Become a Master at Price Action Trading – TradeThatSwing

Price action trading is using price movements themselves to make trading decisions. It doesn’t matter if logic says it should rise…until it rises the price isn’t rising. As price action traders, we look at price waves like a detective, gaining insight into when to stay out and when to take to action.

Price action trading is not predictive: “I know where the price is going to go next.” Thinking like that will lead to problems.

Rather, price action trading is adaptive and probability-based. The mind frame is: “If the price does this, then I will do X. If price does that, I will do Y.”

Developing Price Action Trading Skills

To get into this mind frame of “If….then”, and to trade off it, requires two skills sets:

  • Understanding price action patterns.
  • Understanding when to trade within the patterns and when not to.

The truth is, most price action is junk or has a low probability of generating high-probability winning trades. So understanding price action patterns doesn’t mean we trade all time. It means we wait for high-probability opportunities (clear patterns) and avoid the times when the patterns are choppy or the price movements are more random.

I break down price action into three categories:

  • Don’t trade
  • Questionable
  • Tradable

As price action unfolds, we may go from a “Don’t” period to a “Tradable” period to a “Questionable” period and then back to “Don’t. This can unfold in all sorts of combinations. Some days we spend much of the time in Don’t or Questionable price action. Other days we spend more time in Tradable.

Tradable doesn’t mean we are hammering away at keys. It means we know conditions are right if we get an entry signal for our strategy. We may get some trades or we may not.

If we are swing traders, we may spend weeks or even months in any one of these conditions.

In my EURUSD Day Trading Course I talk about when not to trade. An example is when movement is very low. In low movement, the price isn’t moving enough to propel the price to our target or to a decent reward vs. the risk we are taking on.

The patterns I trade and teach also tell us when to trade and when not to. Since most of my strategies are price action based, you can think of them as the rules, and price action as the context or reason behind the strategies.

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Higher Highs & Higher Lows and Lower Highs and Lower Lows

No matter the time frame you’re looking at, uptrends are created by higher highs (HH) and higher lows (HL).

Downtrends are created by lower highs (LH) and lower lows (LL).

We could make a living off this concept alone… once we understand that new information is coming out all the time, and we need to respond to that information by updating our viewpoint on whether the price action is tradable, questionable, or not tradable.

For most people, it is hard to adapt to new information. It takes mental work, and most people want their prior analysis to be right, especially if they took a trade based on it.

When I was learning price action, I connected one swing high to the next, and swing lows to the next.

If both lines are moving up: uptrend. Deploy trending following/continuation strategies or trend reversal strategies when valid signals appear.

uptrend - higher highs and higher lows

If both lines are moving down: downtrend. Deploy trending following/continuation strategies or trend reversal strategies when valid signals appear.

Downtrend - lower highs and lower lows

If one line is moving up and the other down: The trend is in conflict. Could be a range or other chart pattern forming.

Price action with unclear trend. Lower highs, but lows are flat. Not a clear downtrend.

If both lines are horizontal or close to it: Ranging. If sufficiently large, it may be possible to place trades within the range. If it is small, better to stay out and wait for other price action signals.

Downtrend turns questionable when the price starts moving sideways

You can start to see that depending on what type of trader you are, you may prefer some conditions over others. If you are trying to capture trends, ideally we want to trade in trending conditions.

If we like trading in ranges, then the range needs to be sufficiently big enough to make a decent profit if the price moves back to the other side.

This is where velocity and magnitude come in. It gives us the additional evidence we need to truly decide if conditions are good, bad, or questionable.

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Velocity and Magnitude of Price Waves

Is one higher high the same as another? Nope.

If the price just barely moves above the prior high and then reverses, that’s a much weaker move than if the price surges above the prior high.

That’s magnitude. How far price waves move (relative to other price waves).

Velocity is how quickly prices move. There’s a difference between a big move up on one price bar, compared to the same size move that takes place over 20 price bars. They are giving very different information on how fast price is moving.

Magnitude directly relates to the higher highs and lower lows (etc) discussed in the section above.

If a wave up is followed by a wave down of equal or great length, it means selling pressure is as strong or stronger than the preceding buying pressure. Be careful about buying.

