Price Action: what it is and why it matters in trading
The financial markets can be a daunting and complex world, filled with technical jargon and complicated trading strategies. However, there is a simple and powerful approach to trading that has stood the test of time: price action.
At its core, price action is a way of analyzing the movement of prices on a chart to gain insights into the underlying market dynamics. It is a timeless and essential tool for any trader seeking to understand the ebb and flow of market sentiment and make informed trading decisions.
In this article, we will dive deep into it, exploring its fundamental principles, key patterns, and real-world trading strategies. Whether you are a seasoned trader or a novice just starting out, this guide will provide you with a comprehensive understanding of what it is, and its potential to transform your trading approach.
What is price action?
This is a term commonly used in the world of trading to refer to the movement of an asset's price over time. It encompasses everything from the high and low price points to the trends and patterns that emerge over time.
Many traders adopt it as their preferred trading method since it relies on basic technical analysis tools, and traders make trading decisions solely based on price charts. This approach is known for its focus on price movements and patterns, which can offer clear trading signals without the need for complex indicators or algorithms.
It operates on the principle that market participants, both buyers and sellers, influence all price movements. Therefore, practitioners of this technique analyze the behavior of buyers and sellers to determine which side is dominating the market and hence, predict the next direction of price movement. If buyers hold control of the market, demand outweighs supply, resulting in price increase, indicating a good time for traders to consider placing a BUY order. On the other hand, if sellers hold the upper hand, supply surpasses demand, causing prices to decline, thereby prompting traders to explore a SELL order.
Price Action traders base their analysis on candles or specific price levels such as resistance and support, as well as candlestick patterns and price patterns (see below). They use these tools to scrutinize price behavior and anticipate the market's next direction. Technical indicators or any other analytical tools hold no interest for them.
Benefits of utilizing the price action approach for trading
- It simplifies the analysis and trading process, making it the biggest advantage. Traders can rely solely on observing candle or candlestick patterns on the chart to analyze and make trading decisions without the need for complicated and confusing indicators. By doing so, traders can focus on analyzing, observing, and finding better trading signals.
- Easy Access
- It also simplifies the analysis process by only relying on the visual information provided by the candlesticks. Unlike traditional methods that require complex indicators, traders can easily recognize and trade the signals provided by price action. This makes it easier for novice traders to learn and implement, thus increasing accessibility to the market. Additionally, the simplicity of the method reduces the likelihood of errors in analysis, allowing for more accurate trading decisions.
- No lag
- It provides the advantage of having no lag, unlike traditional technical indicators. Traders can quickly observe market moves and react promptly, creating an opportunity to catch a wave. This advantage is superior to all other technical indicators since they always have a certain lag compared to the market.
- Encourages traders to think more
- The method encourages traders to observe and analyze the behavior of price movements, identify trends, and make predictions based on the observed patterns to make trading decisions, instead of depending on traditional technical indicators. It engages traders’ analytical and critical thinking skills to make informed trading decisions.
This approach promotes independent thinking and helps traders develop their own trading strategies based on their analysis, rather than relying on pre-programmed indicators. In essence, it provides a more hands-on and engaging trading experience that encourages traders to think critically and creatively.
Disadvantages of the price action method:
It is prone to subjectivity and can lead to different interpretations among traders. While it has many advantages, it is not a perfect method and may not work well in all market conditions. Additionally, due to its reliance on traders' ability to interpret candlestick patterns accurately, it cannot be fully automated, requiring traders to invest more time in analysis and decision-making.
Key Tools for Price Action Traders
To prepare for this trading, it is advisable to eliminate any unnecessary indicators on the chart and begin searching for trading signals. The three primary tools that traders need to pay attention to are resistance/support, candlestick patterns, and price patterns.
These tools assist traders in analyzing price behavior and identifying the market's dominant side. However, traders must determine these tools themselves by observing the candles on the chart since they are not readily available. Regardless of the tool used, traders must understand candlestick meanings and interpret the crucial information presented by each candle.
