Price action trading for the FX markets

Price action trading can provide traders with the tools to focus on the price itself when making investment decisions. This article highlights how you can use a price action trading strategy in the FX market.

Source: Bloomberg

Technical traders within forex markets are rife, as they seek to find a means to gain an advantage of markets that typically do not have the same historical bias as those seen within stock markets. Given that currencies are traded against one another, the ability to find trends rather than presume one is always going to be key for the FX space.

Price action trading utilises the price as the number one component that informs decision making, setting aside popular aspects such as indicators. Importantly, this approach makes sense given that it involves a focus on the one aspect that will make or lose a trader money: the price. You cannot make money through the stochastic oscillator or the relative strength index (RSI) falling when you are shorting a market. Nevertheless, many will pin their hat on indicators rather than the price itself.

The use of price action typically centres around significant peaks and troughs, providing traders with swing highs and swing lows. The use of historical levels of support and resistance levels are also key tools for a price action trader.

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The sequence of highs and lows

The pattern of highs and lows provide much of the information about whether a market is in an ascent or a decline, with the creation of higher highs and higher lows providing a bullish signal. Lower highs and lows signal the opposite, with the pair looking set to decline further.

The consistent creation of sequential higher highs and higher lows will give traders a significant degree of confidence on the future direction of the market, irrespective of whether we see a short-term counter-trend move. Given the expectation of another higher low being posted, traders can look towards any counter-trend move as likely falling short of the prior swing low.

The chart below provides one such example of a highly trending market, with the creation of higher highs and higher lows providing signals of a continued uptrend.

The expectation that we will see another higher low created once the market starts to retrace again means that a short-term counter-trend move can be seen as a buying opportunity. The utilisation of price action tools such as trendlines and Fibonacci retracements can add another element to the trading strategy.

Looking at the AUD/USD chart below, we have a clear downtrend in place, with each rally greeted by a new lower high. The descending trendline adds another element for that bearish setup, with a reversal back into that line providing a strong sell signal. Finally, we also see the Fibonacci retracement come into play, with the price ultimately reversing lower from the 76.4% level. Essentially, the ability to remain below the prior swing high of the $0.7382 level is key in determining whether the downtrend remains intact.

Interestingly, looking at the most recent rally, we are seeing a rising wedge formation. This is traditionally a bearish pattern, adding greater confidence to the notation that we will see another breakdown for this pair. The four-hour chart below highlights this pattern in greater detail, with the price attempting to break lower. The ability to break below the $0.7112 swing low will be crucial in signaling the potential beginning of another downward phase. This highlights that while we have not seen the currency pair rally back into the trendline, the use of price action formations can provide signals of where the market goes next.

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