Price Action Trading

The price action meaning refers to the movement of a security’s price plotted over time. It is the basis for all technical analysis of a stock, commodity, and other asset charts. Technical analysis is a derivative of price action, as it utilises past prices in calculations to make informed decisions in trading. Short-term traders rely exclusively on the price action, the trends and the formations extrapolated from it to make trading decisions.

What is Price Action Trading?

Price action trading commonly refers to the change in the security’s price over time. The chart plotting the trends in price action is presented differently to make the data more comprehensive for the traders. Clarity is extremely crucial when traders are analyzing data ranging over different periods.

What is price action in the stock market?

Price action is vital in the chart and technical analysis formations. Tools like moving averages, which can also be calculated from price actions and further projected, help traders make informed investment decisions. Price action is also extensively used to forecast future prices. However, It does not guarantee any results in the future.

Traders use a price action trading strategy as a day trading method and base their decisions on price movements rather than indicators derived from technical analysis. Traders use multiple price action trading strategies including candlesticks, breakouts, etc.

What is the difference between Price Action, Technical Analysis & Indicators?

Price action indicators represent flickers of activity on a trading chart that signal the emergence of a trend. Experienced traders quickly spot these price action indicators and utilise them for making informed market bets in real time.

Technical analysis utilises diverse calculations to predict future price movements. On the contrary, price action relies solely on the price movements of an asset within the trading timeframe.

Technical analysis attempts to find order within a seemingly chaotic world of trading. Traders tend to use a price action strategy to make a more intuitive trading decision by identifying and acting on price action indicators.

Best Price Action Trading Strategies

Here are seven top price action trading strategies with price action signals

● Price action trend trading:

The price action trend trade focuses on analyzing trends. Traders use several trading techniques to identify (spot) and follow the price action trends. A commonly applied approach is the head and shoulders trade reversal. 

This strategy is popularly used as a trading tool by new traders, as it effectively leverages the experience of their peers by chasing visible price action trends. The trader will likely benefit from a ‘buy’ position when the trend shows an upward movement and a ‘sell’ position when the trend starts to show a downward move.

● Pin Bar

It is commonly known as the candlestick strategy because of its distinctive shape. The pin bar pattern appears like a candle with a long wick. The candle represents a sharp reversal and rejection of a particular price, while the wick or the tail represents the range of rejected prices. 

The price is assumed to continue moving opposite the wick, and the traders utilize this information to decide whether to take a long or short position in the market. A longer lower tail/wick of the candle signifies a trend that rejected lower prices, implying an expected price rise.

● Inside Bar

This is a two-bar strategy, where the inner bar is smaller than the outer bar and falls within the low and high range of the mother bar (or outer bar). The smaller bar is often formed during the moment of consolidation in the market but can also represent a turning point in the market, acting as a red herring.

● Trend following retracement entry

This is a relatively simple price action strategy where the trader has to follow the existing trend. In case of a downturn in the price, the trader may look to take a short position. However, if the prices rise incrementally, the highs and lows trend increasingly higher. Here, the trader can consider a buy position.

● Trend following breakout entry 

All major market movements are tracked under this trend under one assumption - a retracement is likely to follow post a price spike. If a scenario presents where the market moves outside a defined support or resistance line, it is a breakout. This phenomenon is utilised as a signal by traders to take a long position, in case the stock price is in an upward trend, breaks above the resistance line, or a short position moves below the support line.

● Head and Shoulders reversal trade

The pattern in the head and shoulders trend represents a market movement similar to the silhouette of a head and shoulders. It is one of the most popular price action trading strategies. It is easier for the trader to choose an entry point (typically after the first shoulder) and to set a stop loss (post the second shoulder) to benefit from a temporary peak, represented by the head.

● The sequence of highs and lows 

Traders follow a sequence of 'highs and lows strategy' to map out emerging market trends. For instance, if the stock price is trading at higher highs and higher lows, it is indicative of an upward trend, and in the case of lower highs and lows, it is representative of a downward trend. 

By understanding the sequence of highs and lows, traders can choose an entry point at the lower end of an upward trend by setting a stop before the previous high or low.
 

Benefits of Price Action in Trading

Less research time, favourable entries and exits compared to indicator trading are a few of the multiple benefits of price action trading. It is testable on simulators and allows traders to choose from multiple strategy options.

Conclusion

All traders with varying experience levels can benefit from implementing a price action trading strategy. Interpreting chart movements is similar to becoming a trading system. Other analysis tools such as indicators, statistics, or seasonality are also helpful.

How to Use Price Action

Price action isn't just a trading tool like an indicator, it's the raw data that all trading tools are based on. Swing and trend traders often rely heavily on price action, ignoring fundamental analysis and instead focusing on key levels of support and resistance to predict market moves like breakouts and consolidations.

However, even these traders must consider other factors beyond the current price, such as trading volume and the timeframes used to determine support and resistance levels, as these can affect the accuracy of their predictions.

Many financial institutions now use algorithms to analyze past price action, helping them make informed trades in specific situations. This combination of price action analysis and advanced technology is becoming increasingly important in modern trading strategies.
 

Limitations of Price Action

Interpreting price action in trading is subjective, meaning different traders can have varying opinions even when analyzing the same data. One trader might see a downward trend, while another might expect a potential reversal. The time frame used also affects interpretations, a stock could show short term downtrends during the day but still be on an upward trend over a month.

It’s important to remember that predictions based on price action are speculative, no matter the time frame. Using multiple tools to confirm your predictions can improve accuracy but it doesn’t eliminate risk. Even if a trade seems likely to succeed based on past price movements, there’s no guarantee it will. Price action analysis doesn’t always consider broader economic factors or other non financial influences on a security. Ultimately, trading based on price action involves risk, as traders must balance the potential rewards with the inherent uncertainties.