How to Trade FOREX Price Action
The foreign currency exchange market, sometimes known as forex, is one of the most actively traded markets in the investment industry. Traders speculate on the value of one currency in relation to another in a round-the-clock market that is not subject to the same strict federal regulations as the stock market. While many charting packages include hundreds of technical indicators that may be superimposed on a price chart to aid in price prediction, many traders prefer to trade based solely on price action alone. This style of trading involves instincts and market experience to develop a sense for where prices are likely to move based on their recent activity.
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Instructions
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Study the concepts of Dow Theory. This theory was formalized nearly 100 years ago and outlines the basic price action that defines a true trend. Traders who trade based on price action alone are intimately familiar with these concepts. In short, the Dow Theory defines a trend as any price cycle that results in higher highs and higher lows. Prices never move in a straight line up or down. Rather, they move in waves. When those waves take prices to a new high, and the subsequent pullback fails to create a lower low than the previous pullback, it is said that the price is in a trend. Purchase a position in the charted currency during the decline from the new high. If the trend remains intact, the price action will push to a new high, generating a profit.
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Imagine a line drawn on a price chart that would connect all the dips in the price action. This line is based solely on the prices created by the natural auction mechanism. If such a line can be drawn, it usually helps you to visualize a trend in the market. Only one of two things may occur when a price retraces to the line. Either the line holds and the price rebound or the line is penetrated, thus suggesting that conditions have changed. Traders employing trend line analysis will often buy into the market as a price touches the line, hoping for a bounce. Should the line fail to hold, traders take opposite positions on the expectation that prices will soon reverse.
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Identify when the price action is creating a double top or a double bottom. These so-called "M"s and "W"s can signal major turning points in a market. If two peaks appear in a price chart, forming the "M" shape, this classic pattern often retreats into a new decline. The same holds true for double bottoms. Traders study this price action and trade accordingly. After a "W," for example, a trader will buy into the market with the expectation that the decline has halted.
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Tips & Warnings
Auction markets are a complex phenomenon. These are the most basic and frequently observed patterns. As you gain experience studying price action, soon other patterns will become apparent and you will develop an ability to predict the most likely market directions.
Forex trading offers the possibility of great reward but also significant loss. Never trade with hard-earned capital until you have gained experience with a trading simulator. Most major brokerages provide a simulator to test strategies before committing real capital.
References
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