How do you tell whether a market is more likely to go up or down?
By decoding price action patterns.
Price action is the art and science of interpreting the market’s movement into actionable trade ideas.
Price action tells us the story of the fight between the bulls and the bears.
And price action is what you should focus on if you want to be profitable in the markets.
But you might be wondering…
How do you interpret price action?
How do you tell if the price action is indicating that the market is going up or down?
And how do you know what price action patterns you should be looking out for?
In this post, I will share with you what price action at its core really is…
I’ll also share with you how to interpret price action…
And more importantly, I’ll share with you 6 powerful price action patterns that you can use to get high probability trade entries.
What Exactly is Price Action
I’m sure you’ve probably heard the word “price action” get thrown a lot on the internet.
But few know what price action really is.
Many “trading gurus” tell you price action is candlestick patterns.
Some say price action is chart patterns.
But that’s not actually true.
Price action creates both candlestick and chart patterns.
And by that, I mean that both candlestick patterns and chart patterns are a result of price action.
What price action is at its core, is simply the movement of price from the buying and selling in the market.
How Price Moves
Have you ever wondered how price actually moves from one level to the other?
Here’s an example…
Imagine there is a stock with a Bid and Offer at $1.00 / $1.01.
So if you wanted to buy the stock immediately, it means you would have to lift the Offer at $1.01.
And by “lift the Offer”, it means you buy someone’s Offer at $1.01.
Similarly, if you want to sell the stock immediately, you would have to hit the Bid at $1.00.
So here’s the question for you:
How does the stock move one cent up to become $1.01 Bid and $1.02 Offer?
This is where many people have no clue.
But it’s important to understand this because this is price action at its core.
So how does the stock go from $1.00 Bid / $1.01 Offer to $1.01 Bid / $1.02 Offer?
Some people say it’s because there are lots of buyers coming in to buy at $1.01.
That statement is not necessarily true.
You see, it’s not the number of buyers that move a security’s price up.
Instead, it’s the SIZE of the position that moves the security’s price up.
So it can just be ONE person that move the stock up.
And that one person is usually someone from an institution like a bank, hedge fund, and even a prop firm, that manages huge funds.
So here’s exactly how price moves:
The image above shows the order book of the stock, or commonly called the Depth-of-Market (DOM) or ladder.
The DOM basically shows all the Limit Orders at all the price levels.
The Bid at $1.00 is called the Inside Bid, and the Offer at $1.01 is called the Inside Offer.
This is the first level of Bids and Offers.
In order for the market to go $1.01 Bid / $1.02 Offer, the sell order for 100,000 shares at $1.01 must all be executed.
So if one buyer comes in to lift the Offer for 200,00 shares, the $1.01 Offer will flip to become $1.01 Bid with a buy order for 100,000 shares:
As you can see in the image above, the Inside Bid is now at $1.01 and the Inside Offer is now at $1.02.
This is price action at its core.
Price Action Manipulation
Now, the scenario that I gave you above is just the simplistic overview of price action.
But there’s much more happening behind the scenes of this order book.
And that is that manipulation of price action is happening all the time.
Let’s use the DOM below as an example to illustrate this.
If you take a look at the $1.00 Bid, you will notice that there is a Buy Limit Order for 110,000 shares.
Now, the 110,000 Buy Limit Order at $1.00 can be seen as the amount of demand to buy at $1.00.
So if you see a 500,000 buy order at the bid of $1.00, but the offer at $1.01 remains at 100,000 sell order, it generally means there is more demand to buy the stock than to sell it.
However, just by seeing the total size of the order doesn’t tell us whether it’s placed by just one trader or a number of traders.
It could be just one trader placing the 110,000 order at the Inside Bid.
Or it could be 10 different traders forming the total order of 110,000.
And this is important to understand because this can give information on whether or not the order is “genuine”.
You see, placing an order at the Bids and Offers doesn’t mean that it must be executed.
The trader who placed these orders can choose to pull their order anytime they want.
And because of this, it adds a level of complexity as this gives room to manipulation.
One big player can spoof the market by showing big orders at the bid and show small orders on the offer to trick other people watching the DOM that there is more buying demand than selling.
So what happens is when traders see this, they want to get into a trade first expecting the market to move up and so they lift the offer.
However, what they don’t realize is that the big players are on the offer waiting to be filled.
So what big players do is they utilize an Iceberg Order on the Offer to secretly be filled their full size.