Every individual candle presents four key pieces of information to traders, which include the opening price, closing price, highest price, and lowest price of the trading session that led to the formation of the candlestick. The various parts of the candlestick signify the buying and selling behavior during the trading session, giving rise to the price action.
The color of the candlestick body signifies whether the price increased or decreased at the end of the session compared to the opening. The length of the candlestick body reveals the extent of control exerted by the buyers or sellers during the trading session. Longer upper shadows indicate stronger selling pressure, while longer lower shadows indicate stronger buying pressure. The overall length of the candlestick reflects the intensity of price movement during the session, whether strong or weak.
Support and Resistance
Another key tool among traders is support and resistance. Price zones of support and resistance play a crucial role in identifying potential trend reversals or slowdowns before the trend resumes. These areas serve as ideal entry points for buy and sell orders, and hence, traders often rely on them for trading purposes.
When the price moves upwards and meets the resistance area, it tends to level off or turn downwards, especially when there is a strong selling pressure. In such a situation, traders can contemplate entering a SELL order. Conversely, when the price drops and touches the support zone, it is likely to level off or reverse upward, particularly when the buying pressure is robust. At this juncture, traders can think of entering a BUY order.
Candlestick patterns offer vital insights into price behavior and market sentiment, which can help traders make accurate predictions about future price movements.
Apart from analyzing the market sentiment, candlestick patterns also provide traders with essential information about price trends. Therefore, traders need to pay close attention to various candlestick patterns, such as basic patterns like Inside bar, Pin bar, and Fakey, bullish reversal patterns such as Dragonfly Doji candle, Hammer candle, Inverted Hammer candle, morning star candle, engulfing bullish candle, and downward reversal patterns like Doji tombstone, Hanging man candle, bearish engulfing candle, evening star candle, Shooting star, and three black crows candle. Additionally, there are continuity candlestick patterns like 3-step bullish pattern (Rising Three Methods) and 3-step bearish pattern (Falling Three Methods) that traders need to consider.
A price pattern is formed by a group of candles over a certain period of time that creates a unique shape and carries a specific meaning. These patterns help traders analyze the behavior of buyers and sellers during the formation of the pattern and predict the future direction of price movements.
There are various popular price patterns that traders should keep an eye on, including the 2-peak and 3-peak patterns, 2-bottom and 3-bottom patterns, head and shoulders pattern, cup and handle pattern, wedge pattern, pennant pattern, triangle pattern, rectangular pattern, and more. However, correctly identifying these patterns requires traders to have a good understanding of each pattern and observe price charts on different time frames.
The Relationship between Price Action vs Trading (Forex)
Price action is a critical component of trading, especially in the Forex market, where changes in currency values can happen quickly and unpredictably. Traders use it to help them identify trends, make predictions about future price movements, and determine when to buy and sell assets.
For example, suppose a trader is analyzing the price action of the EURUSD currency pair. In that case, they might look at a candlestick chart that shows the opening price, closing price, high price, and low price for each time interval (such as one minute, one hour, or one day).
The trader would then use this information to identify trends and patterns in the price action, such as support and resistance levels, bullish and bearish trends, and other indicators that might suggest future price movements. Based on this analysis, the trader would then make decisions about when to buy and sell the currency pair.
One of the most interesting aspects of price action trading is that it encourages traders to develop their intuition and analytical skills. By analyzing price movements and identifying patterns and trends, traders can become better at predicting future price movements and making profitable trades.
However, its analysis can be challenging, and it takes time and effort to become proficient at it. Traders must be disciplined and consistent in their approach, always striving to improve their skills and stay up to date with market trends and developments.
If you are interested in exploring the world of price action trading, the key is to start small and be patient. With time and practice, you can develop the skills and knowledge necessary to navigate the world’s financial markets. So why not take the first step today and start learning about it?
Not investment advice. Past performance does not guarantee or predict future performance.