreases the interest rate encouraging an economic growth and lower inflation. Business investments and consumer spending rise because of cheaper borrowing. As a result, implementing such a policy, the bank creates conditions for the economic growth but affects the domestic currency.

Because of low real interest rates, foreign investors won’t hold financial and capital assets in the country, and domestic investors will look for more appealing rates of return abroad as well. The decline in investments will lead to the decline in demand for domestic currency. The domestic currency will depreciate versus foreign currencies.

Making a conclusion about the accommodative monetary policy, it can be said that when the central bank implements such policy it leads to the growth of the domestic economy but has a harmful impact on the national currency.

Restrictive/ tight/ contractionary monetary policy

When the amount of money in the economy is huge, the central bank raises the interest rate to reduce the money supply and decrease the inflation level. The high interest rate gives a limited ability to businesses and households to borrow. Domestic consumers are at a loss. However, raising interest rates, the central bank creates conditions for investments. Foreign investors tend to hold more domestic assets. As a result, the balance on nation’s capital account improves. Domestic investors will invest in their own country as well. The high level of the investments will lead to the rise of the domestic currency thus its exchange rate will increase.

To conclude, implementation of the restrictive policy affects domestic businesses and households because of the high level of interest rates and the lack of opportunities to borrow but it strengthens the national currency.

Conclusion: Why should traders pay attention to the central bank policy?

How should traders use the central bank policy?

Coming back to the main question of this article, let’s sum up why it is so important for traders to take into account the policy of central banks.

To simplify the explanation, let’s consider an example. When one central bank has lower interest rates and keeps them so for a long period of time, traders can look for a central bank that has an opposite policy – increases interest rates. Traders keep money in the currency of the second central bank with the higher interest rate to get a higher return or they can borrow money from the first bank with the lower interest rate and then use it to fund investments in the other currency.

Another important fact is that the currency of the country where the central bank implements the restrictive monetary policy is more stable and the economy of the country is healthier than of the country with the accommodative monetary policy.

As a result, the currency with a higher central bank’s interest rate will appreciate against a currency, the central bank of which has a lower interest rate.