Platform Insight What is Price Action Trading

What is Price Action Trading

Price action refers to the movement of the price over time. It is used to analyse a security, index, commodity, or currency performance to predict where the price may go in the future. It is the base of all trades, and many traders use the price action analysis alone to define their strategy. In fact, technical analyses are a derivation of price action trading since they use trends to define the formulas used to make the decisions.

For many years, traders have been trying to find patterns in the price chart to predict which way the trend will head. Then, based on those predictions, the trader will make his decisions and profit from the trade.

There are many ways in which traders try to find patterns. Candlesticks charts are a good example. The candlestick chart helps them to visualize movements. The traders want to match the price movements with known patterns to predict which way the price will go. The same thing goes with other types of charts.

Why is price action important?

Price action is the data resource of which all the trade tools are built. For example, swing traders and trend traders tend to make their decisions more closely to price action instead of using any other indicator. So, they build their strategy on resistance and support levels to figure out when the breakout and consolidation phase will occur.

In any case, price action trading is a very subjective practise since there is no established time frame to do the analysis because many patterns can be used. It's very hard to know which is more appropriate for each moment. One trader can see a clear downtrend coming next, while another trader may be seeing the opposite case based on different pattern analyses or may be based on a different time frame. The first trader may expect the price to go downwards in the next few hours, while the second trader sees the same movement as a fluctuation between his resistances and support levels before the price goes up in the next few days predictions.

The role of individual experience and psychology

When using a price action approach, psychology plays a fundamental role in the decision-making process. This is because the way price movements are interpreted by the trader is very subjective, and it varies from one trader to the other. For example, when a price gets to a level way higher than expected, two different traders can react in two very different ways. While the first one can get excited thinking that the price will go even higher, the second may want to sell immediately, thinking that a price reversal is coming.

So the difference in criteria is very common among traders who base their strategies on price action alone. On the other hand, traders using technical analysis will be more likely to share similar conclusions.

Price action vs technical analysis

Pure price action is when the trader formulates his trading strategy and decisions solely on price behaviour and understanding the market instead of using complex formulas and analysis.

On the other hand, technical analyses are more complete resources. They include trend lines, price bands, high and slow swings, technical levels, giving the trader a wider picture view.

While price action attempts to predict movements in the short-term based on known patterns, the technical analysis goes a step further and tries to find long-term reliable patterns where interpretations are not as important as they are with price action trading.

The popularity of price action trading

Price action trading is used by retail traders, speculators, and trading firms, and it can be used not only on forex but also on equities, bonds, commodities, etc.

The popularity of price action among traders is based on a few reasons:

  • Even if you are an inexperienced trader, nothing stops you from trying to find patterns in the chart so you can make your call.
  • It's ideal for quickly opening and closing positions.
  • The forex market is always moving, but changes are rarely extreme. This allows new traders to experiment with small amounts and low risks before putting more money on the line.

Trading strategies with price action

There are many ways to draw a trading strategy based on price action, but the 4 more popular are

Price action trend trading

This strategy consists of the study of trends. The goal is to use some techniques to follow price action trends and act accordingly. This technique is ideal for new traders due to it is simplicity. It consists of chasing the price and opening a long position when the trend goes up and a short position when it goes down.

Pin bar

When using this strategy, traders look for a pin bar pattern that looks like a candle with a wick. The larger the wick, the better because what the wick represents is the range of price that the market rejected, meaning that few are willing to pay the prices within the range represented by the wick. So, to trade, sellers will have to accept lower prices (If it's a rejection to an uptrend), or buyers will have to pay more (in case it's a rejection to a downtrend).

Inside bar

It consists of a bar pattern formed by two bars, one smaller than the other. The big one will be the first one, and it will be to the left, while the smaller one will be the one right next to the first one. These patterns tell us that the price will consolidate like if it was approaching a “point of equilibrium”. Although, it can also be signalling a turning point. So, traders must use their macro knowledge to decide whether it is a consolidation or a turning point.

Trend following retracement entry

Here, the trader is just trying to follow an existing trend that he thinks will continue. You don't want to predict the trend before it starts but follow it once the trend began if you think that it will continue.

For the case of an uptrend, if the price is clearly going up, the trader may enter a long position to make a profit. It doesn't matter how low was the price before or where that trend began. The only thing that matters was the difference between the prices when he entered the position and the exit price.

In Summary

Price action is a trading practice based on recent price history where decisions among traders will vary depending on their personal experience and interpretation of the different scenarios. Price action trading is the best suited for short-term limited profit trades instead of long-term investment. A successful strategy can be designed to combine technical analyses tools with recent price history and traders' own experience.

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