In today’s article, I want to give you 5 tips that I think will help you become a much better price action trader. Reading the price action that forms in the market can often be a very challenging experience for new forex traders, but I think that with the tips I’m going to share with you today, you’ll have a much better understanding of what the different price action suggests about the near term market direction, which of course will make it easier for you to get into more profitable price action trades.
1.Swing Highs And Lows That Form At Similar Prices Often Lead To Reversals
Analyzing swing highs and lows is an important part of being a price action trader, but a little secret which I think not a lot of forex traders know, is that when you see multiple swing highs or lows forming at similar prices to one another, it’s usually a strong sign a reversal may be about to take place in the market.
You can see that before each one of these reversals took place multiple swing lows had formed at relatively similar prices to one another. These swing lows have all formed as a result of the bank traders coming into the market and placing buy trades to make the price move up. The reason they’ve all formed so close to one another is because the bank traders are never able to get their entire trading position placed into the market at one single price.
This is because the size of the buy trades they’re placing are so big that there just isn’t enough sell orders available in the market for them to get all of their trades executed. So what they have to do to actually get all of their buy trades placed, is make the price swing up and down as a means to generate sell orders which they can use to get all of their buy trades placed, albeit at different but similar prices in the market. They try to get them all placed at similar prices so as to mimic the effect of having just one big trade placed into the market at one price, which is what they would have done initially if they had enough sell orders entering the market.
So the next time you see multiple swing highs and swing lows forming at similar prices to one another, understand that it could be an early warning sign the market is getting ready to reverse. Use the example above as your guide. You want to see the market make a swing low or high and then swing back in the opposite direction before creating another swing low or high at a similar price to where the other lows or highs have formed.
2. Reversals Usually Begin With A Sharp Counter Trend Movement
Predicting when a reversal is going to take place is the goal of many a price action trader. Unfortunately there are not many ways to actually predict when a reversal is going to take place based off the current price action alone. Most methods involve watching for a reversal to begin upon the market reaching a price point drawn from the past, like a support or resistance level or a supply or demand zone. When the market reaches a level or zone price action traders will look for signs that suggest to them a reversal is about to begin in the market. The most common of these signs would be something like a candlestick pattern such as a pin bar or engulfing candle forming inside the zone or on the level itself.
Whilst these are all okay to use, they don’t really give you much confirmation a reversal is going to take place, mainly because they’re only showing you one candlesticks worth of data. An engulfing candle may always signal the beginning of a reversal, but it’s only identified as causing a reversal once has market has continued to move in the direction of the engulf itself, which means using engulfs to actually predict when reversals are going to occur can often be very difficult and result in many false signals.
What I tend to instead, is look for a sharp counter trend movement taking place once the market has been moving in one direction for a long duration of time.
You can see the drop which caused this reversal ( marked in orange ) was really sharp and was constructed of bearish large range candles that contained very little evidence of buying taking place during the move down. These are the types of movement you will often see cause large reversals to take place in the market. Of course they won’t all look like the one you can see above, but they will all have the same features present when they occur. i.e multiple large range candlesticks and few candlestick of the opposite type forming during the movement itself, like how no bullish candles formed during the move down seen above.
When you see a sharp movement take place, you should mark the point where the move originated from as a supply or demand zone, because if it has actually been created by the bank traders placing trades to make the market reverse, they’ll try to get any of their additional trades placed into the market around the same point as where they have already got some of their trades placed, which is the point where the sharp movement originated from.
So if you see the market move into the supply or demand zone created by the sharp movement and then produce a common price action signal like an engulfing candle, it’s usually a good sign the market is going to reverse and create another swing in the reversal structure.
3. Pin Bars Form For Different Reasons
I spoke about this in another article I released a few days ago but I thought I’d mention it again here because it could drastically improve your pin bar trading if you understand it. Forex traders mistakenly assume all pin bars have formed in the market for the same reason. They think the only differences between one pin bar from the next, is the characteristics of the pin, like the size of the wick, and the technical levels the pin has confluence with. Because traders believe all pins have formed for the same reason it means they never stop to think about action has caused a pin bar to form, when it’s the action that’s caused the pin to form that will ultimately determine whether the pin has good chance of causing a reversal to take place.
The majority of the pin bars you see form in the market have a low probability of causing a decent reversal to take place. This is because they’ve formed from the bank traders taking profits off their trades, not because they were placing trades to make the market reverse, as is commonly assumed for all pins. The pin bars created by profit taking will cause a reversal to take place, but it will be short lived and the market will soon start moving back in the direction it was originally moving in prior to the pin bar forming.