If a wave down is followed by a wave up of equal or great length, it means buying pressure is as strong or stronger than the preceding selling pressure. Be careful about shorting or holding longs.

I classify waves as either impulse or corrective (pullback) waves. An impulse wave is large compared to a corrective wave. When a corrective wave becomes larger than the prior impulse wave, that is a potential trend reversal (and that corrective wave is now an impulse wave).

analyzing magnitude of price waves when price action trading

As you look at that, you may say “Great…how do I know when an uptrend is going to reverse like it did on the chart above?” Recall my words from earlier…we don’t know! But this is still immensely powerful trading information. So bear with me for a bit more price action knowledge, and then we will get into how we can trade and build strategies using these price action models.

Sometimes velocity tells us a lot, and other times it doesn’t tell us much. But it still provides clues. Let’s look at the same chart, this time studying velocity.

analyzing velocity of price waves when price action trading

With some knowledge of these concepts, we can start to assess once again whether we want to trade, not trade, or if the outlook is questionable.

We can determine this by looking at:

  • Are the size of price waves big enough for me to make a good reward relative to the risk I am taking?
  • Is the price moving enough, and quickly enough for me to trade? If the price is moving very slowly and choppily (but still in a trend) we may trade differently than if the price is making large quick moves.
  • What about overall movement? The chart above could be a weekly chart with a 150% rally in the middle. Or it could be a one-minute chart covering 5 pips or 40 pips. What is tradable to you may not be tradable to someone else.
  • I am always comparing recent price moves to prior price moves. This tells me when conditions are changing. If trading the same strategy every day we can also compare current velocity and magnitude to what is typical.” This can let us know if the current price action is bigger/faster/smaller/slower than usual, and we can adjust or trade/not trade based on that information.

Here is another example to show how to use these concepts. This is a stock I traded after the pullbacks. “Trading” will be discussed a bit later.

measuring corrective and impulse waves to aid in trade selection

Below is another one.

Notice the sharp price rises on the left, followed by smaller pullbacks that get smaller and smaller…showing that selling pressure is diminishing and the buyers that were strong prior are stepping in. I have highlighted two areas (like triangles) where this is the case.

strong rises and drops followed by periods of sideways movement often signaling the trend will attempt to re-emerge

Also in terms of magnitude and velocity, that first really big drop in mid-June erased the small rally that started in early June. It was also the biggest decline you can see on the chart in a long time. Following a massive drop, based on what you know now, is that bullish or bearish? Most likely bearish. It is a shift/impulse down.

Therefore, I wouldn’t likely take a long trade right after a big drop (unless I had some other evidence to do so). I would need to wait for selling to slow and buying to kick in (velocity and/or magnitude to the upside). Or, we could take a short on a pullback that stays below the prior high. We get the same triangle-like pattern on the way down, showing weakening buying pressure on the bounces before another big drop.

Ranges and Range Breakouts

A range is a period where up and down waves are roughly equal. We can also have trend channels. A rising trend channel is when up waves are slightly larger than down waves. A falling channel is when the down waves are slightly larger than the up waves. This creates an angled channel or range.

Everything on the chart can be analyzed based on velocity and magnitude…including highs and lows, whether they are higher or lower or the same as prior highs and lows.

When I have three waves in a row of near equal size I start to consider the possibility that a range may be forming. It may not, but that possibility may make me more conservative if I’m trading a trend strategy, for example.

If the range is sufficiently large, I may still take trade signals within the range assuming there’s enough room within it to make sufficient profits for the risk I am taking.

What needs to happen for a range breakout to occur?

We need a bigger wave than what we have been seeing. If it is quite a bit bigger that makes it much easier to spot. If it is only a tiny bit bigger, then the waves are still similar size and that breakout is suspect.

ranges are formed via price waves of similar size

For any strategy or trader that seeks to avoid choppy conditions, this is one of the things to look for.

Equal size price waves mean equal buying and selling pressure.

If there was a massive drop prior the above range, maybe we still keep our short bias because the up moves in the range are small compared to the prior big drop. But if the price was meandering with little magnitude or velocity in any given direction, and then the ranges forms, it’s not a trending environment and trend traders should be careful about taking trades.

