Following on from part one: What is Price Action in Forex Trading where we touched on the basics of price action, part two will dive in a little deeper and begin focusing on how the charts form specific price-based structures. While we would love nothing more than to show all the subtle nuances that make these structures tick, we feel this would not only be beyond the scope of a single article, but it would also be too overwhelming for traders who are just beginning their journey. Therefore, consider the following piece a brief introduction to market structure.
What we mean by a clean chart is simply scrubbing away all of those indicators at the bottom of your screen. What you should be left with is an uncluttered candlestick chart similar to ours below:
Understanding how to plot support and resistance lines on a chart is crucial for a technician. A support basically represents the floor of a market, while a resistance signifies a ceiling. Take a look at the pre-drawn image below. You should see that downside was, at least for a period of time, capped by the support levels marked in blue. By the same token, you should also notice that upside, again for a brief period of time, was capped by the resistance levels marked in red.
This is what support and resistance levels typically look like on a candlestick chart: (notice here that once a support level is consumed, it generally serves as a resistance and vice versa).
While support and resistance levels are plotted horizontally, a trendline is drawn diagonally. Trendlines are another crucial piece of a trader’s toolbox.
Primarily, there are two types of trendlines to consider. A bullish trendline and bearish trendline. A bullish trendline has an ascending angle and is formed by connecting two or more low points (higher lows). A bearish trendline is shaped by linking two or more high points (lower highs).
Take a look at the pre-drawn image below. Note how each time price action generates a higher low, followed by a higher high, a bullish (rising) trend is put in motion. As you can see, the trendline helps identify this. The same goes for the declining market pictured to the right. Each time price action forms a lower high coupled with a lower low, a bearish (negative) trend is put in play, which, again, is easily identified using trendlines.
Essentially, this is what trendlines look like on a candlestick chart:
While supply and demand is a similar concept to support and resistance, we, at IC Markets, plot it on the charts a little differently. The main idea behind technical supply and demand zones comes from seeing a strong/sharp move in one direction (see point A on the image below).
Why do these areas carry weight? It’s thought that these zones hold unfilled orders from large institutions. Given the momentum at which price left the supply or demand (seen at point A on the image above), institutional traders were likely unable to fill all of their orders, thus leaving unfilled orders in and around the zone. A reaction is, therefore, expected on return (seen at point B on the image above).
This is what supply and demand zones look like on a candlestick chart:
Understanding what a candlestick formation is telling you allows one to pin-point a reversal and also predict when a market may continue to rally or decline. The two most common candlestick patterns: the pin-bar candle and the engulfing candle, are formations that are particularly effective at signalling a reversal.
The pin-bar (see the image below) is a singular candlestick setup that usually boasts an elongated wick/tail. Preferably, we look for this wick/tail to be over two times the size of the candlestick’s body. This pattern is especially potent when formed around significant support and resistance or supply and demand.
The engulfing candlestick setup (see the image below) requires two candlesticks to complete the pattern. It forms when a small (in the case of the image below) black candle takes shape, which is then engulfed (smothered) by the next printed candle. Generally, we like to see the previous candle completely engulfed, meaning both the wick and tail too. However, this is not always possible in the forex market.
This is what the above noted candlestick formations generally look like on a candlestick chart:
In closing, learning to trade price action successfully takes time. Simply looking to trade individual pin-bar setups in the middle of nowhere will not do your account any favours. Be prepared to spend time perfecting your craft. The more screen time you put in the better trader you will become. This is where having a demo account comes in handy! So, sign up Open a Demo Account and let’s begin our journey into the world of price action!
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