For example, they may want to get filled 400,000 shares at $1.01 to go Short but they don’t want to show their intention to the market because that would be blatantly telling the market what you are trying to do.
And if they do that, everyone else will jump in before them and go Short at $1.00.
So they utilize these Iceberg Orders where the Offer will keep refreshing every time the initial 80,000 shares have been filled at $1.01.
That means once the initial 80,000 shares have been filled, the Offer will immediately show another sell order of 80,000 shares.
And it will keep doing that until the full 400,000 shares have been filled.
Then once they have been filled, they will pull all their orders from the Bids and then spoof the Offers to make it look like this:
And this point, suddenly the market doesn’t look so bullish anymore.
Then the next move is where the big player makes their move by sweeping the $1.00 and $0.99 Bid and taking out all the buy orders there.
When this happens, all the traders that are caught Long at $1.01, $1.00 and $0.99 now suddenly need to get out of their trades and place their orders on the Offers hoping to get a better exit price.
What this does is add more selling pressure to the market, causing the market to go down even further.
This is classic price action manipulation that’s happening every single day in the markets.
Now, what I’ve shared with you here is on a small scale price movement.
But on a large scale, the summation of all these price action movements forms the candlestick patterns.
And the summation of all the candlestick patterns forms the chart patterns.
So what you see in the candlestick patterns and chart patterns all started from just one tick in price movement.
That’s the core of price action.
Now that we know exactly what price action is, let’s get into the actual price action patterns.
6 Candlestick Patterns You Must Know
The very first type of price action patterns you want to familiarize yourself with are candlestick patterns.
Everything that I just explained with regards to price action on the DOM, is represented by candlestick patterns.
And there are 6 candlestick patterns that you want to be very familiar with as you will be looking out for them very often when trading.
Where there is a multitude of candlestick patterns, for our purposes, we only want to focus on 3 bullish candlestick patterns and 3 bearish candlestick patterns.
3 Bullish Candlestick Patterns
1) Bullish Pin Bar
The Bullish Pin Bar is a one-candlestick pattern that has a body that is 50 percent or less than the length of the whole candlestick.
It signifies the bulls winning the battle because the price went to the lows, but then got pushed back above the halfway mark of the candlestick.
The body can be bullish or bearish in color.
As long as the body is above the 50 percent level of the whole candlestick, then it can be considered a Bullish Pin Bar.
And the longer the wick, the more significant the pattern because it’s a sign of strong bullishness.
2) Bullish Piercing Pattern
The Bullish Piercing Pattern is a two-candlestick pattern where the second candlestick bar has to close above the 50 percent mark of the previous candlestick bar.
It is also smaller in length compared to the previous candlestick bar.
And unlike the Bullish Pin Bar, a Bullish Piercing Pattern must always have a Bullish body.
And that means that the close has to be higher than the open, and the wick at the top has to be minimal.
If there is a long wick at the top of it, then it won’t be considered a Bullish Piercing Pattern.
3) Bullish Engulfing Pattern
The Bullish Engulfing Pattern is also a two-candlestick pattern where the second candlestick bar is bigger and overshadows the first candlestick bar.
Hence the name “engulfing”.
Like the Bullish Piercing Candle, it can only have a bullish body.
And we want the body to be at least 80 percent of the whole length of the candlestick.
The longer the body, the more bullish the candlestick pattern is.
3 Bearish Candlestick Patterns
If you noticed, the 3 bearish candlestick patterns are pretty much the upside-down mirror image of the 3 bullish candlestick patterns.
1) Bearish Pin Bar
The Bearish Pin Bar is a one-candlestick pattern and has a body that is below the 50 percent mark of the length of the candlestick bar.
This candlestick is the exact opposite of the Bullish Pin Bar and signifies that the bears won the battle here as there was a rejection of the high.
Like the Bullish Pin Bar, it can also either be a bullish or bearish body.
And the longer the wick at the top, the more significant the Bearish Pin Bar.
2) Dark Cloud Cover
The Dark Cloud Cover is a two-candlestick pattern and the second candlestick bar must close below the 50 percent mark of the first candlestick bar.
It is smaller in length compared to the first candlestick bar and can only have a bearish body.
And that means that the close must be below the open of the candlestick bar.
While there can be a short wick at the top and bottom of the candlestick body, we do not want a long wick.