Since we are going to get into some trading shortly, here’s a little trick I find helpful for trading around ranges.

After the price breaks out of range, watch how the next pullback acts. If the price breaks lower and the next pullback stays outside the old range, or only comes slightly inside, but then starts dropping again (moving back outside the old range) I feel better about shorting it.

range breakout where pullback holds hold outside of range

Compare the above to the below example.

While there is a large drop outside the range, the next pullback doesn’t hold outside the range. It comes back in (all the other instances of breakouts also had this feature). Taking a short after this breakout (once it comes back into the range) has a low probability of success. This range was also expanding. Waves in each direction were slightly bigger than the last. But after three of these waves (up, down, up, all similar) we can already be anticipating the possibility of a range.

false breakout from range confirmed when price price make moves back inside old range and then moves toward other side of range.

As I was writing this article, this concept kept me out of trading during an entire session (typically about 2 hours) of choppy price action. The price would form a range, breakout, but the pullback couldn’t stay outside the old range. It would just come right back in. By understanding this concept I likely saved myself a lot money. I could easily see it was choppy since the price couldn’t move out of these ranges.

If instead, we expected the price to keep rising following a push higher we would have been disappointed. There was little follow-through in the trending direction because we were ranging which means not making much progress beyond prior swing highs or lows.

Price is unable to clear recent ranges, indicating choppy or range bound conditions even though the price was moving briefly moving beyond prior range support and resistance

Some people may have still opted to trade on this day. And that’s fine. But by understanding these range breakout/false breakout concepts those people would have likely been able to make better trading decisions for the conditions that were present. We can trade ranges, but use these concepts to trade inside the range, or as price moves back toward the other side.

I would have traded some of my strategies on this had I got some nice short signals near the top of the ranges or long signals near the bottom of the ranges. But on this particular day they just never setup. Our strategies (including our entries) still need to get into a trade. Price action is just the context for whether we should be trading or not.

The Key Principle of TRADING Based on Price Action (for me)

Wait for the price to start moving in our anticipated trade direction (based on the price action information) before taking a trade.

To go long, I need an impulse up, a pullback (or sideways move) that starts to move higher while still above the impulse low.

To go short, I need an impulse down, a pullback (or sideways move) that starts to move lower while still below the impulse high.

Essentially all my strategies are based on this concept. The strategy itself defines the precise entry trigger and exit method, but the concept behind all the strategies is the same.

If pricing is shooting up I don’t just buy as it is shooting up. I need to wait for a turn. Thinking of our trend concepts, that means if there’s an uptrend, I wait for a pullback (or sideways move or pattern) and turn back higher.

This is my Trend Continuation (TC) pattern, covered in the EURUSD Day Trading Course. There are specific things I want to see from the price action, most of which are discussed in this article. Mainly, NO choppiness, just “clean” waves.

price action trade signals in an uptrend

An uptrend to me is any time there is a higher swing high, and price is turning higher at a higher swing low.

Or a downtrend is when we have a lower swing low and the price is turning lower at a lower swing high.

This is the concept behind my Rounded Top and Rounded Bottom patterns. It gets us into a trend early, essentially the first pullback after a likely reversal. This is also discussed in the EURUSD Day Trading Course.

rounded top with price action explained for entering

No matter how long a trend has gone on for, an uptrend must consist of a higher swing high followed by a pullback that turns higher at a higher swing low. When that stops happening, our trend becomes questionable and we need some other evidence to consider taking trades. We can’t rely on the trend alone anymore, because it is in question.

If we are trading a trend channel, or range, we define the area where we will watch for a turn. And assuming nothing invalidates our trade, we take our trade at the turn. This is usually near the edge of the range, but if the range is large, we could also be taking trades anywhere inside the range as long as the price has enough room (within the range) to give us a nice possible profit.

trend channel example using price action entries and analysis

Price is dynamic, our price action is ONLY AS GOOD AS THE LAST PRICE WAVE. The next price may produce more of the same or it may change something.

The job of the price action trader is to adapt to that new information and then decide how they will trade (or not trade) based on what scenarios unfold.

