Price action trading is one of the simplest and oldest trading strategies in existence.
Price action is the original and most basic form of technical analysis and forms the raw data from which all other technical analysis is derived. Price action trading is a quick-fire method of financial trading that relies solely on price action, plus the trader’s own knowledge and instinct, to make trading decisions for short- or medium-term gain.
Understanding price action
Price action is the changing price of a security in the financial market over time, as plotted on a chart or graph. Price action traders look at this chart in different ways to see the security’s price history and to identify patterns that may be repeated or may indicate future trends. Traders take a long or short position depending on which direction they expect the price to move in, based on their interpretation of past price action performance.
Price action trading is not an exact science, but it is one of the most reliable forms of trading. Although uncomplicated by the use of other technical indicators, it uses multiple disciplines, including psychology, finance and math, to predict future performance. Nevertheless, it is relatively subjective, and it’s possible that one experienced trader may interpret a chart in quite a different way to another. Only time will tell which one of them is right.
Getting started
Price trading is widely and effectively used by professional traders the world over. It’s especially popular in forex trading, where the highly liquid nature of the market makes it suitable for interpretation in this way. Beginners should adopt one of several tried and tested price action trading strategies in order to have the best chance of success.
Looking for breakouts, where the price rises above a previously established line of resistance, is one of the best strategies for beginners. The resistance level is an imaginary line that indicates the highest point the price will rise to in its current pattern, while the support level is the lowest point. If the price breaks through either of these lines, it could indicate a new trend, either upwards (beyond the resistance level) or downwards (below the support level), ultimately leading to a new pattern being formed.
Different strategies
While price action trading is essentially a simple matter of identifying trends, buying low and selling high, there are different strategies that can be adopted, often based on the type of pattern. A popular option is the Head and Shoulders Reversal Trade, which is based on a pattern that resembles a human head and shoulders when mapped out on a chart.
The first shoulder is formed from a modest rise in price followed by a modest fall. Then a more significant price rise takes us to the peak of the head before a more-or-less equal drop in price takes us back to the base level. Another modest rise and modest fall create the second shoulder. If you think this pattern is beginning to emerge, you should enter a trade by buying securities after the first fall — the first shoulder — and exit at the top of the head, or as close as you can get.
Identifying trends
Identifying the direction of the trend is crucial in price action trading. While some investment strategies may involve going against the trend, in price action trading, you should always go along with the trend, if you can find out what it is. The time period covered by your chart will make a big difference, as will the length of time between your entry and exit positions.
A trend may be smooth, steadily moving in one direction, or uneven, including many smaller movements that seem to go against the trend. An uneven trend is a volatile one, and should be avoided by beginners, although experienced traders can still make a profit. Overall, if the highs and lows both get higher over time, then it is still an upward trend. If both highs and lows gradually get lower, it is a downward trend.
By focussing on support and resistance levels, price action can be used to predict breakouts and consolidation. Different looks can lead to different conclusions, but the objective is always to enter a trade when the price is at its lowest and sell when it is at a high. Price action trading isn’t based on fundamental factors concerning an underlying asset’s worth, so it is still considered a form of technical analysis. As it is only based on the actual price of a security, it is still rooted in real movements, so it remains one of the most reliable financial trading methods.