The term price action is a way to analyze the basic movements of the price to get signals for when to enter and leave trades. It stands out because it is reliable and doesn’t need indicators.
What is price action?
Price action describes the characteristics of an asset’s price movements. This movement has been quite often analyzed concerning price changes in the past.
In simple terms, price action is a trading method that lets a trader read the market and make subjective trading decisions based on recent and actual price movements, rather than relying solely on technical indicators. The price action trading strategy is reliant on technical analysis tools because it ignores fundamental analysis factors and focuses on recent and past price movements.
Many day traders focus on price action trading strategies to quickly generate profits over a short time frame. For example, they might look for a simple breakout from the session’s high, enter a long position, and use strict money management strategies to make a profit. Tools and software platforms can be used to trade price action.
Tools Used For Price Action Trading
Since price action trading relates to recent historical data and past price movements, all technical analysis tools like charts patterns, trend lines, price bands, high and low swings, technical levels (of support, resistance, and consolidation), etc. are taken into account as per the trader’s choice and strategy fit.
The tools and patterns that a trader looks for can be as simple as price bars, price bands, break-outs, and trend lines, or they can be more complicated, like candlesticks, volatility, channels, etc. An important part of price action trades is how the trader interprets and acts on psychological and behavioral information.
Example: If the price of an asset hovering at 580 crosses the personally-set psychological level of 600, then the trader may assume a further upward move to take a long position. Other traders may hold the opposite viewpoint: once 600 is reached, they expect a price reversal and thus enter a short position.
No two traders will interpret certain price actions in the same way, as each will have their interpretation, defined rules, and behavioral understanding of them. On the other hand, a technical analysis scenario (like the 15-day moving average crossing over the 50-day moving average) will yield similar behavior and action (a long position) from multiple traders.
Price action trading is a systematic way to trade that uses technical analysis tools and recent price history. Traders are free to make their own decisions in a given situation to take trading positions based on how they feel, how they act, and how they think.
Who Uses Price Action Trading?
Price action trading is used by retail traders, speculators, arbitrageurs, and even trading firms that hire traders because it is a way to guess prices and make bets. It can be used on a wide range of securities including equities, bonds, forex, commodities, crypto derivatives, etc.
Price Action Trading Steps
Most experienced traders who follow price action trading keep multiple options for recognizing trading patterns, entry and exit levels, stop-losses, and related observations. Having just one strategy for one (or multiple) stocks may not offer sufficient trading opportunities. Most scenarios involve a two-step process:
- Identifying a scenario: Like an asset price getting into a bull/bear phase, channel range, breakout, etc.
- Within the scenario, identifying trading opportunities: Like once a stock is in the bull run, is it likely to (a) overshoot or (b) retreat? This is a completely subjective choice and can vary from one trader to the other, even given the same scenario.
Here are a few examples:
- An asset reaches its high as per the trader’s view and then retreats to a slightly lower level (scenario met). The trader can then decide whether they think it will form a double top to go higher or drop further following a mean reversion.
- The trader sets a floor and ceiling for a particular stock price based on the assumption of low volatility and no breakouts. If the stock price lies in this range (scenario met), the trader can take positions assuming the set floor/ceiling acting as support/resistance levels, or take an alternate view that the stock will break out in either direction.
- A defined breakout scenario being met and then trading opportunity existing in terms of breakout continuation (going further in the same direction) or breakout pull-back (returning to the past level)
- As can be seen, price action trading is closely assisted by technical analysis tools, but the final trading call is dependent on the individual trader, offering flexibility instead of enforcing a strict set of rules to be followed.
The Popularity of Price Action Trading
Price action trading is better suited for short-to-medium-term, limited-profit trades than long-term investments.
Most traders believe that the market follows a random pattern, and there is no clear, systematic way to define a strategy that will always work. By combining the technical analysis tools with the recent price history to identify trade opportunities based on the trader’s interpretation, price action trading has a lot of support in the trading community.
What does Price Movement tell You?
Technical analysts examine price action on charts for patterns or indicators that can help predict how securities will behave in the future, as well as to time trade entry and exit points. Technical tools like moving averages and oscillators are based on the way prices move and try to predict what will happen next.
Disadvantages 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.
Conclusion
Price action is often subjective, and traders may interpret the same chart or price history somewhat differently, leading to different decisions. Another problem is that the way prices moved in the past is not always a good indicator of what will happen in the future. So, technical traders should use a variety of tools to confirm their indicators and be ready to quickly get out of trades if their predictions turn out to be wrong.
