Price action technique refers to analyzing the performance of a particular trading instrument (a currency pair, a Commodity, a Stock, a Cryptocurrency etc.) in order to predict its future price movement by identifying certain patterns (signals) in the market. Price action traders employ a variety of methods to predict market movement and earn short-term gains.

Some traders will use naked (pure) price action to make their investment decisions. In other words, they will not rely on time-consuming analysis and complex formulas, but only on their own reading of the market.

By reading the segments (candlesticks or bars) of a price chart, traders will look for easily-recognizable price action signals (price action patterns) to predict market behavior in the future. Traders with vast experience will usually detect such signals at a glance by recognizing particular candlestick formations or repetitions in past price performance.

Why is price action so popular in Forex trading? The difference between price action and technical analysis

Foreign Exchange is a preferred choice among price action traders because:

  1. First, it delivers unmatched liquidity compared to other market segments, thus, traders will be able to enter and exit their positions quickly and with ease;
  2. Second, the market is so mature that it is easier to detect recurring patterns and trends;
  3. Third, the market is always active, but rarely reaches significant peaks or troughs. This way, it is suitable for beginners who are willing to experiment with smaller positions before increasing their trade size as they gain more experience.

If we are to compare price action with technical analysis, we should note that price action indicators are mere flickers of activity, which experienced traders can detect quickly on the price chart and use them to make informed decisions in real time.

While technical analysis utilizes a wide range of calculations across multiple trading time frames to forecast future market movement, price action focuses only on price movement of a particular trading instrument within a single time frame (the one examined by the trader). Price action traders will also abstain from using any additional technical indicators to read the market.

In the current guide, we shall discuss the variety of trend reversal and trend continuation patterns, based on one, two or more segments of the price chart (candlesticks), which traders can use in their approach to global markets.

First, we shall begin with the single candlestick formations.

“Hammer” and “Hanging Man” Candlestick Patterns

Although these candlestick formations may appear similar on the chart, they play a different role. Both of them have long lower wicks, small bodies and short (or no) upper wicks.

The “Hammer” is a bullish reversal pattern and usually appears after the market has been in a bear trend. It may be spotted at support levels and indicates that price action has reached a trough and may reverse direction. This pattern represents an opportunity to go long, but still, traders need to have confirmation price action is indeed reversing up. This may come in the form of a green candle with a closing price above the open price or the high price of the candle that precedes the “Hammer”. This pattern will have the following key features:

  • short or no upper wick
  • long lower wick (preferably three times longer than the body of the candle)
  • the body is at the upper end of the candle
  • in terms of the candle’s color, a green Hammer is preferable.

“Hammer”

The “Hanging Man” is a bearish reversal pattern and usually appears after the market has been in a bull trend. It may be spotted at resistance levels and indicates that price action has reached a peak and may reverse direction. This pattern represents an opportunity to go short, but still, traders need to have confirmation price action is indeed reversing down. This may come in the form of a red candle with a closing price below the open price or the low price of the candle that precedes the “Hanging Man”. This pattern will have the following key features:

  • short or no upper wick
  • long lower wick (preferably three times longer than the body of the candle)
  • the body is at the upper end of the candle
  • in terms of the candle’s color, a red Hanging Man is preferable.

“Hanging Man”

“Inverted Hammer” and “Shooting Star” Candlestick Patterns

Just as was the case with the previous two patterns, the “Inverted Hammer” and the “Shooting Star” may appear similar on the price chart, but they are used in different contexts. Both of them have long upper wicks, small bodies and short (or no) lower wicks.

The “Inverted Hammer” pattern usually appears after the market has been in a bear trend. It may be spotted at support levels and signals that price action has reached a trough and may reverse direction. This pattern represents an opportunity to go long, but still, traders need to have confirmation price action is indeed reversing to the upside. This may be a green candle with a closing price above the open price or the high price of the candle that precedes the “Inverted Hammer”.

At times, the “Inverted Hammer” may appear near a regular “Hammer”, while this occurrence provides confirmation that the particular level of support is quite strong.

The “Inverted Hammer” pattern will have the following key features:

  • short or no lower wick
  • long upper wick (preferably three times longer than the body of the candle)
  • the body is at the lower end of the candle
  • in terms of the candle’s color, a green Inverted Hammer is preferable.

The “Inverted Hammer” pattern

The “Shooting Star” pattern usually appears after the market has been in a bull trend. It may be spotted at resistance levels and signals that price action has reached a peak and may reverse direction. This pattern represents an opportunity to go short, but still, traders need to have confirmation price action is indeed reversing to the downside. This may be a red candle with a closing price below the open price or the low price of the candle that precedes the “Shooting Star”.