Based on the concepts you have learned, what would you do with this chart right now?

price action quiz

Take a minute and actually think about it as if this was the time frame you take trades on.

Like chess, traders need to think moves ahead. But unlike most other sports or games, we don’t have to act all the time. We can wait for conditions we like.

First, let’s write down what I see:

  • I see a series of lower highs and lower lows.
  • The first drop was relatively small and quick while the second drop was choppier but larger.
  • The last rally was bigger than the prior rally.
  • The last drop was very sharp (high velocity).
  • The last drop turned lower from a pullback that peaked at a lower swing high (relative to prior swing high).
  • The current drop has not made a lower swing low yet.
  • The rally (pullback) prior to the drop didn’t make a higher swing high.
  • Since the turn lower has already happened in a downtrend, I need to wait. Based on this chart there is no trade for me right now.
    • To go short, ideally, I want the price to make a lower swing low, rally a bit (staying below the recent high) and then turn lower for a possible trade. Because the price has already dropped from the pullback high by so much, that opportunity is gone. I will wait for a new one.
Scenario for potential price action short
  • The price could move sideways from here (sideways movement and patterns are like pullbacks…if the moves are small or large, that tells us something (sections above)), and then if it drops below that sideways period I could take a short trade based on the recent drop and the longer-term downtrend.
scenario for potential price action short
  • To go long, I would need the price to rally above the most recent swing high (shift up), then pull back, staying above the most recent swing low. Once the price starts turning higher, I could consider a long trade.
scenario for potential price action long

But what if you viewed this chart differently? I see another variation based on the concepts discussed in this article.

Alternative view:

The person above is seeing the price action like this. The lines mark the main waves they are looking at and the rectangles mark the key highs and lows.

one possible way to view the price action - big lines mark the waves and the rectangles mark the highs and lows we are considering

But what if you saw the image below when you looked at the chart?

another possible view of the price action - big lines mark the waves and the rectangles mark the highs and lows we are considering

Is this correct too? YES!

We will NEVER see all price moves exactly the same as someone else. And it doesn’t even matter!

Recall from the beginning of the article that trading price action is not about predicting anything. It is about knowing how we will act (or not act) based on what the price is doing, and planning for scenarios that may come.

How we view price action may give us more or less trading opportunities than someone else, so we can always work on “seeing” various scenarios that may play out, but we also don’t want to give ourselves “analysis paralysis” by thinking about too much and thus never pulling the trigger.

Make your assessment of the relevant waves, and make your trades based on that.

This trader has a different view of the market than the prior trader…

First, let’s write down what I see:

  • There was a downtrend that started slowing…the down waves got smaller and could barely make progress below the prior low.
  • There is a sharp move higher (4 green bars in a row). This is a lot of buying velocity compared to recent selling which was choppy and hesitant (unable to make much headway lower).
  • The rally moves above the last two swing highs.
  • This is the first part of a trend change higher. We have a higher swing high…now we need a higher swing low to indicate a potential uptrend.
  • The price is currently above the last swing low, but it hasn’t turned up yet, so we don’t know if this is a swing low yet or if the price is going to keep dropping.
  • The last drop was very sharp. After such a sharp drop do I want to buy right away? If I buy right now I am going against a lot of recent selling velocity which may need time slow before it turns higher. I prefer to wait.
    • Going long is the main consideration right now…with a caveat. There was a strong move up, followed by a smaller by higher velocity move down. The drop was also quite large. It is almost back to near the lows. I would consider a long if there are some small waves that show the price is struggling to drop. Given the strength of the recent drop, I view the long as “questionable”. I may still take it but with a trailing stop or a willingness to get out if I don’t see a lot of buying strength after I get in.
    • If the price moves sideways and then breaks to the upside, I may consider a long trade. Same as above and with the same precautions.
    • I would not go short right now. There was a higher swing high and price is currently at a higher swing low. Until the price drops below the recent swing low I wouldn’t consider a short. Then the price would need to pull back, showing a lower swing high followed by a turn lower and then I would consider it.

Price is dynamic. My outlook above is based on the chart right now.

What if the price bounced from here (staying below prior high) and then drops below the recent low (far right of the chart currently)? Now we have a lower high and a lower low…I will need to consider that, and I would be looking for short trades instead of longs.

