Price action is the price movement that a security makes over time. Price action traders use both technical analysis or indicators, and price movements to chart their trading strategies but many are known to rely exclusively on price action. Technical analysts consider price action as key information for telling future security price trends, breakouts, informing potential exit and entry points and other vital factors for trading.
In fact, many short-term traders rely mainly on price action for their trading decisions. As they capitalise on quick and small price movements, they do away with lagging indicators like the Moving Average. A Moving Average is considered as a lagging indicator because it is an asset’s average price and does not get updated in real time with the asset’s latest price — feedback is delayed. Any lapse in time in obtaining price action data would work against short-term traders like scalp and day traders who trade numerous positions a day. For example, if an asset’s value were to drop and increase again in a matter of seconds to minutes, a trader would only be able to calculate the asset’s Moving Average after determining the new price of the asset. This would work against a scalping trading strategy that requires trading at speed.
It takes a good grasp on price action to make profitable trades. With a good deal of trading strategies out there, it’s worth knowing how price action traders use price charts to their winning advantage. It begins with understanding its basics.
Making Sense of Price Action on a Chart
A lot happens on a price chart. When it comes to price action, there are two takeaways for understanding price action: price and volume directions. Price action is usually illustrated with either a bar chart or line chart showing the relationship between past and current prices. As price action continues, a pattern develops elucidating movements in price and volume which establishes the trend direction.
By simply looking at whether to buy or sell a security, traders would take security price increasing as a good sign to buy. Afterall, price moving upwards means an uptrend. However, this isn’t always the case as price action has revealed. Price action indicates that as security prices increase along with a spike in its volume, then it’s a strong indication to go long as market sentiments are positive. On the flip side, if a security price increased albeit at a low volume, then the trader should think twice on buying as not many traders are buying at the said price increase.
Another way to read price action is with candlestick charts, the more popular ones being the Engulfing Pattern, Harami Cross and Three White Soldiers for the visualisation they provide. Candlestick patterns consist of rectangular shapes depicting price conditions of a security: the Open, Close, High and Low (OHCL) values making it easier for a trader to see if it’s a bullish or bearish market. Keeping in mind how price action plays a central role throughout, it’s worth remembering that technical analysts make use of price action to make calculations on technical indicators.
As previously mentioned, price action is significant for the purpose of technical tools such as for drawing trendlines which enables traders to predict reversals, uptrends, downtrends and breakouts among others. Price action is fundamental to trading but does it alone suffice in trading and how important are other indicators, including lagging indicators, in the art of trading?
Price Action: Without or With Technical Indicators
Price action trading strategies focus on price movements to inform how market movements could continue to unfold. A general price action strategy is made up of mainly two things: leading and lagging indicators. Price action falls under the category of leading indicators which help in predicting market trends. On the contrary, lagging indicators: oscillators, pivots, moving averages and etc, give signals in hindsight. More than for predicting, lagging indicators are signals taken as a confirmation to leading indicators. Together, they form traders’ price action strategies.
However, price action trading utilises a pure price action setup to make trading decisions. When a trader opts for this price action strategy, a clean or naked price chart is used for reading price movements. A clean price chart displays mainly price action without lagging indicators on it or hardly any. Some indicators that might be included are some moving averages for pinpointing support and resistance areas.
The choice of trading strategies whether with the combination of price action and lagging indicators or simply just the former depends on a trader’s personal trading style and the type of trading they get into. For lagging indicators, they are found the most useful for heavily trending markets as more data is required to confirm relatively long-term trends. For market trend watchers, although lagging indicators inform a financial instrument’s past data, their value is seen in the quantity of the data. With more data for affirmation, lagging indicators give more confidence in choosing entry and exit points. Again, this type of trading strategy is preferred for long-term trading.
Trading styles are subjective to the trader but as a beginner to trading, automatic trading platforms are worth considering. An electronic trading platform such as the MetaTrader 4 (MT4) is one such platform that provides three types of charts: line, bar and candlestick charts. For beginners who are keen on getting their feet wet, the MT4’s candlestick chart is great for tracking price action with their minimalistic interface making for better useability. The MT4, developed and released by MetaQuotes Software can be used upon registration with MT4 licensed brokers such as ZFX. The MT4 is provided free of charge with ZFX’s live trading account or demo account.
4 Types of Price Action Trading Strategies
For the sake of argument, we’ll take price action trading as the simpler form of trading strategy. With a relatively lower learning curve, it would be well suited to a rookie forex trader due to the high liquidity required for forex trading. Price action trading makes reading price charts straightforward and effective for completing trades at minimal loss, for the most part. Below are four basic price action strategies:
- Price Action for Market Trends – The first basic to have a good grasp of is being able to detect an upward or downward trend on a price chart. With price action, an uptrend is indicated when price moves in the direction of Higher Highs and Higher Lows (HH, HL). The opposite would be the case for a downtrend where there would be Lower Highs and Lower Lows (LH, LL).