The “Shooting Star” pattern will have the following key features:

  • short or no lower wick
  • long upper wick (preferably three times longer than the body of the candle)
  • the body is at the lower end of the candle
  • in terms of the candle’s color, a red Shooting Star is preferable.

The “Shooting Star” pattern

White Marubozu

This is a single candle pattern that appears after a bear trend and signals a bullish reversal. The candle has a huge bullish body and no upper or lower wicks, which suggests the buyers are exerting pressure and the price may reverse up.

White Marubozu

Black Marubozu

This is a single candle pattern that appears after a bull trend and signals a bearish reversal. The candle has a huge bearish body and no upper or lower wicks, which suggests the sellers are exerting pressure and the price may reverse down.

Black Marubozu

Doji Candles

These candles appear on the price chart, whenever a particular trading instrument has virtually identical open and close prices. As a result, the doji candle has a considerably smaller body compared to the regular candles. Doji candles provide useful information to traders, since they help them to determine if a given trend is losing momentum and when it may reverse its direction. This way, traders will be able to enter and ride a market trend when it commences or exit one before it ends. Setups based on doji candles tend to offer reliable signals only within trending markets.

There are 4 different types of doji candles – star doji, long-legged doji, dragonfly doji and gravestone doji.

The star doji candle has short upper and lower wicks and they may appear to be of nearly identical length. This doji candle forms, when the opening and closing prices are one and the same, while the price range has been tight. The star doji indicates indecision among market participants during the respective period.

Star Doji

The long-legged doji candle has longer upper and lower wicks, while the price range has been considerably wider. This doji candle indicates that again bulls and bears are battling for control, but now both sides are much more active.

long-legged doji

The dragonfly doji has a long lower wick and the candlestick opens and closes at one and the same price level – at the high end of the range. This doji signals that bears have dragged the price in their favor, until control was lost as a result of increasing long positions. The absent upper wick implies that bears stand firm and bulls do not cause sufficient pressure to trigger a breakout beyond that price level. The dragonfly doji usually generates a bullish signal.

dragonfly doji

The gravestone doji has a long upper wick and the candlestick opens and closes at one and the same price level – at the low end of the range. This doji signals that bulls have dragged the price in their favor, until control was lost as a result of increasing short positions. The absent lower wick implies that bulls still support the price and bears do not cause sufficient pressure to trigger a breakout beyond that price level. The gravestone doji usually generates a bearish signal.

gravestone doji

Short-term price patterns can also consist of two candlesticks. They are as follows: Bullish and Bearish Engulfing pattern, Dark Cloud Cover and Piercing Line, Tweezer Tops and Tweezer Bottoms, Harami.

Bullish and Bearish Engulfing patterns

The Engulfing formation is a double candle setup that signals a trend reversal. This signal tends to be quite strong in case we have the ideal scenario for the pattern. Since the formation is supposed to indicate trend reversals, the market needs to be in a recognized trend for the Engulfing to work properly.

In a confirmed trend, a Bearish Engulfing formation will indicate the market has reached a peak and a new, bear trend may be about to begin. A Bullish Engulfing formation will indicate the market has reached a trough and a new, bull trend may be about to form.

There are several requirements for the Engulfing formation to be identified:

  1. First of all, the market should be in a confirmed short-term or long-term trend.
  2. Second, one of the candles should be of bullish type and the other one – of bearish type. In case the first candlestick is bearish, the second one should be bullish to complete a Bullish Engulfing formation.
  3. Third, the body of the first candle should be smaller than that of the second candle. The second candlestick does not need to additionally engulf the wick of the first candle. Yet, its high-low range should be equal or wider than the high-low range of the first candle.

Engulfing formation 1

Engulfing formation 2

The ideal Engulfing formation assumes the body of the second candle engulfs the entire first candle (including its wicks). If the formation appears after a Doji candle, the setup will be even more powerful.

It is generally accepted that the smaller the first candle and the larger the second candle is, the stronger the Engulfing formation will be. If the difference between the two candlesticks is not that significant, then the pattern will be weaker. And if both candles appear of almost equal size, then the formation becomes irrelevant and is very likely to lead to sideways price movement.