I made the video a couple of years ago. From the 10 to 15-minute mark I talk about a rally which has me looking longs, and then I wait for confirmation of that. I wait for the price to tell me to get long based on velocity and magnitude (and my trade signal occursing as the price starts moving back out of the old range.

Nowadays, I would probably take a short (RT) when the price breaks out of the range and comes back in (just after 12:00 on 24 day on the chart). But then the price forms an RB right after and starts rallying, setting up the trade I was taking about in the video.

As discussed above, there are many ways to view a price chart. And it doesn’t matter if we see it differently. We will! Even if we look back at charts we traded, we will probably see it differently than we saw it in real-time.

It doesn’t matter! What matters is knowing how we will trade based on what we ARE seeing now. As long as we do that, we can make money. But if we aren’t thinking ahead and aren’t figuring out what has to happen for us to take a trade, then we run into problems.

If a strong move up has us looking for longs, awaiting the price action signals that tell you to get long. Some one else may be considering a short. That’s ok, they are trading what they see and you are trading what you see. What matters is sticking to your entries and your method based on what YOU see.

Summary Price Action Guidelines

These are the things I am thinking about while trading…constantly while day trading since the trades come so quick and I am generally trading the same things all the time. With swing trading, I am using a scanner to find trades and therefore the scanning has already done some of the work for me (isolating uptrend, downtrend, contraction, etc.)

Overall movement: big enough to trade? Does the possible reward justify the risk based on how the price has recently moved?

To go long: need a higher swing high then a pullback or other pattern that turns higher above the prior swing low (TCs, DPs, RBs, RTs, Snap Backs, Contractions, Trend Channels, Cup and Handles).

To go short: need a lower swing low followed by a pullback or another pattern that turns lower below the prior swing high (TCs, DPs, RBs, RTs, Snap Backs, Contractions, Trend Channels, Cup and Handles).

Range breakout: tradable if the price moves significantly out of the range, and the pullback stays mostly outside the old range and then turns back in the breakout direction outside the range (or only very slightly inside).

False breakout: The price moves out of the range, but the pullback after the breakout moves back into the range. The pullback after that stays inside the range. If the price starts moving back toward the other side of the range then consider a trade in that direction. Range must be big enough to justify the trade.

Velocity: swiftness of moves provides clues to strength. It lets us know how long trades may last. It provides clues as to whether the environment is choppy or high momentum.

Magnitude: what basically every strategy and concept I trade is based on. The patterns I trade are based on wave size: how do recent waves compare to prior waves? That’s pretty much it.

Trade triggers: Price action is NOT a strategy. It simply provides a context. The entry, stop loss, profit-taking method, and position size are additional elements of a strategy. A trade trigger is a precise event that tells us to get into a trade. We need to define this. While I used the word “turn” to define my entry, this is actually a very precise occurrence. Examples of trade triggers here.

Not prediction: We aren’t predicting what will happen in the maket. We are using price action to determine what scenarios we will trade and how. Market conditions can be favorable, unfavorable, or questionable for how we trade.

If conditions are questionable, it means I may still take trades, but I may get out of that trade as soon as the trade turns or stalls because conditions are not great. Or I may use a trailing stop loss to get me out in the event of a turn against me.

In good conditions, I’m more inclined to let my trades play out and hit their target or trailing stop loss as defined before the trade and by the strategy…unless the price action turns unfavorable or questionable (see above to handle that situation).

If conditions are not good for my strategy, I stay out.

This article may actually make you more confused. But go back to the very beginning…”If…then”. If you can start thinking like that, you will probably do very well, even if you don’t fully grasp all these concepts.

Plan ahead. If the price drops, what has to happen for you to take a trade. If the price moves sideways, what has to happen for you to take a trade? Think that through. That is trading.

I do it all day while day trading…I call it commentating the price action. A great skill to develop. Start commentating the price action, talking through what is happening and what needs to happen for you take a trade based on your strategy. Watch your results improve.

And you don’t need to trade everything! We aren’t trying to predict anything. Just isolate price action patterns you like, and zero in on those.

By Cory Mitchell, CMT

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