Price action trading focuses on the movement of price of a stock, currency pair or commodity to take buy or sell decisions. It is based on the belief that past price actions or patterns are reflected in future as the human emotions derive the price movements and these emotions remain constant. Traders who use price action trading strategies do not rely on any technical indicators. In fact, all technical indicators are based on price so, instead of using the second-hand information which is depicted in indicator, they rely on first-hand information that is reflected in terms of price.
What is Price Action Trading
The main focus of price action traders is to identify the market structure, whether the market is in the uptrend, downtrend or in consolidation, identifying the key support and resistance levels and different chart patterns to enter or exit the trade. Support and resistance are the key levels on a price chart which indicate that there are higher chances of price reversal at these levels. Support level provide the necessary buy support that stop the price to fell down further and the resistance level provides the selling pressure that stops the market to go up beyond these levels.
If price break down from support level or break up from resistance level, we call it breakup that may be the indication of a trend start. In trends, price action traders analyze the strength and direction of the trend and the key levels to enter and exit those trends. Trend reversal or consolidation can be identified with the help of different chart patterns.
In price action trading strategy, market is always right. The price of a financial instrument that is being show is already reflected the fundamental, economical and all other associate factors. The market can also correct itself whenever required. The price is the collective behavior of all the stakeholders that can affect the price. That why, the price action trades depend only on price actions and chart patterns to find the trading opportunities and make their decisions based on those price actions.
Benefits of Price Action Trading
The key benefit of price action strategy is that, it can be equally applied on all the financial instruments like stocks, currency pairs, commodities, crypto etc. because the price action remain same irrespective of the market. It can also be used in any time frame i.e. daily, four-hourly, hourly, 10 minutes etc. and for any kind of trade i.e. position trader, swing trader or day trader.
Along with benefits, it also has some challenges. The biggest challenge does not come from the market but from the trader himself. Emotions are biggest enemies in this kind of trading. You need a strict discipline and trading mindset to be successful in price action trading. The trading should be based on logic not based on greed or fear. Trader is supposed to have well-defined trading plan and take the trading decisions based on logic i.e. on support or resistance level, or at other key price levels. Decisions based on emotions or revenge will ultimately lead to wipe out your trading account.
Price action trading requires more objective approach for taking the trading decisions. In price action, decisions are on the basis of price moves rather than looking at technical indicators which provide contradictory signals most of the time. At one time, one technical indicator shows buy signal and at the same time the other indicator shows a sell signal. So, as compared to technical indicators, price action trading is a more consistent and clean approach to follow.
How to Read Price Actions
Technical charts are the main source of information for price action trader. They typically use line charts, bar charts, candlestick chart or heikin ashi charts to have the clear understanding of the price movements. With the help of these charts, they identify the key price areas and support and resistance levels. They also study chart patterns with the help of these charts. Below are the few steps that will be helpful for reading the price action charts.
1. Market Structure
The first step in reading the price action chart is to recognize the market structure. The market can be defined into three major structures, uptrend, downtrend and consolidation. If the price is moving higher, this is called uptrend. The uptrend can be defined on the basis of higher highs and higher lows (which are the price swing levels) or the price is above the 200-period moving average. If the price and making lower high and lower low or it is below the 200-period moving average then it is called downtrend. If the price is moving horizontally between two points, then this is called consolidation. The upper level of consolidation is called resistance point and the lower level is called support point.
2. Support and Resistance Levels
Support and resistance level may be identified in the consolidated market and in trending market as well. In consolidation, look at those level where the price is finding difficulty in going up, this is called resistance. And find the level where the price is finding difficult in moving downward, this is called support zone. In a trending market, as the market make a new high by breaking the previous high which was resistance now become support after breaking that level and vice versa for down trend.
3. Chart Patterns
The third point in reading the price action movements is identifying the chart patterns where the price the expected to behave in a certain way. There are number of chart patterns that can be identified. For example, Head & should pattern, double top, double bottom, triple top, triple bottom, inverted head & shoulder. These charts patterns can be identified to judge the possible reversal of the price movements in case of trend and consolidation.
4. The Candlestick Analyses
Candle stick charts are the most famous kind of charts that price action traders use because it gives a lot of information about price behavior. A single candle stick gives the information of open, close, low and high price of the period. There are different kinds of candles for example, hammer, bullish candle, bearish candle, hanging man, engulfing candle, long wick candles, shooting star. These can be used to determine the certain kind of price behaviors and to predict the next price movement.
5. Volume Analyses
The trading volume at any level can give a lot of information for future price prediction. For example, if the price is break at a certain resistance level and the volume is more than the double of the regular volume. Than there are higher chances that the price will continue to move upward because the volume is showing the buying pressure at that level. Similarly, if the volume is low at a certain level, it shows the lack of buying and selling pressure at that level and the price will tend to move horizontally.