Dark Cloud Cover, Piercing Line

The “Dark Cloud Cover” and its opposite, the “Piercing Line”, represent double candle, trend reversal patterns. The “Dark Cloud Cover” forms at a market peak and signals a reversal to the downside. The first candle in the setup is large and of bullish type, while the second one is smaller and of bearish type. That second candle is required to open above the upper wick of the first candle. Thus, an upward gap will usually form. Then, the price is required to move lower and close within the body of the first candlestick, ideally below its midpoint. The bigger the penetration is, the stronger the pattern will be.

The ideal Dark Cloud Cover formation assumes the second candlestick closes below the midpoint of the first candle’s body. We should note that liquid markets such as Foreign Exchange may require more flexible setup conditions. For instance, the second (bearish) candlestick may open above the closing price of the first (bullish) candlestick instead of its high price, while the close may not be that deep. Yet, if the closing price of the second candle does not reach the midpoint of the prior candle’s body, the formation may be inconclusive.

Dark Cloud Cover formation

The “Piercing Line” pattern can usually be found after a strong bear trend and it indicates that a support level (or zone) has been reached. Therefore, the pattern provides an early signal a market correction is about to occur or even a new, bull trend is about to begin. All the requirements for the Dark Cloud Cover can be applied for the Piercing Line, but in reverse.

The “Piercing Line” pattern

Tweezer Tops, Tweezer Bottoms

Tweezers also signal a trend reversal. Tweezer Tops indicate that an existing bull trend is about to end and, thus, they are a bearish formation. Tweezer Bottoms indicate that an existing bear trend is about to end and, thus, they are a bullish formation.

Tweezer Tops” pattern

Tweezer Bottoms

Both variations are comprised of two opposite candlesticks – one bullish and one bearish, with their lows and highs matching. Again, in order for Tweezers to work properly, the market needs to be in a recognized short-term or long-term trend.

How can this pattern be interpreted? In a bull trend, at the wick of the first candlestick the bulls have been overpowered by the bears. Then, the wick of the second candle indicates another attempt by the bulls to drive the market higher. After two failed attempts by the bulls to take control over the market, the sellers have finally managed to gain the upper hand and, thus, they are able to drive the price down.

In general, Tweezers are required to have matching highs or lows, regardless of that whether it is their wicks or their bodies that match. It is possible to observe an Engulfing formation with the two candles’ highs or lows matching – it would still be considered as a Tweezer. Therefore, more than two candles may participate in the formation of Tweezers and they are all required to have matching lows or highs.

The ideal Tweezer scenario assumes that the size and the wicks of the two candlesticks appear to be quite similar. The formation tends to be even more powerful in case the candles appear like “twins”.

Note that the bodies of the two candlesticks are not necessarily required to be of equal size. Also, even the matching lows and highs may show a small difference. Yet, the more exact the candles appear on the chart, the greater the possibility of a trend reversal will be.

Harami

This is a double candle pattern comprised of one large candlestick (of either color) and one small candlestick, whose body is completely engulfed by the prior candle’s body. The second candlestick is also known as a spinning top and can be of the following type – a Doji, a Hammer, a Hanging Man, or a Shooting Star. What traders need to look for is that the second candle’s body should be within the first candle’s body. The wicks of the second candle are not required to be within the range of the first candle. Therefore, traders need to watch the open-close range, not the high-low range of the candles.

Harami 1

Harami 2

The second small-body candlestick suggests a contraction in market volatility. In the near-term, this is usually followed by a surge in volatility and the beginning of a new trend. Therefore, the Harami may signal either a trend reversal or an acceleration of the current trend. It depends on the direction of the breakout.

Next, we shall discuss some price patterns comprised of three candlesticks.

Evening Star, Morning Star

Those two formations are aimed to signal a trend reversal. The Evening Star is a triple candle bearish formation, which appears at a market peak, signaling the end of a bull trend. The first candle in the pattern is a big bullish one, followed by a small candle, which is known as a “star”. As was the case with Dark Cloud Cover, the appearance of a star candle suggests an opening gap. Yet, since the price decreases afterwards and the body of the star forms, we should note that it must not cross the body of the big bullish candle (first candle in the pattern).

The star candle can be either bullish or bearish. It can also be a Doji candle and, in this case, the formation will be an “Evening Doji Star”. Even if the second candle is not a Doji candle, it will always bear certain similarity to the Doji, as it indicates a sudden halt in price movement.

