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The foreign exchange market started September off with a boisterous attitude, after the prospects of the pound heating parity against the U.S. dollar – once unthinkable – is now starting to look more and more like reality.
But like other developed nations in the west, the UK economy has seen its fair share of major blows this year so far. The threat of a looming recession, acute dependence on foreign capital, rising debt costs, and the likelihood of the Bank of England’s independence have all been major headwinds for the country trying to recover its post-pandemic economy.
Earlier in the summer, forex investors were caught off guard when the euro managed to hit parity with the dollar for the first time in more than two decades.
Across-the-board forex markets have been entering uncertain territories in recent months as many countries – those with dominant currencies – are struggling to take control by dampening rampant running inflation with aggressive interest rate hikes and increasing the overall cost of borrowing to help cool off market conditions.
Here in the United States, outlandish market performance has also left many investors scalping the market in hopes of shielding themselves against a potential recession.
Late last month, Federal Chairman Jerome Powell estimated that increasing interest rates and the slower growth of the overall economy and labor market would potentially bring down inflation. Powell went further to state, “These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
Investors have been scrambling in all sorts of directions since Powell’s address, as the federal committee is looking to pivot away from monetary tightening in 2023.
Spirits have been distraught nonetheless, and many are still looking for the small window of opportunity that could help them shift positions in case any unruly waves come crashing down onto the market.
Forex markets have calmed down since Powell’s hawkish remarks at the Jackson Hole Symposium on Friday, August 26, and investors have managed to rebound and erase small daily losses.
With markets trading almost upside down, some investors are looking toward price action trading as the window of opportunity. Yet, these strategies have evolved beyond arbitrage, as forex traders look to watch the needle move from the middle price range, hoping that it would return to the baseline.
This is where the misconception lies with traders who are looking to get as many trades in before the needle moves again. Unless you already have a working scalping strategy or constantly follow the market trends, the best way to go would be to focus on a limited number of currency pairs – for now, at least until conditions have calmed again.
To clear the air, I’ve considered three aspects, among many others, that should take up more interest from traders as a way to underpin better trades.
Of course, there is a multitude of things worth considering in price action trading, and it’s not as nearly as simple as scalping the market. Perhaps these aspects could lead to a better understanding of how forex prices fluctuate against broader market indicators and be a framework that can help to better strategize.
Consistency of Analysis
Having a consistent analysis that you can follow will help you get the analytical points right more so than once. It’s important to consider your consistency, as this plays a big role in your daily, weekly, or monthly performance.
The consistency of analysis is comprised of three buckets. First, traders should minimize the effects of recency bias, and it’s tricky to do so, considering the ongoing market fluctuations. Being influenced by the outcomes of events only leads to greater disregard of your analysis.
Secondly, if your analysis may be proven successful, it’s common that your morale or level of confidence will automatically become inflated. Being confident is one thing, but being overconfident can hurt your baseline and expose you to a slew of new problems.
And then finally, consider the importance of a checklist to help construct your analysis. Having a checklist helps you to cover all the grounds and the most important steps of the analysis. If you miss a step, it’s possible that your entire analysis can come crashing down.
It takes more time to get used to, but the faster you start to make use of different strategies that can help to drive a meaningful analysis, the quicker you will become comfortable with the idea. In the current state, a bit of consistency is all that you need right now to help you navigate the choppy waters.
Support and Resistance Levels
Nearly every forex trader or investor has some form of support and resistance indicators embedded in their strategy; it’s almost a given.
Three important pillars of support and resistance include; market direction, time of market entry, and timing points of exiting the market. Whether you trade against a profit or loss, it helps to plan your exit strategy.
But what many newer and lesser experienced traders don’t take into consideration is that support and resistance levels need to be monitored, as they tend to change according to price movements.
What’s more, is that traders should also consider the type of trading strategies they will be using for their support and resistance levels. I’ve found that range trading, pullback, trendline, and moving averages are the most useful for support and resistance, as this gives you more leverage to control and adapt your analysis and overarching strategy as you progress through each trade.
Commonly, directional uncertainty would leave you looking to exit before considering what the potential near-term results will be. This is where you will need to backtrack to your consistency analysis and minimize the influence of recency bias. For a strong directional change, consider how a pullback towards the point of resistance will help you to sidestep a false breakout.
Indicator Confirmation
The most difficult aspect of price action trading is incorporating indicator confirmation to help confirm the analysis. You can include an indicator confirmation beforehand or as you trade to help you build a true reflection of the market.
For starters, we know that indicators work in mathematical formulas that operate on the backdrop of the market. This is what makes it so difficult to follow, meaning if your analysis is inconsistent with an indicator, you might miss your target almost completely.
More so, indicators help to identify a price breakout; what’s more, technical indicators can also help to determine the start and trajectory a breakout may follow. This gives the perfect open position at the start of the movement to help build better analysis and follow a baseline strategy.
So what do you use then as a technical indicator to help determine or identify potential breakouts?
For starters, you can consider the MACD or moving average convergence/divergence indicator as a baseline tool. This is usually a more common choice for forex traders in price action trading, as it helps them to understand the momentum behind a breakout. MACD also makes it easier for traders to have a closing position as momentum cools down.
Then for relevance in evaluating potential breakout, traders look towards the relative strength index or RSI to scale the purchasing trends of currency pairs in the broader market.
The reason why RSI works so well, in most cases, is that it helps to determine whether a currency pair is overbought or oversold, allowing traders to better analyze a potential breakout point. The RSI does help to monitor the conditions, but lagging data and information can leave traders in the dark.
Other trading strategies that may also help traders are slow stochastic and Bollinger bands, both of which can help to pinpoint breakouts but are also a good combination of strategies for new and seasoned traders.
An honorable mention
Bid-Ask Spread
As an honorable mention, I thought it would be interesting to include the bid-ask spread in price action trading.
Without having to go over the most basic principles of the bid-ask spread, traders need to draw more focus on either working with a variable or a fixed spread. The current conditions might make it the perfect time to use variable spreads, but fixed spreads have their fair share of positives when market performance suddenly slows down.
In the case of price action trading, traders need to consider the instrument they’re trading and its liquidity. For optimal outcomes, it’s best to consider your position in the market and your account size, and experts such as ForexFactory suggest that execution during peak hours is important for traders who are looking to benefit from larger swings based on variable spreads.
Final Thoughts
It’s quite straightforward to understand how price action trading on the foreign exchange market works; it’s right there in the name itself. While it’s easier said than done, the real results reflect in the performance strategy and which components you made use of.
The general rule is to keep a good foot on both sides of the market to help you better determine market volatility and price breakouts and establish a point of entry and exit.
It’s important to also not be swayed by the myths and misconceptions that fill the forex market, but rather keep to your strategy, build and improve as you need, and see how close you can get to following the needle throughout ongoing fluctuations.
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