The pin bars which do cause large reversals to take place will always form as part of a larger reversal structure. By that I mean you will see them form as one of the swing lows or swing highs that are created by the banks getting trades placed to cause the market to reverse. If you go back to the first image where I showed you the two reversals, you’ll see that one of the swing lows that formed just before reversal two began was a bullish pin bar. This bullish pin bar is considered to be part of the larger reversal structure, as the swing low it creates has formed due to the bank trader placing buy trades.
4. Swing High And Swing Lows Are Always Created By The Bank Traders Placing Trades And Taking Profits
Swing highs and swing lows are used by most price action traders for just determining which direction the market is currently trending in, but what the vast majority of people fail to realize, is that virtually all the swing highs and lows you see form in the market have been created by the bank traders either placing trades to make the market reverse, or by taking profits off trades they’ve already got placed.
The reason why is because in order for the banks to actually be able to take profits and place trades, there needs to be a large number of buy or sell orders entering the market. If you look at the market structure which preceded the formation of any swing high or low, you’ll see that there would have been a lot of traders entering trades right before the banks came into the market and caused the swing low or high to form by placing trades or taking profits.
The swing high has been created by the bank traders taking profits off their trades and the swing low has formed as a result of them getting buy trades placed into the market. The reason they chose to take profits and place trade here is down to the number of buy and sell orders that were entering the market just before the swing high and swing low formed.
Just before this swing high formed a reasonably sharp move higher had taken place ( marked in orange ). This move higher would’ve convinced the average retail trader to place a buy trade, as at that time it looked as though the price was probably going to move up by quite a considerable number of pips. With so many traders entering buy trades, the banks now have the opportunity to take some profits off their own buy trades, because taking profits off a buy trades for them requires there to be a large number of buy orders entering the market.
The swing low forms right after the move down from the swing high taken place. This move down would have caused a large number of the traders who placed buy trades during the move up marked in orange to close their trades at a loss, which would’ve put sell orders into the market that the banks could then use to get more of their own buy trades placed. In addition to this, the size and severity of the drop would’ve made people enter short trades anyway, because it would’ve looked like the market looked was probably going to continue moving lower.
So the reason the bank traders decided to take profits / place trades was because they had a large number of opposing orders entering the market from people placing trades and closing losing trades. If there wasn’t many people placing trades or closing losing trades then the banks wouldn’t have had enough orders available to take profits off their trades or place trades of their own, and thus you wouldn’t see a swing high or low form in the market. All swing highs and lows will form after some kind of large movement has taken place relative to the time-frame you’re viewing, because that’s when there are enough orders entering the market from traders placing trades and closing losing trades for the banks to actually take some kind of action of their own.
Motioning how the market acts once it reaches a swing low or high created by the bank traders placing trades can give you important clues about the future direction of the market, because if the bank traders still have the trade which created the low or high open, you won’t see the market break a large distance beyond it, as they’d want the market to continue moving in the direction it has been placed in order to make money. If you do see the market break below a high or low which has been created by the banks placing trades, then its a sign that whatever trades had been placed to cause the swing low or high to form have now been closed, and that you’re probably going to see the market continue moving in the opposite direction in the near future.
5. Supply And Demand Zones Are Better For Predicting Reversals Than Support And Resistance Levels
Because supply and demand trading and price action trading are seen as being two separate things, it means price action traders rarely ever use supply and demand zone in their analysis of the market. This is a mistake because supply and demand zones are actually much better at predicting where the market is likely to reverse than support and resistance levels are.
This is because supply and demand zones are drawn as zones instead of lines.
You can see that in this reversal the market reversed when it was inside the supply zone but didn’t get far enough to touch the resistance level and thus give price action traders a signal that a reversal was taking place. In this situation the trader who uses supply and demand zones to predict where reversals are going to occur has a good chance of being entered into a successful trade, but the price action trader has virtually no chance of even getting a trade placed, because he only identifies a reversal may take place once the market reaches the resistance level, which of course it doesn’t actually do.
Herein lies the big problem with using support and resistance levels to trade reversals. Unless the market actually hits the level you’ve got marked on your charts and then produces some kind of price action signal like a pin bar you’re not going to realize a reversal is taking place in the market. You rarely have this problem with supply and demand zones because you have a defined area which you can use to watch for reversals. If the market breaks through the zone you know that for the most part the market is now unlikely to reverse. I mean of course there are times when the market reverses just before entering a zone and just after breaking a zone, but this happens far less frequently that it does with when it misses support and resistance levels, which makes supply and demand zones much better for predicting where reversals are going to occur in the market than support and resistance levels.
Being able to read the price action in a way where you have a good understanding of what’s happening in the market will always be one of the hardest skills to acquire as a forex trader, but I hope that some of the tips I’ve shared in this article will make it a little bit easier for you from now on. If you have any questions about the tips contained in this article, please let me know in the comment section below.