In order for the Evening Star pattern to be successful, the third candle must be a big bearish one. This way, it will signal the bears have overpowered the bulls during the formation of the star candle. The body of the third candle must also not cross the star. However, note that such an occurrence may be rarely observed and, thus, it is not that strict requirement for the Evening Star. On the other hand, a key condition for the pattern is that the bearish candlestick deeply penetrates the body of the bullish candlestick. The extent of penetration is of the essence – the body of the third candle must extend to 2/3, or even more preferably, to ¾ of the height of the first candle in the formation.

the Evening Star pattern

If the market closes above the pattern’s high, the Evening Star formation is considered as failed. And if the market closes below the pattern’s low, the formation is considered as successful.

The Morning Star is a bullish formation and all the requirements we discussed above apply in reverse.

The Morning Star

Three White Soldiers, Three Black Crows

Those two patterns are comprised of 3 identically colored candlesticks. The Three White Soldiers formation signals a bullish reversal, while the Three Black Crows pattern signals a bearish reversal.

The Three White Soldiers formation consists of 3 successive bullish candles of similar size and usually appears after a bear trend. The second candle is required to be larger than the first, while the third candle needs to be at least the size of the second candlestick. If the third candle appears to be considerably smaller than the first two, this would suggest buyers are not fully in control of the market, while such an occurrence may be the reason why there is no reversal of the bear trend.

The Three White Soldiers formation

Each of the candles needs to open within the body of the prior candle or at its high. Overextended bodies are also something to be on the lookout for, since the trading instrument could become overbought and a retracement may occur. The three candles need to be reasonably long and to have small or no upper wicks – or, they need to close at or in proximity to their highs. Note that if the wicks are too long and match or even exceed the length of the candles’ bodies, this would suggest sellers are still strong.

The formation becomes more powerful in case the open prices of the second and the third candlesticks coincide with the closing prices of the first and the second candles respectively. The pattern will also be stronger if it appears not just after a prolonged bear trend, but after a consolidation that follows the bear trend and separates it from the Three White Soldiers setup.

The Three Black Crows pattern is comprised of 3 successive bearish candles of similar size and usually appears after a bull trend.

The Three Black Crows pattern

Bullish Abandoned Baby Pattern

This is a three candle pattern that forms in an existing bear trend and signals the potential reversal of that trend. Price action traders expect that once the pattern has been completed the market will continue to move higher, as selling has been exhausted (at least for now). There are certain criteria that will need to be met for the Bullish Abandoned Baby pattern to form:

  1. First of all, the first candle is a large bearish one and it is part of a defined bear trend;
  2. Second, the next candle is a Doji that gaps below the closing price of the first candle;
  3. Third, the final candle is a large bullish one that opens above the Doji and demonstrates aggressive movement to the upside.

Bullish Abandoned Baby Pattern

The idea behind this pattern is that the market has been moving in a defined bear trend and another big sell-off has just occurred (as evidenced by the appearance of the first large bearish candle). Then, the appearance of the Doji indicates leveled-off selling, with the open and closing prices of the candle being almost the same. It also indicates bears may be losing momentum and bulls are starting to join in. The Doji is followed by a large bullish candle that gaps higher. It indicates that bulls have regained control of the market, while selling has been exhausted (at least for now).

At times, traders can observe the formation of two or three Doji candles before the market makes a move to the upside. It will again be considered as a Bullish Abandoned Baby pattern, because there has been a steep decline, a leveling off, followed by a sharp increase.

Bearish Abandoned Baby Pattern

This is a three candle pattern that forms in an existing bull trend and signals the potential reversal of that trend. Price action traders expect that once the pattern has been completed the market will continue to move lower, as buying has been exhausted (at least for now). There are certain criteria that will need to be met for the Bearish Abandoned Baby pattern to form:

  1. First of all, the first candle is a large bullish one and it is part of a defined bull trend;
  2. Second, the next candle is a Doji that gaps above the closing price of the first candle;
  3. Third, the final candle is a large bearish one that opens below the Doji and demonstrates aggressive movement to the downside.

Bearish Abandoned Baby Pattern

Three Inside Up, Three Inside Down

The Three Inside Up represents a bullish reversal formation that appears at market troughs, while the Three Inside Down is a bearish reversal formation and appears at market peaks. The Three Inside Up formation can be observed at the end of a bear trend and it often coincides with a support level. Note that the pattern does not necessarily hint a trend reversal will soon occur – it may precede simply a market pause or a correction. The first candle in the pattern is a large bearish one, while the second is a smaller bullish spinning top candle or a Doji candle. Thus, the two candles form a Harami.

The smaller candle is required to close at least at the midpoint of the prior candle’s body. Then, a third candle (of a bullish type) breaks up and closes above the body of the first candle. An even stronger signal will be generated, in case that third candle closes above the first candle’s high.

