What is Price Action Trading?
Price action trading means basing your trading decisions on the price movements of an asset. You won’t work with indicators or other methods of analysis, or you’ll give them very little weight in the trading decision process.
Price action traders believe that trades need to be made on the most important and up-to-date information, which they hold to be the current price as well as price history of a particular security.
Price action is simply how prices change – the action of a price. In other words, price action is a technique by which a trader reads the market and then makes a decision based on the actual price movement on the chart, as opposed to by relying on lagging or leading technical indicators.
Price action trading is one of the simplest forms of trading to learn since it only involves open, high, low and open prices in making decisions.
Price Action Traders
Price action traders are likely to confine their data sources. They rely on technical analysis and not on conventional indicators. They instead use a combination of price movement, chart patterns, volume, and other raw data from the market to decide whether or not they will make a trade.
The price action trader will use setups to figure out entries and exits for positions. Each setup has its optimum entry point. Some traders also use price action signals to exit a trade, simply entering at one setup and then exiting the whole position on the appearance of a negative setup.
One key observation of price action traders is that the market often revisits price levels where it reversed or consolidated. If the market reverses at a certain level, then on returning to that level, the trader expects the market to either continue past the reversal point or to reverse again. The trader takes no action until the market has done one or the other.
Likewise as an example, after a break-out of a trading range or a trend line, the market may return to the level of the break-out and then instead of rejoining the trading range or the trend, will reverse and continue the break-out. This is also known as ‘confirmation’.
How To Read Price Action
Price action is a constant movement of data. To analyze price action, you must first condense the data into discrete parts.
You can do this easily with OHLC price charts. OHLC means Open-High-Low-Close.
This means that the price chart must show the open, high, low, and close price of each trading period. (E.g., 5-minute, 1 hour, 1 day)
Both traditional bar charts and candlestick charts fit the bill here. To read price action:
- Read price bars/candlesticks bar-by-bar.
- Observe price swings to determine the market context (trending or ranging).
- Understand the different types of price action setups suitable for each market context.
Types of Price Action Trading Strategies
Many price action techniques are present. The tools and patterns that the traders can use vary from simple price bars, price bands, break-outs, trend-lines, or complex combinations involving candlesticks, volatility and channels. There are dozens of price patterns that are represented by bar and candlestick patterns., such as
|Price Action Bar Patterns||Price Action Candlestick Patterns|
|Pin Bar||Hammer / Hanging Man|
|Two-Bar Reversal||Inverted Hammer / Shooting Star|
The pairings above will get you started on studying the similarities and differences between bar patterns and candlestick patterns.
Given the right market situation, these patterns provide potential trading opportunities and are referred to as trading setups.
Benefits and Drawbacks of Price Action Trading
Price action trading is a better choice suited for short-to-medium term-limited profit trades, instead of long-term investments.
Once you understand a price action strategy it won’t require much research time. Find an asset with the specific price conditions you need, or wait for those conditions to develop. As another benefit, you often get more ideal entries and exits compared to many indicator-based methods.
It can be challenging to automate price action strategies based on price patterns, which is a drawback. That means you’ll need to watch for patterns to develop as well as manually trade them yourself. On the other hand, pure OHLC-based techniques can be automated, and Investar recently introduced a separate Price Action category in the Custom Screener, which initially has Pivot-Point based scans. We will soon be coming out with custom screener features that will allow you to create more sophisticated Price Action-based strategies like the Opening Range Breakout etc.
We will have a more detailed blog post in the future explaining many price action strategies.