price action article

Price Action Trading General Overview

Mon Nov 08 2021 18:14
Price action founds the basis of all technical analysis of a commodity, stock or any other asset chart. Short-term traders rely solely on price action and the trends inferred from it to make investment decisions. 

As a practice, technical analysis is a derivative of price action as it utilizes past price calculations that are used to make trading decisions.

Understanding price action is the first and essential step to trading in the global markets. Investing requires skills and one such skill is understanding price action trading secrets. This post covers price action in detail to take your trading to the next level.

What is price action?

Price action is simply the up and down movements of a security's price over time. It describes the characteristics of an asset's price movements. Often, this movement is analysed with respect to price changes in the past.

In simple words, price action is an important trading technique that enables traders to study the market then make trading decisions based on actual and recent price movements rather than depending exclusively on technical indicators.

Since price action ignores fundamental analysis and focuses on past and recent price movements, price action trading strategy relies on technical analysis tools.

Who uses price action?

Being an approach to speculation and price predictions, price action trading is used by speculators, arbitrageurs, retail traders as well as trading firms that employ traders. 

This strategy can be applied in a wide range of securities such as derivatives, forex, commodities, bonds, equities, among others.

You can also employ a price action trading strategy as a trader in the global markets and make huge profits.

Understanding essential tools used in price action trading

Because price action trading relates more to past price movements and historical data, most technical analysis tools such as trend lines, charts, price bands, technical levels as well as high and low swings are taken into account depending on the trader's choice and the best strategy.

The patterns and tools used by a trader may be simple price bands, price bars, trend lines, breakouts or complex combinations that involve channels, volatility and candlesticks.

Behavioural and psychological interpretations, as well as subsequent actions made by a trader, also impact price action trades. 

For example, if security lingering at 580 crosses the personally-set mental level of 600, other things remain constant; the trader may presume an upward move and take a long position. 

Another trader may have an opposite view and assume price reversal once the stock hits 600, taking a short position.

Every trader interprets price action differently and no two traders will have the same interpretations. Each trader will have their defined rules, interpretation and behavioural understanding. And that is what will guide them. A technical analysis scenario yields similar action and behaviour from multiple traders.

In other words, price action is a systematic trading practice, supported by technical analysis tools and price history and traders are free to make their own decisions in a given scenario to take trading positions according to their behavioural, subjective and psychological state.

Using price action

To succeed in price action trading, you need top-notch price action trading strategies. And if you are a beginner, learn all price action entry rules, such as ensuring the pin bar is closed before you set orders to enter for pin bar traders.

Price action is not seen as a trading tool such as an indicator but as a data source where all tools are built. Trend traders and swing traders work closely with price action avoiding any fundamental analysis and focusing solely on resistance levels and support to predict consolidation and breakouts.

Even such traders need to pay attention to factors other than the current price since the volume of trading, as well as periods used to establish levels, have an impact on the accuracy of their interpretations.

Successful traders like Munehisa Homma, the best price action trader in the world, started by recording price movements in the market until he realized there were repetitive trends. 

All these translated to the idea of price action giving him the title, 'father' of technical analysis and price action.

Price action trading steps

Experienced traders watch out for a price action indicator, which is a flicker of activity on a certain trading chart that signals the emergence of a movement or trend. 

Apart from that, they keep multiple options for identifying trading patterns, stop-losses, entry and exit levels and other related observations.

Having a single strategy on multiple or just one stock may not provide enough trading opportunities. Most trading scenarios involve two steps:
  • Identifying a scenario: an example is noting a stock getting into a bear or bull phase, breakout or channel range.
  • In the identified scenario, identify trading opportunities: for example, when a stock is in a bull run, what is the likelihood of retreating or overshooting. This scenario is completely subjective and the choice will vary from one trader to another even in an identical scenario.

Here are three examples:

  • A stock hits its highest according to the trader's view and retreats to a slightly lower level, but the scenario is met. The trader is left to decide whether the stock will drop further, leading to a mean reversion or form double top to go higher.
  • A clear breakout scenario being met then a trading opportunity existing as a breakout continuation, that is, moving further in the same direction or a breakout pull-back, that is returning to the initial level.
  • Trading sets the floor and ceiling of a specific stock price on the assumption of no breakouts and low volatility. If that stock price will lie on the set range, the scenario is met.  The trader may take positions with the set floor and ceiling in mind and act as resistance levels or have an alternative view that the stock may breakout in either direction.
You can see technical analysis tools closely support that price action trading. However, the final trading call or action is entirely on the individual trader; therefore, it offers flexibility but not a strict set of rules that must be followed.

Drawbacks of price action

Even in advanced price action trading, there are challenges that come with investing. This is because interpreting price action is completely subjective. It's not uncommon for two traders to come to different conclusions even when analysing the same price action. 

While one trader may believe there is a bearish downtrend, another may believe the price action shows a near-term turnaround. We can't overlook the time as it has a huge impact on what traders see since a stock may have numerous intraday downtrends while sustaining a month over another uptrend.

It is worth noting that trading forecasts made using trading price action trends on any time range are speculative. The more tools a trader can apply in their trading forecast, the better. 

After all, the past price action of any stock does not guarantee future price action. Even that high probability trade is still a speculative trade which means a trader is taking risks to get close to any potential rewards.

The bottom line

Price action remains an important trading technique in the global market. Though predictions made from it are entirely speculative, traders have used it and come out with huge profits. It is rumoured that the inventor of price action and technical analysis made almost $10 billion in today's currency.

Take action and sign up with Xosignals to start price action trading with our free trading signals!

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