Three Inside Down

The Three Inside Up pattern

The Three Inside Up pattern bears certain similarity with the Morning Star. Yet, it is even more powerful, since the second (middle) candle has not reached a new high or low when the opposite side (bulls in this case) takes control of the market. What is more, by the moment the third candle begins to form, the bulls are already dominating and eventually they manage to drive the price even higher up compared to price movement we can see in the Morning Star pattern.

Three Outside Up, Three Outside Down

The Three Outside Up (bullish) and the Three Outside Down (bearish) formations also signal a trend reversal. The Three Outside Up formation usually appears at market troughs. The first candle is a small bearish spinning top type candle, which matches recent market movement. The second candle in the pattern is a large bullish one, which engulfs the first candle. Or, we can say that the Three Outside Up formation actually starts with an Engulfing formation. After that the pattern is finalized with the appearance of a third bullish candle that closes above the second candle. The third candlestick reaches a new peak, above the high of the Engulfing formation.

Three Outside Up

Three Outside Down

The Three Outside Up pattern is usually regarded as less reliable than other triple candle formations, because outside candles are less predictable and profitable compared to inside candles, as in Morning Star/Evening Star and Three Inside Up/Three Inside Down patterns.

Now, let us take a look at several trend continuation candlestick setups.

Mat-Hold Pattern

This is a five candle trend continuation pattern, which has two variations – bullish and bearish. The bullish pattern is comprised of a large bullish candle, a price gap higher, followed by three small-bodied bearish candles. Those three candlesticks should form above the low price of the first (bullish) candle. The final (fifth) candlestick is again large and of a bullish type, signaling potential continuation of the uptrend.

Mat-Hold Pattern

Upside Tasuki Gap

This is a three candle bullish continuation pattern that appears during an existing bull trend. The first candle has a large body and is of a bullish type. The second candle is also bullish and forms after a gap up. The third candle is of a bearish type and closes in the gap formed between the first two (bullish) candlesticks.

Upside Tasuki Gap

Downside Tasuki Gap

This is a three candle bearish continuation pattern that appears during an existing bear trend. The first candle has a large body and is of a bearish type. The second candle is also bearish and forms after a gap down. The third candle is of a bullish type and closes in the gap formed between the first two (bearish) candlesticks.

Downside Tasuki Gap

Falling Three Methods Pattern

This is a five candle bearish continuation pattern, which indicates a temporary interruption in the market, but not a reversal of the existing bear trend. The pattern includes two large candles in the direction of the underlying trend at the start and at the end as well as three small counter-trend (bullish) candles in the middle. The formation signals price action traders that the buyers are still not strong enough to reverse the existing trend.

Falling Three Methods Pattern

Rising Three Methods Pattern

This is a five candle bullish continuation pattern, which indicates a temporary interruption in the market, but not a reversal of the existing bull trend. The pattern includes two large candles in the direction of the underlying trend at the start and at the end as well as three small counter-trend (bearish) candles in the middle. This formation signals price action traders that the sellers are still not strong enough to reverse the existing trend.

Rising Three Methods Pattern

Conclusion

Price action trading is tightly related to recent historical data and it takes into account all technical analysis tools such as charts, trend lines, price bands, swing highs and swing lows, levels of support and resistance, consolidation and so on. Patterns, which price action traders usually observe include breakouts, retracements, simple or more complex candlestick combinations (setups). In comparison, a typical technical analysis scenario such as a shorter-term moving average crossing over a longer-term moving average will lead to similar behavior and action among multiple traders.

Psychological and behavioral interpretations and resulting actions taken by the trader also comprise an essential aspect of price action trading. Different traders will usually interpret certain price action in a different way, because they have defined rules and different behavioral understanding of the market.

Price action trading is more appropriate for short-to-medium term profit trades rather than for long-term positions. Many traders believe that global markets follow a random pattern and there is no systematic way to build a trading strategy that works flawlessly every time. Since price action trading combines technical analysis tools with the recent price history to detect trade opportunities based on one’s own interpretation of market conditions, this approach has gained huge support within the trading community.

Also, self-defined price action strategies offer flexibility to traders, can be applied to a variety of asset classes, can be easily used with any trading software, application or trading portal and can be easily back tested. Price action trading is tightly assisted by technical analysis tools, but still, the final decision to open a position depends on the individual trader. Again, price action strategies allow room for flexibility, instead of strictly adhering to a set of rules.