Price action trading
Many traders search for the most accurate forex strategy or the most profitable strategy. The truth is any strategy could be profitable if a smart trader uses it. You cannot expect to win every trade, but if you are smart, your risk management will keep you booming.
To be accurate in your forex strategy, you better practice it on a demo account first.
Forex traders tend to lose themselves in a hunt for the best technical indicators. However, most of these indicators were created many years ago for the stock market and are not really applicable in forex trading today.
Price Action vs Indicators
Somehow, traders believe that there is an algorithm out there that will show them the trend and when the price will reverse. Thus, you would know when to enter the market and when to exit. Sounds great, right? Unfortunately, all technical indicators you are using at the moment won’t tell you that.
It is probably a good idea to get rid of all indicators and focus on the price itself. You will be amazed how much more you can learn by just following price behaviour instead of combining different indicators. When we say “price behaviour”, we mean human behaviour.
When we trade forex, we want to predict what the big boys will do next, the guys who actually make decisions and move the prices. Obviously, we are not the big boys, but if we are smart, we might learn to think like them.
Trading in a price range
Basically, there are two options: the price is moving in a trend or in a range. We are going to discuss range trading, so take a look at the recent EUR/USD chart. It is not difficult to see that the price was recently moving in two channels.
When it comes to range trading, many would go with the Bollinger Bands indicator, but in my opinion, it is much better to learn to draw the channels by yourself. You can also read our lesson on support and resistance levels for more tips.
Once you draw the high and low levels on the chart, then the rules are simple:
- Buy the bottoms and Sell the tops.
When the price breaks out of the range, you can also expect the price will return to the range, and you place your positions accordingly. As you can see in the image above, when the price hits the bottom, you are ready to buy, and in that particular case, you would be stopped out.
When the price returns to the range, then you buy again. In our example, that would result in a profitable trade.
How to be profitable
You want to know for how long the price will stay in the range and when it will break out of the range. Unfortunately, you can’t know that. You might have a good guess, but you cannot be 100% sure. Therefore, to be profitable, you need better risk management.
This means you have to limit your loss and increase potential profit. For example, you could use Stop Loss 30 pips and Take Profit 90 pips, which means a 1:3 risk reward. Thus, you would need just 30% winning trades to make a profit.
If your strategy is to use a 1:2 risk reward (Stop Loss 30 pips and Take Profit 60 pips), then you would need 35% winning trades to stay above water.
Your strategy is simple math. You need to make sure that your trading system gives you correct signals more that 30% of the time. In the image above, you can count the potential winning trades in our particular EUR/USD example.
It is important to understand that trading forex is a risky game, and if you are dealing with real funds, you better know what you are doing. In theory, 30% winning trades might sound doable, but in reality, you might find it difficult to achieve. If you are using very high leverage, your account could be easily blown away.