Ideally, we want a short wick at the bottom of the second candlestick bar as that would represent a very bearish sentiment as the close is near the low.
3) Bearish Engulfing Pattern
The Bearish Engulfing Pattern is also a two-candlestick pattern with the second candlestick bar engulfing the first candlestick bar.
The second candlestick bar is also longer in length than the first candlestick bar…
And has to close below the low of the first candlestick bar.
While there can be wicks at both ends of the body, we want the body to be about 80 percent of the candlestick’s length.
The bigger the body compared to the wicks, the more significant and bearish the candlestick pattern is.
6 Chart Patterns You Must Know
Now that we know the candlestick patterns, we need to find the right context to trade it because we never want to trade the candlestick patterns by itself.
And that’s where the chart patterns come in.
Similarly, while there are many chart patterns as there are candlestick patterns, there is no need to know all of them.
As long as you know a handful of them and master it, it’s more than enough to be profitable trading the markets.
And all you need to know are these 6 chart patterns.
3 of them are bullish patterns and 3 of them are bearish patterns.
3 Bullish Chart Patterns
1) Bull Flag
The Bull Flag is a bullish continuation pattern that happens in an uptrend.
And it usually happens when the 20 EMA is above the 50 EMA.
In an uptrend, the market will continually make higher highs and higher lows.
And these higher lows can sometimes form the Bull Flag.
The Bull Flag is essentially a pullback in an uptrend.
And they signify that the market is taking a rest before it continues its move upwards.
2) Double Bottom
The Double Bottom is a bullish reversal pattern that happens most of the time in a downtrend.
And most of the time, it forms below both the EMAs.
In a downtrend, a market will form lower lows and lower highs.
However, when the market struggles to make a significantly lower low and forms a Double Bottom, this is a sign that the market has possibly exhausted its downward move and is about to reverse.
The Double Bottom can be a powerful reversal pattern when traded properly.
The V-Bottom like the name suggests looks like a “V”.
V-Bottoms can happen anytime in an uptrend, downtrend and even in a sideways market.
They generally form when the market has a sudden push to the downside and creates long candlestick bars, followed by a big push to the upside again, thus creating the V-shape bottom.
While V-Bottoms can be very lucrative when you catch it, you do not want to get into every V-Bottom trade.
Instead, we only want to trade the ones that are formed because of a prior support level.
3 Bearish Chart Patterns
1) Bear Flag
The Bear Flag is a bearish continuation pattern that happens in a downtrend.
And it usually happens when the 20 EMA is below the 50 EMA.
In a downtrend, the market will continually make lower lows and lower highs.
And these lower highs can sometimes form the Bear Flag.
Similar to the Bull Flag, the Bear Flag is a pullback in a downtrend.
And they signify that the market is taking a rest before it continues its move downwards.
2) Double Top
The Double Top is a bearish reversal pattern that happens most of the time in an uptrend.
And most of the time, it forms above both the EMAs.
In an uptrend, a market will form higher highs and higher lows.
However, when the market struggles to make a significantly higher high and forms a Double Top, this is a sign that the market has possibly exhausted its move upwards and is about to reverse down.
Likewise, the Double Top can be a powerful reversal pattern when traded properly.
The V-Top is the inverse of the V-Bottom.
Similarly, V-Tops can happen anytime in an uptrend, downtrend and even in a sideways market.
They generally form when the market has a sudden push to the upside and creates long candlestick bars, followed by a big push to the downside, thus creating the inverse V-shape.
And likewise, you do not want to trade every V-Top, but only the ones that are formed because of a prior resistance level.
Combining Candlestick & Chart Patterns For High Probability Trades
Every candlestick tells a story of the struggle between the bulls and the bears.
And when these candlesticks combine, they form chart patterns that give us an idea of the direction on where the market might be going.
Some traders solely rely on candlestick patterns to enter into a trade.
While some traders solely on chart patterns to enter into a trade.
But what happens if you combine both the candlestick patterns and chart patterns to get into a trade?
Then you’d be able to increase the odds in your favor and have a higher likelihood that the trade will work out.
When trading, we never solely enter on any individual candlestick pattern.
We want to see the whole context of how the candlestick pattern is formed.
And that’s where we look to chart patterns.
Bullish Candlestick Patterns with Bullish Chart Patterns
When you combine the 3 bullish candlestick patterns with the 3 bullish chart patterns, we get a total of 9 bullish price action patterns.
