We’ve discussed the importance of price action when it comes to trading using technical analysis in our previous article. There are several price action trading strategies that a trader can use.
In this article, we’ll cover two commonly used price action trading strategies.
1. Using Continuation Patterns
Price charts often seem to be random. However, the job of the trader is to find patterns within this seeming randomness. These patterns form the basis on which future price movements occur.
A continuation pattern indicates that the current price trend is quite likely to continue in the future. Thus, if such a pattern that shows the price to be going up, then it is likely that the price will rise in the future, and vice versa.
This pattern can take the form of a triangle. However, just one triangle is not enough to indicate a trend. For a continuation pattern to occur, the triangle must form at least twice, as shown in the chart below. The chart below shows an uptrend due to the formation of two upward triangles. (Read more on triangle patterns.) When this occurs, it is quite likely that the price of the security is going to break its resistance level and continue rising.
In addition to triangles, a continuation pattern can also take the form of flags or pennants or rectangles. If the pattern repeats, it is likely that the upward or downward trend will continue.
2. Using Price Action Reversal
Just like a continuation pattern reveals that an uptrend or a downtrend is likely to continue, a reversal pattern indicates that an uptrend or a downtrend is likely to break. If the basic rule of a trend is breached, traders can predict that the trend will not continue.
Consider the case of an uptrend, as shown below. Within the uptrend, the price action is making higher swing lows and highs. Next, the chart makes a lower swing low and then a lower swing high. This indicates that the pattern is about to reverse and enter a downward trend. As soon as the lower swing high is made, the basic rule surrounding the pattern and trend has been broken.
The chart below shows two reversal patterns. The first reversal is from uptrend to downtrend, and the second reversal is from downtrend to uptrend.
Thus, price action reversals can help you detect important changes in the movement of the markets. Usually, when using price action reversal as a basis for your trades, you should look out for retracements back to support or resistance levels (as the case may be). If these levels are broken, a trend reversal is more likely to occur.
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