Reading Price Charts Bar by Bar

1. Price Action is the Language of the Market

Learning what the market is telling you is very time consuming and difficult, but it gives you the foundation that you need to be a successful trader.

Understanding price movement. Price action, defined as any change in price, is the most fundamental data a trader can analyze. It encompasses every tick, every trade, and every bar on a chart, regardless of the time frame. By focusing on price action, traders can discern the underlying forces of supply and demand, and make informed decisions.

Institutions drive price action. Institutional traders, such as mutual funds and hedge funds, are the primary drivers of price movement. Their collective buying and selling activities create the patterns and trends that price action traders seek to understand and exploit. While institutions don't conspire to manipulate the market, their actions leave a clear footprint on price charts.

Reading the story of the bars. Each bar on a chart tells a story, revealing the battle between buyers and sellers. By analyzing the size of the body, the length of the tails, and the relationship between the open and close, traders can gain insights into the prevailing sentiment and anticipate future price movements.

2. Trend or Trading Range: The Trader's Eternal Question

For a trader, the fundamental issue that confronts him repeatedly throughout the day is the decision of whether the market is trending or not trending.

Two market states. The market is either trending or in a trading range. In a trending market, traders look to enter in the direction of the trend, while in a trading range, they seek to fade moves back towards the center of the range. Accurately identifying the current market state is crucial for selecting the appropriate trading strategy.

Trend bars vs. doji bars. Individual bars can be classified as either trend bars or doji bars. Trend bars have a clear body, indicating that either buyers or sellers were in control, while doji bars have a small or nonexistent body, suggesting a balance between buying and selling pressure.

Context is key. The interpretation of trend bars and doji bars depends on the surrounding price action. A series of doji bars with trending closes, highs, and lows can indicate a hidden trend, while a strong trend bar may represent exhaustion or a false breakout.

3. Bars Tell a Story: Decoding Signal and Entry Points

Almost every bar offers important clues as to where the market is going, and a trader who dismisses any activity as noise is passing up many profitable trades each day.

Setups, signals, and entries. A setup is a chart pattern that suggests a potential trading opportunity. A signal bar is the bar that triggers a trade, and the entry bar is the bar in which the trade is executed. Beginners should focus on entering trades when the signal bar is a strong trend bar in the direction of the trade.

Candlestick patterns demystified. Candle patterns are often overemphasized, but each bar or candle is only important in relation to price action. Focus on the story the bar tells about who is in control, rather than memorizing a collection of names.

Reversal bars. Reversal bars are a classic signal for Countertrend trades, but they must be analyzed in context. A strong reversal bar in a strong trend is more likely to fail, while a reversal bar that breaks a trendline and tests the extreme is a high-probability setup.

4. Trendlines and Channels: Guiding Lights in the Market

The most useful tools for understanding price action are trendlines and trend channel lines, prior highs and lows, breakouts and failed breakouts, the size of bodies and tails on candles, and relationships between the current bar to the prior several bars.

Trendlines define direction. Trendlines are straight lines that connect a series of swing highs or lows, providing a visual representation of the prevailing trend. They are most useful for identifying entries in the direction of the trend on pullbacks.

Trend channels define boundaries. Trend channel lines are parallel to trendlines and mark the upper or lower boundaries of a trend. They are most helpful for identifying potential reversal points and profit targets.

Micro trendlines. Micro trendlines are small, steep trendlines that form within strong trends. A failed breakout of a micro trendline can be a reliable signal for a With Trend entry.

5. Trends Within Trends: Understanding Market Structure

Any trend that covers a lot of points in very few bars, meaning that there is some combination of large bars and bars with very little overlap, will eventually have a pullback.

Trends, swings, pullbacks, and legs. A trend is a sustained move in one direction, while a swing is a smaller trend within a larger trend. A pullback is a temporary Countertrend move, and a leg is any smaller trend that is part of a larger trend.

Two-legged moves. Most trends, swings, and pullbacks have at least two legs. This means that after a trendline break, the market will often test the extreme of the prior trend before continuing in the new direction.

Signs of strength. Strong trends are characterized by large bodies, small tails, minimal overlap, and a lack of significant pullbacks. Recognizing these signs can help traders identify high-probability With Trend entries.

6. Pullbacks: Opportunities in Motion

The only thing that is as it seems is the chart. If you cannot figure out what it is telling you, do not trade. Wait for clarity. It will always come.