You want to memorize the following images below so you know exactly what to look out for when you open your charts.
There will be lots of noise on your charts, and that’s where you want to imprint these price action patterns into your mind so when it appears on your chart, you will immediately be able to recognize it.
1) Bull Flag with Bullish Candlestick Patterns
Bull flags in itself are already bullish patterns.
But when you combine them with a Bullish Candlestick Pattern, it will increase the probability of your trade working out.
So here’s a diagram of what you want to be looking for on the charts:
Most Bull Flags appear when the 20 EMA is above the 50 EMA.
Some of the best Bull Flags happen when you have the bullish candlestick pattern forming on the EMAs.
This is a further sign of bullishness because the EMAs act as a dynamic support.
So if you see either of the bullish candlestick patterns appear with a Bull Flag, and is formed on the EMAs, then that is a high probability price action pattern.
2) Double Bottom with Bullish Candlestick Patterns
With Double Bottoms, most of the time you are looking for it in a downtrend when the 20 EMA is below the 50 EMA.
Ideally, we want the bullish candlestick pattern breaking the low of the first bottom, and then closing above it.
So for example, if the first bottom has a low of 100.50, then we want the bullish candlestick pattern to break below 100.50, and then come up to close above 100.50.
This is a very bullish signal.
And if you combine this price action pattern with a stochastic divergence, then there’s a very strong chance that the market will be heading up.
3) V-Bottom with Bullish Candlestick Patterns
With the V-Bottom, you want to only enter into the ones that have broken a previous untested support level.
If the V-Bottom has formed out of the blue without testing any support level, then you want to avoid it as the chances of it working out won’t be as good.
Some of the best V-Bottom trades I’ve had are the ones where it broke a previous swing low, then formed a bullish candlestick pattern like the ones in the image above, and closed above the previous swing low.
This signifies that the previous swing low has held as a strong support level, and hence it formed a bullish candlestick pattern and closed above that support level.
Bearish Candlestick Patterns with Bearish Chart Patterns
Similar to the bullish price action patterns, there are also 9 bearish price action patterns.
They are the exact opposite of the bullish price action patterns so you want to memorize them as well.
1) Bear Flag with Bearish Candlestick Patterns
Bear Flag patterns happen in a downtrend and ideally when the 20 EMA is below the 50 EMA.
Similarly to the Bull Flag, we want to look for bearish candlestick patterns to appear on either the EMAs as that would signify that the EMAs have held as a dynamic resistance.
2) Double Top with Bearish Candlestick Patterns
With Double Tops, we also want the bearish candlestick patterns to break the high of the first top, and then come back down to close below it.
Now, it’s not often that you get this exact pattern because sometimes, the bearish candlestick patterns will break above the first top’s high but not close below it.
In that case, if you’re an aggressive trader, you can go Short once the market breaks the low of the bearish candlestick pattern…
Or if you’re more conservative, you can wait until the market closes below the first top’s high to go Short.
The aggressive entry can get you a better risk-to-reward ratio but at the risk of getting stopped out more often.
Whereas the more conservative entry will have less stop-outs, but the risk-to-reward ratio may not be as good.
So this is something you want to balance as a trader to see which makes more sense for your trading style.
Similarly to the Double Bottom, you can use stochastic divergence to further increase the chances of this price action pattern working out.
3) V-Top with Bearish Candlestick Patterns
For V-Tops, similar to V-Bottoms, it’s important to only enter into a trade when the V-Top coincides with a resistance level.
This is key because if you trade a V-Top that has no previous resistance level and just forms out of the blue, the probability of it working out will not be as high.
So only enter into V-Tops when there’s a resistance level that causes the bearish candlestick patterns to form.
And again, an ideal V-Top trade setup is when the bearish candlestick pattern breaks above a previous swing high, then comes back down to close below it.
To sum things up, price action is the study of price movement from the buying and selling over time.
You now know that the number of traders does not move the market…
Instead, it’s the size of the trade that moves the market.
This price action forms the candlestick patterns, and these candlestick patterns form chart patterns.
And through the combination of candlestick and chart patterns, we’re able to identify where the market is likely to go, and then get into a trade based on the price action pattern we see.
While there are many other price action patterns that are profitable as well, start with the ones I’ve shared with you in this post.
Understand it, memorize it, then master it.
Once you’ve done that, then you can start to find other price action patterns to trade.
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