- Price Action for Market Type – The next thing to keep in mind is learning how to tell apart a trending market from a consolidating one. With price action, it is easy to tell if a market is trending using Highs and Lows. A consolidating market would be dissimilar in terms of not having a pattern of HH, HL and LH, LL. Instead, the price movement would be bouncing repeatedly off an upper resistance level and a lower support level giving the impression of price moving sideways.
- Trend Post Breakout – Breakout happens when asset price moves outside the delineated resistance level (horizontal line above) and support level (horizontal line below) with rising volume. By tracking price action for breakout direction, it could benefit traders in their trading decisions. A trader usually takes to going long when the asset price breaks the resistance level. A short position would be taken when price drops pass the support level.
- Candlestick Strategy – This makes use of the one-price pin bar usually depicted by a candlestick price bar with a short real body and long tail. This type of price bar indicates a rejection and sharp reversal of price, also known as the pin bar reversal.
A bearish pin bar with a longer tail above shows the likelihood of a price drop in the near future. The longer tail above represents a rejection of higher prices. For a bullish pin bar, it signals towards a potential a rise in price soon. Its longer lower tail simply means a rejection of lower prices.
Price Action Trading for Short-Term Traders
Price action being a requisite to trading in itself, is however more impactful for short to medium term trading. A price action trader is at more liberty to decide on their positions, entry points and exit points based on price alone, giving them more sense of control. In the situation of depending on a set of technical tools which pure price traders find distracting, traders can easily be side tracked. At the end of the day, technical analysis and indicators are derived from price action after all. Technical analysis and indicators may also be overwhelming for time sensitive trading because of the many variables involved.
Due to the high dependency on price fluctuation of short to medium term trading, it would make more sense to take on the path of a pure price action strategist in this scenario. Price action makes for faster and easier reading for fast-paced trading and is self-explanatory in terms of predicting likely trend directions of an asset. There are also numerous apps, automated and electronic trading platforms and charts that are highly complementary to price action strategies.
Price action entry is a price action strategy valued by short-term traders. In this case, support and resistance level and trends are closely watched using price action so that traders can make the best decision on when to enter the market. Still, completely jettisoning technical analysis for a pure price action strategy may not be the wisest. As previously mentioned, lagging indicators do inform past patterns and historical data that supplement price action signals.
Why PA is Popular Among Forex Traders?
A forex price action strategy is quite formulaic in its approach while also using raw price action as a key factor. Merging a technical step-by-step method with purely asset price gives forex traders more clarity and confidence when choosing their open and close positions. The steps taken by some traders are such: Chart out resistance and support levels, wait for the close of the day’s session, and use price actions to signal off long and short positions.
These steps are not exclusively meant for short-term forex trading especially because more data is required when trading forex with price action. A forex traders’ ability to see trend patterns create opportunities for profit because they are able to see buy and sell orders better. Price action makes it possible to spot out swing highs and swing lows which helps in seeing reversal and trend patterns. Knowing this makes for a more educated trader who would be able to clearly differentiate a reversal from an uptrend or downtrend and in turn correctly open and close positions accordingly.
However, it’s quite interesting that with forex price action trading, the strategy works for a more varied timeframe, from days to months, and not limited to short-term forex trading alone. A marked differentiator here is garnering enough information from a daily chart every end of session to see a pattern. How a daily chart settles daily over time can indicate bearish or bullish signals making a forex trader’s decision a more informed one.
Price Action as a Trading Strategy
Price action may not be a 100% accurate in predicting future price movements but has been proven to inform traders on the likely trend outcome of an asset. In many instances with a high success rate. With no definitive statement on pure price action trading being superior to technical analysis and indicators, rookie traders would be better off making use of both initially. The only conclusive fact being that all trading analysis tools are derived from price action, being a pure price action trader could well be in any trader’s future if and when price action trading proves to that trader to be the superior trading strategy.
FAQs
- What does price action mean in trading?
Price action is the price movement that a security makes over time. Price action traders use both technical analysis or indicators, and price movements to chart their trading strategies but many are known to rely exclusively on price action. Technical analysts consider price action as key information for telling future security price trends, breakouts, informing potential exit and entry points and other vital factors for trading. - How do you trade with price action?
Detecting Trend Post Breakout – Breakout happens when asset price moves outside the delineated resistance level (horizontal line above) and support level (horizontal line below) with rising volume. By tracking price action for breakout direction, it could benefit traders in their trading decisions. A trader usually takes to going long when the asset price breaks the resistance level. A short position would be taken when price drops pass the support level. - What is an example of a price action?
Price action as seen in a market trend – With price action, an uptrend is indicated when price moves in the direction of Higher Highs and Higher Lows (HH, HL). The opposite would be the case for a downtrend where there would be Lower Highs and Lower Lows (LH, LL). - Is price action trading profitable?
With no definitive statement on pure price action trading being superior to technical analysis and indicators, rookie traders would be better off making use of both initially. The only conclusive fact being that all trading analysis tools are derived from price action, being a pure price action trader could well be in any trader’s future if and when price action trading proves to that trader to be the superior trading strategy.
