No doubt about it: the best and most effective forex indicators are those related to Price Action Trading. But just exactly what is Price Action Trading?
This page follows on from the previous introduction to Price Action Trading. The following chart is repeated here to emphasize the confusing dangers involved in overuse of indicators on a chart. In the hunt for the best forex indicators to use in trading, most traders at some stage early in their career will make this mistake:
Figure 1: Chart cluttered with indicators
Forex for beginners is not easy, and to those just starting out, this mess of points, squiggles and lines etc is confusing to say the least. However, as just pointed out most beginning traders, searching for the most effective and best indicators to load on their charts, will generally wind up with something looking like this.
It may take forex newbies quite some time grappling with all the pieces of information shown on such a chart before they start to understand what is going on. They may then proceed to trade some system based on this. For most traders this is not a happy progression: as is often pointed out, over 90% of beginning traders either blow up their accounts or fail to make money.
What’s the solution?
Take that same chart, and strip off everything – the indicators below the screen and on the screen – just leaving price. What you get is something like this:
Figure 2: Uncluttered Chart
What you are looking at above is the basic tool of price action trading: the mere representation of price itself, in this case by the use of candlesticks. Of course, some traders will opt for a bar chart or even a line chart, but I am going with what has become (for very good reason, see section on Forex Candlesticks) the convention in forex trading.
Now ask yourself, which of the two charts above stands out in terms of clarity? That isn’t to say that you would find the uncluttered version easier to trade necessarily – that will come later after you have studied the principles of forex price action – but simply that you can now see the actual price movements much more clearly.
So how do we interpret the bare chart in order to trade it? Price action trading depends on the following, which I and many price action traders have come to regard as the best indicators for use in forex:
- The prevailing Trend of the time frame being looked at. Use the simple rule of lower lows and lower highs to identify a descending market, and higher lows and higher highs to identify an ascending market. Look for the swing points (a price reached by a bar that is either higher (for a Swing High) or lower (for a Swing Low) than the price reached by the 2 bars before it and the 2 bars after it), and plot their direction up or down.
- Support and Resistance. Levels where price has recently stopped and reversed. This is covered in more detail in the section on Forex Indicators.
- Round Numbers: for example: $1.1000, 1.1020, 1.1500 etc. Price most often reacts here and may turn decisively.
- Pivot Points. Levels based on the previous sessions high, low, open and close. Again, look to the section on Forex Indicators for more details if you don’t know what pivot points are.
- Fibonacci Levels. Levels based on a run-up or down from one significant swing point to another. Again, look to the section on Forex Indicators for more details if you don’t know what Fibonacci is.
I refer to the above tools as the best forex indicators, although purists would no doubt disagree. I try not to get too hung up on issues such as these. As far as I’m concerned anything on the chart that indicates either possible future trend or possible future reaction level will be regarded as an indicator here.
Some price action traders may incorporate other tools, but these form the basics. There really is no need for any fancy fx trading software for forex price action trading.
So, our new chart may look like this when loaded with some of the above:
Figure 2: Price Action Trading with minimal but effective indicators
In this example I have zoomed out to the four-hour time frame to get a bigger picture of the pivot indicator levels. These pivots are shown by the dotted and dashed coloured lines.
I usually turn off the actual weekly, monthly etc. labelling for extra clarity; I have included them here for the purpose of better illustrating which is which.
The only other indicator on this chart is the freely available Metatrader Round Numbers indicator (available in Forex Indicators).
You can see at a glance that we have taken the best of both previous examples – the relevant information from the cluttered first graph and the simplicity of the bare second graph – and produced a chart that shows the following:
- The current trend: obviously down since old lows have been broken to the downside by recent price movement
- Respected price level at the round figure of 1.03500
- Respected price level at the most recently broken weekly pivot which is now resistance
- Price beginning to bounce away from the daily central pivot but yet to be confirmed
In the following, last example I highlight several areas of interest to us for future price reactions at levels where there is a confluence of price action indicators:
Figure 3: Price Action Trading at levels identified by confluence of indicators
The use of pivot points and Fibonacci levels is somewhat optional. Some price action traders use them, some use one or the other and some use neither. Personally, I would never trade without weekly, monthly pivots, plus the daily central pivot plotted on a chart, but I can take or leave Fibonacci. It’s a personal choice, based on what works for you: experience will tell you what to do.
So here we come to the major distinction between a normal chart that is loaded with all the groovy gizmos most traders are bedazzled by, and bare price action charts. The former are heavily reliant on off chart indicators, the latter avoid these and only use on chart indicators. Of course, both types of indicator are based on past price action. But there are differences that are critical for the trader to understand:
- on chart indicators are PREDICTIVE
- on chart indicators predict a LEVEL at which price is highly likely to react
- off chart indicators are LAGGING, REACTIVE
- off chart indicators predict the DIRECTION price is likely to take at some undefined point in the future
Another major reason to forego the use of off chart indicators is that they can be a major source of distraction from what is this really happening to the price. I know when I used them that I would be constantly flicking between the indicator at the bottom of the screen and the chart itself. Quite often I would spend so much time and energy trying to figure out what the indicator was predicting that I would miss what price was telling me, with unhappy consequences…
I really recommend the study of price action trading to any beginning trader, and in fact to any trader who is at a point in their trading where dissatisfaction with what they have learned has set in. Stripping away the clutter from your charts, combined with some education in price action trading and use of the indicators referred to here, will work wonders for your clarity and emotional state when trading.
N.B. It’s important to note that price action should not be your only consideration when taking a trade. Don’t forget the importance of the following, as they of course should be factored into any strategy you adopt whether it is based on price action or indicators or whatever:
- Prevailing fundamentals
- Time of day
- Market session (Asia/London/New York)
- Imminent News Announcements etc…
The next page on Price Action Trading discusses putting it all together using the best indicators to get the best entries. Go to Price Action Trading Entries