What is Price Action Trading?
Price action is a trading method that will allow you to understand the market and make subjective trading decisions that are based on the actual and recent price movements. In this form of trading, you do not rely on technical indicators or fundamental analysis. The trading decisions are based on the naked price chart, which means there are no lagging indicators outside of the moving averages. All financial markets generate data about the price movement in the market over a period of time. You can see this data on the price charts which will show the actions and beliefs of the participants who are trading in a market over a certain period of time. Such actions or beliefs are shown on the price chart of the market in the form of price action.
Popularity of price action trading
The vast majority of market participants strongly believe that forecasting asset prices is next to impossible because there are so many factors that can influence the prices of these assets. Indeed, it is very difficult to develop a perfect system that will work regardless of the ever-changing market cycles & trends.
However, it has been observed that asset price movements in the near term can at times be correctly estimated using a combination of past price data and some basic knowledge of technical analysis. This is precisely where the price action trading strategy comes into the picture.
Price action at its core is very simple and easy to grasp even by budding traders. Another plus point is that it works really well across multiple asset classes such as stocks, commodities and can even be applied in the forex and crypto markets.
Why Does Price Action Work?
As technical traders, it’s important for us not to get too distracted with why something works. When I first started trading Forex in 2007, I was constantly trying to figure things out. Technical, fundamental, you name it. I would reverse-engineer anything I could get my hands on.
Having been through that experience, I can tell you that a far better use of your time is to practice identifying these levels on your charts. Let’s leave the in-depth analysis to the fundamental traders. 😉
But I suppose it couldn’t hurt to at least know the basics. And it may prove beneficial for some, so let’s briefly touch on why price action works.
How Price Action Works?
Price action trading is simplistic, and most systems usually have a two-step process for identifying and taking advantage of trading opportunities in the market. The steps are as follows:
1. Identify the Prevailing Market Conditions
As mentioned above, a market can either be in an uptrend, downtrend or moving sideways. By observing asset prices, traders should quickly be able to tell what phase of price action the market is in at that moment.
2. Identify the Trading Opportunity
After identifying the prevailing market condition, a trader then proceeds to establish whether there is an actionable trading opportunity. For instance, in an uptrend, the price action should tell the trader whether prices will continue extending higher, or whether a retracement is expected. An example of a price action trade is when the gold price has been trending higher and is approaching $2,000. If it successfully breaks that level, then $2,000 will now be the new support area.
A long position will now be entered after a pullback fails to break below $2,000. If an earlier support level was $1,980, the price action trader would place a stop loss level below that price, which is exactly where the uptrend will be deemed invalid. The exit on the trade can be triggered when the trader satisfies their risk/reward ratio, or when the market does not make higher highs and higher lows.
What are price action signals?
Price action signals – sometimes called price action patterns, or price action triggers – are easily-recognisable patterns in a market, which can be used to predict future market behaviour. Experienced traders can sometimes spot these signals at a glance by recognising certain shapes or repetitions in past performance.
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Top six trading strategies with price action signals
1. Price action trend trading
If price action trading is the study of price movements, price action trend trading is the study of trends. Traders can make use of a number of trading techniques to spot and follow price action trends such as the head and shoulders trade reversal.
2. Pin bar
Sometimes called the candlestick strategy because of its distinctive shape, the pin bar pattern looks like a candle with a long wick on it. It represents a sharp reversal and rejection of a particular price, with the ‘wick’ or tail showing the range of price that was rejected.
3. Inside Bar After Breakouts
When breakouts occur, the challenge for traders is if it is a genuine one or a fake one. An inside bar breakout pattern is when one or more candles trade within the highs and lows of the large breakout candle, hence the name ‘inside’. The psychology for the setup is that market participants are unwilling to give back any breakout gains and are ready to defend and back the new trend going forward.
4. Trend following breakout entry
This trend tracks any major movements in the market under the assumption that after a price spike, a retracement will follow. If a market moves outside a defined support or resistance line, it’s known as a breakout.
5. Head and shoulders reversal trade
As the name suggests, the head and shoulders pattern is a market movement that looks a bit like the silhouette of a head and shoulders. In other words, prices rise, fall, rise even further, fall again, and rise to a lower high before a modest drop.
6. Understanding Price Action Trading in Technical Analysis
In simple terms, Price Action Trading is underrated in technical analysis and often ignored by traders.
This webinar aims to prove the importance of price action trading and Dow theory with practical chart examples which will release the complicated approach towards trading rather than looking into complex trading systems.
What Are Some Limitations of Using Price Action?
Price action is often subjective and traders may interpret the same chart or price history somewhat differently, leading to different decisions. Another limitation is that past price action is not always a valid predictor of future outcomes. As a result, technical traders should employ a range of tools to confirm indicators and be prepared to exit trades quickly if their predictions prove incorrect.
The Bottom Line
A lot of theories and strategies are available on price action trading claiming high success rates, but traders should be aware of survivorship bias, as only success stories make news. Trading does have the potential for making handsome profits. It is up to the individual trader to clearly understand, test, select, decide and act on what meets the requirements for the best possible profit opportunities.
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