The Price Action trading strategy: Trading the trend

1 - Bar types

Upward bars: highs and lows are higher than those of the previous bar. The bars are indicative of an an uptrend. Notice how the close is higher than the open until the trend reverses when the close falls below the open.

Downward bars: highs and lows are lower than those of the previous bars. The bars are indicative of a downtrend. Notice how the close is lower than the open until the trend reverses when the close is higher than the open.

Inside bar: also referred to as a narrow range bar; this is a bar with a high lower than the previous bar and a higher low. An inside bar usually represents market indecision .

Outside bar: also called a wide range bar or an engulfing bar; this is a bar with a higher high and a lower low than the previous bar. When the opening price is in the lower third of the bar and the close is in the upper third, it is a bull engulfing bar. When the opening price is in the upper third of the bar and the close in the bottom third, it is a bearish engulfing bar.

Another definition is used for this bar - especially with candlestick charts - when the open and the close have engulfed the open and close of the previous bar, and not just the bar's high and low. With this definition, the engulfing of the bar does not need to have a high or a low to form. The first definition probably arose from bar charts where it is harder to observe the opening and closing prices.

2 - The trend on a 5-min. chart

The following chart shows high and low swings in both trend directions: upward and downward. The price for a given period is in an uptrend if its highs are always higher (HH = higher high) and its lows are always higher (HL = higher low). Prices are in a downtrend if its highs are always lower (LH = lower high) and its lows are always lower (LL = lower low). If prices move differently, it's in a consolidation mode (choppy markets) - ranging or forming triangles, pennants, rectangles, etc...

3 - A change in the trend

The chart below shows how a true test of a high or a low can announce a change in trend.

(A) Price made a HH and a HL and then comes test the previous swing high a second time at A.
(B) Price hits a LL and a LH before coming to test the previous swing low at B a second time.
(C) The price hits a LH (the bar which doesn't touch line C) and then it comes test the previous swing low at C.
(D) Price made a HH and a HL before coming to test the previous swing high at D a second time.

4 - The trend within the trend

When observing a single currency pair, it is possible to see different trends or a consolidation period when you switch between different timeframes. For example, a daily chart shows an uptrend while the H1 chart shows a retracement or a correction. How can this affect your trading? The following exercise is an excellent way to understand what is meant by the expression "trend within the trend".

Take a 15-minute chart and mark the new highs (HH), and the new higher lows (HL), the new lower lows (LL) and the lower highs (LH). You can print the chart and mark it up by hand. Use red lines for downward trends and green lines for upward trends. Remember that prices are in an uptrend if they make HH and HL and they're in a downtrend if they hit LH and LL. If prices are doing otherwise, they may be consolidating, ranging, forming triangles, pennants, rectangles, etc.

1-4 are within a downward trend.

5-8 are within an upward trend.

Take the same chart, but this time with a 5-minute timeframe, keep the same colored marks and numbers as you had in the 15-minute chart. Mark the new highs and lows with green numbers for the upward trends and red numbers for the downward trends.

We can now see a trend in the 15-minute chart with the HH/LL marks and, at the same time, we can also see a trend in the 5-minute chart with the coloured numbers. The price action in the 15-min. chart only shows two trends, while the 5-min. chart shows five different trends!

At first, both charts are in a downtrend until the 5-min. chart shows a new HH at the first green number 1. The downward trend was interrupted when the LH at the black number 3 was passed through. The price then made a new HL (green number 2) indicating the start of an upward trend that continues up to the new LH (red number 1).

In the 15-min. chart, we just made a HH at the black number 5; at this point, we must wait until a HL forms in order to make a purchase order in the 5-min. chart. Two strategies are possible: buy after the pair of reversal bars at the red 2 or wait until the last swing high at red number 1 is passed through (buy here). The stop will be placed under the last HL and pulled up each time a new HL is made in order to follow the trend. It is nevertheless advised that you take half of your profits while following the trend and that you exit your last position with a stop order.

On the climb up to the HH at the black 7, both timeframes are in agreement. Afterwards, though, the 5-min. chart shifts to a downward trend (red numbers 1 to 6) while the 15-min. chart is still considered as being in an uptrend, achieving a HL at the black 8.

Although it is possible to trade trends in a small timeframe, you must wait for price action to demonstrate the same trend in a higher timeframe in order to genuinely trade the trend.

The trend is your friend!

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