Components of a FX Trading Pattern
Deconstructing the pattern will help you grasp what specifically were looking for in the pattern in terms of highs, lows, and sentiment or corresponding news releases.
You will often hear how indicators are the best place for a new trader to begin. However, there is an important tool that often goes overlooked that will be discussed today. That tool is the utilization of price action to understand the emotions of the market and convictions in a direction.
When you can see key price action levels on your charts, you will often become more effective in your analysis.
Price action is the study of price alone without the use of technical indicators. Put another way, price action study allows you to sit with the data of the market without any additional commentary provided by a moving average, oscillator, or trend following tool like Ichimoku. Surprisingly, when you take a step back will notice that the data communicates a lot on its own without the other indicators.
At the core of technical analysis is the idea that price or the market has a memory. Similar to how a kid will likely never touch a hot stove twice; a market as defined by price will learn what levels are punishable by a quick reversal and what directions are seen as the path of least resistance.
Naturally, we will be looking to take trades in the path of least resistance or near prior reversal levels.
The reason for recognizing these levels and potentially trading near these levels is that it would take a considerable extra amount of conviction to break through these prior memory zones.
Of course, whether you’re looking at pure data in the form of price or price plus indicators the future will always be uncertain.
What price action allows you to do very well is understand key levels on the chart that appear to be packed with either conviction or indecision. You may have heard these key levels called double tops or double bottoms or another name but the argument is that price action around these areas present to you a zone where traders potentially took on a trade hoping for the price to move through only to recognize a failure of the market.
Regardless of the pattern, you trade, the price action behind the pattern will be important for setting specific and asymmetrical risk-reward ratios. More specifically, when recognizing what is happening on the chart and what potential pattern is ensuing, we can use the price levels or a turn has developed or prices failed before to begin building our position.
A Series of Directional Swings
Broken down into its most basic component the market is often providing higher lows on the time from your analysis or lower highs. Higher lows indicate a bullish environment or uptrend whereas lower highs indicate a downtrend that would encourage looking for selling opportunities against swing highs or prior support. When you have identified a directional bias based on multiple swings, whether that be a chart of 15-minute candles, four-hour candles, or daily candles, you can utilize that directional bias is at higher or lower is the probability favored approach.
Narrowing the Focus
Once you have broken down the chart to price alone you can then come to prior levels of support in an uptrend or resistance in a downtrend to identify the potential entry. Our chief concern will always be risk-reward and our fundamental belief that a trend is more likely to continue than to reverse. Therefore, when the price gets close to a trend reversal point yet fails because the conviction is not there, that is where we can enter the trade with a stop below the reversal point in an uptrend or above the reversal point in a downtrend. The most commonly used tool by price action traders to identify the zones is Japanese candlestick wicks on the price chart.
If you are uncomfortable with recognizing reversal points as per Japanese candlesticks, feel free to read this article.