What is price action trading?

Price action trading is essentially trading by technical analysis of the movements of the price itself, rather than indicators that are derived from the price. In price action trading, we just look at the Japanese candlesticks, key S/R levels, major trend lines, and maybe one or two key moving averages as mobile S/R, and to define the higher-probability trade direction. We might also include the major pivot points. We don't use indicators such as MACD, Bollinger Bands, and Stochastics.
Price action trading is a good method for newer traders to learn. This is because newer traders often make the common mistake of relying too much on indicators instead of looking for the underlying story behind the indicators. For example, traders who decide to go long only when the Stochastics are under 30, will miss good opportunities where the Stochastics happens to read 31, and will take poor trades just because the Stochastics says 29 and a half!
An additional reason is that the use of too many indicators can make the chart crowded and very hard to read.
A good analogy is to think of learning to drive a car. During your first lessons you probably focused very heavily on the instruments, while your instructor told you to focus more on the road, and how the movement of the car felt. Since you became an accomplished driver, you probably handle the car very well without looking much at the dials. It is just the same with trading.

Why Does Price Action Trading Work?

Price action analysis of a chart has some predictive power in forecasting the future movement in price of a currency pair. It works because price action often reveals the footprints of large buyers and sellers in the market. These players try to hide, but they are so big that sometimes they can’t. Your job is to find which way they are going, and hitch a ride.

How To Trade Price Action

Draw significant S/R levels and long-term trend lines, putting nothing else on the screen except for maybe one or two key moving averages like the 20 EMA, the 50 SMA and the 200 EMA.
Now watch the candles form. Every candle tells a story. When each candle closes, ask yourself:
  • Did it close up or down?
  • Did it close near its top or bottom, or near its middle?
  • Did it engulf the previous candle or a number of consecutive previous candles?
  • Was it significantly larger or smaller than recent candles?
  • Did it form a long wick bouncing off any kind of S/R or trend line of significance?
  • Is it the first candle that closed outside a certain range for a long time?
Don't forget to pay attention to the overall picture. When the candles produce smooth, orderly and symmetrical patterns, these are some of the highest probability, highest-reward trades. When the candles are wild, have many long wicks, and are running all over the place, then this is a good time to stay out completely until things settle down.
Remember also that different currency pairs have different price action “personalities”. As you follow a few different pairs, you will get used to the way different candlestick patterns seem to work better with some currency pairs than others.