Pullbacks are inevitable. Even the strongest trends experience pullbacks, which provide opportunities for traders to enter in the direction of the trend at a better price.

First pullback sequence. Pullbacks often follow a predictable sequence, starting with a bar, then a minor trendline, then the EMA, then an EMA gap, and finally a major trendline. Each of these levels can serve as a potential entry point.

Double Top/Bottom Flags. Double Top Bear Flags and Double Bottom Bull Flags are common pullback patterns that offer reliable With Trend entries. These patterns occur when the market makes two attempts to break through a key price level, but fails both times.

7. Trading Ranges: Navigating Sideways Markets

If you cannot figure out what it is telling you, do not trade. Wait for clarity. It will always come.

Trading ranges defined. A trading range is a period of sideways price action where neither buyers nor sellers are in control. Trading ranges are characterized by overlapping bars, small bodies, and frequent reversals.

Tight trading ranges. Tight trading ranges are characterized by very little price movement and can be difficult to trade. It is generally best to wait for a breakout or a failed breakout before entering a trade.

Barb wire. Barb wire is a specific type of tight trading range characterized by three or more overlapping bars, at least one of which is a doji. Barb wire is notorious for whipsaws and false breakouts, and should be traded with caution.

8. Breakouts: Riding the Surge or Fading the Falsehood

The only importance of realizing that institutions are responsible for price action is that it makes placing trades based on price action more reliable.

Breakouts defined. A breakout is a move beyond a prior point of significance, such as a trendline or a swing high or low. Breakouts can signal the start of a new trend or the continuation of an existing trend.

Breakout entries. While breakouts can be tempting entry points, they often fail. It is generally better to wait for a pullback or a failed breakout before entering a trade.

Outside bars. Outside bars are bars with a high that is higher than the previous bar's high and a low that is lower than the previous bar's low. Outside bars can be tricky to read, but they often set up profitable trades.

9. Magnets: Price Levels That Attract

The only thing that is as it seems is the chart.

Price magnets. Certain price levels act as magnets, attracting the market towards them. These magnets include prior highs and lows, trendlines, trend channel lines, and Fibonacci retracements.

Measured moves. After a pullback, the market will often move in the direction of the trend for a distance that is approximately equal to the distance of the first leg. This is known as a measured move.

Failed reversals. Reversals often end at signal bars from prior failed reversals. This is because traders who were trapped in the failed reversal will be eager to exit their positions at breakeven.

10. Minor Reversals: Embracing Failures as Setups

If you cannot figure out what it is telling you, do not trade. Wait for clarity. It will always come.

Failures are inevitable. All patterns fail some of the time, and traders should accept that as a normal occurrence. In fact, failures can often provide valuable information about the market and set up profitable trades in the opposite direction.

Failed signal and entry bars. When a signal or entry bar fails, it often sets up a trade in the opposite direction. This is because traders who were trapped in the failed trade will be forced to exit their positions, driving the market in the opposite direction.

One-tick failed breakouts. One-tick failed breakouts are a common source of losses for new traders, but they can also be a reliable signal for a trade in the opposite direction.

11. Day Trading: A Symphony of Skill and Discipline

Ultimately, as a trader understands price action better and better, trading becomes much less stressful and actually pretty boring, but much more profitable.

Market selection. Choose a market that is liquid, volatile, and well-suited to your trading style. The Emini S&P 500 futures contract is a popular choice for day traders.

Time frames and chart types. Most day traders use a 5-minute candle chart, but other time frames and chart types can also be effective. Experiment to find what works best for you.

Trading styles. Day traders can be scalpers, swing traders, or a combination of both. Scalpers aim to capture small profits on many trades, while swing traders hold positions for longer periods, seeking to capture larger moves.

12. Charts Across Timeframes: A Consistent Language

Market Crashes Look the Same on All Timeframes

Price action is fractal. The same price action patterns can be observed on all time frames, from tick charts to monthly charts. This means that the principles of price action trading can be applied to any market and any time frame.

Higher timeframe awareness. While day traders primarily focus on intraday charts, it is helpful to be aware of the longer-term trends and patterns that are visible on daily, weekly, and monthly charts.

Adaptability is key. The market is constantly changing, and successful traders must be able to adapt their strategies to changing conditions. This requires a deep understanding of price action and a willingness to learn from both successes and failures.

Last updated: February 21, 2025