Price action – basic principles in trading.

/The article is intended for novice traders. More training materials can be found here: https://www.varchev.com/trading-uni.htm. /

Evaluating key levels is one of the basic principles of Price Action trading in the financial markets. There are two main ways of price action trading: breakout and reversal.

Key price zones are present in every financial market, including Forex. Often these horizontal zones act as either support or resistance to further price movement, which is why traders are so interested in them. These key areas are formed due to the large accumulation of buy and sell orders. When the price reaches such a bottleneck, the current strength of the trend is usually not enough to close all those orders and move the price further.

Therefore, if the movement does not receive support, the price will turn in the opposite direction. Conversely if there are new volumes that are able to break through a large build-up of orders, there is likely a strong breakout level and trend continuation. Of course, events do not always unfold according to these scenarios, but these are the two most likely options.

The main condition for entering a trade on a reversal from the level is the need for confirmation. In Price Action trading this means forming a reverse pattern.

The most common reverse formations are the following:

• Pinbar (a candle with a long shadow and a small body);
• Bullish/ Bearish engulfing (the next candle is directed in the opposite direction, its body and shadows are larger than those of the previous candle );

Confirmation comes at the breakdown of the low of the pin/engulfing candle for a downward reversal, and accordingly at the breakdown of the high of the pin/engulfing candle for an upward reversal.

Stop Loss should be placed in such a way that an arbitrary movement against the direction of the trade, such as a retest of a level with a false breakout, does not throw the trader out of the position. Usually the high/low of the reversal pattern is used.

As for take profit, the next support/resistance levels should be analyzed, which are the potential next area that the price may reach. The TP should be set so that the price is guaranteed to reach it when it approaches the key zone.

It is worth paying attention to the strength of the level and the probability that it will be broken or held. There is a common misconception that the more price reverses from a certain level, the more likely the level will remain unbroken. In fact, if the price keeps testing a certain level again and again without entering the reverse trend, it means that a breakout is likely. In practice, this means that it is better to skip the third and subsequent attempts to bounce from the level, trading only the second one.

A distinction should also be made between a classic reversal from a level and a retest of the level after breaking it, when, for example, support turns into resistance. Such a retest is an even stronger signal than a simple reversal. The probability of a successful trade is even higher if a clear reversal signal is received after a failed attempt to break the level.

All other things being equal, a reversal of the level is more likely than its breakout. This statistic gives the trader reason to rely more on reversal patterns. However, it should be kept in mind that price action is a method that requires experience to be able to make decisions according to the situation. Despite the existence of rules, there is no clear algorithm that regulates actions in every situation.