Price action trading is a technique that permits a trader to read the market and make relevant trading decisions based on the recent price movement.
In other words, it is a trading decision on the price movement of an asset. It is a mode of technical analysis since it avoids the fundamental factors of security and looks primarily at the security’s price history.
At its most simplistic, it describes the human thought processes invoked by experience, non-disciplinary traders as they observe and trade their markets.
Understanding Price action trading
Price action trading is the art of basing all trading choices on the movement of prices on the price chart.
Traders do not need any indicators to help them identify their go ahead in the form of resistance and support area and trends to trade this way.
The reason for this is because your support and resistance areas will already be visible on the chart.
This discipline of making decisions focuses on the fact that over a certain period, the financial market generates data which focuses on the changes in the price of the market.
This comprehensive data can present itself on the price charts. In the end, the price chart is used to display the beliefs and actions of trading participants, which can finally show on a market price chart in the form of price action.
Each price chart has something different to tell about the struggles that the sellers and buyers have gone through in the past, and current traders make a decision based on these results to determine the price.
Tools used for price action trading
Since price action trading relates to current historical data and past price movement, all technical analysis tools like trendlines, charts, price bands work together into account as per the trader’s choice and strategy fit.
The tools and patterns observed by the trader can be simple price bars, price bands, break-out, tend lines or complex combinations involving candlestick volatility, channels, etc
Psychological and behavioural interpretations and subsequent action as cleared by the trader, also make up on an essential aspect of price action trades.
Price action trading is an orderly trading practice aided by technical analysis tools and recent rice history where traders are free to make their own decisions within a given scenario to take trading positions as per their subjective, behavioural and psychological state.
Who uses price action trading
Since price action trading is an approach to price prediction and speculation, retail traders, speculators, and arbitrageurs use the action.
It can work on a wide range of securities including equities, bonds, forex commodities, derivatives, etc
Price action trading strategies
Price action patterns, also known as price action triggers, are the most important aspect of price action trading. It is these patterns that provide a trader with story clues as to what price might come next.
Below are some examples of price action strategies:
Inside the bar pattern
• The inside bar pattern is a two-bar pattern, consisting of the inside bar and prior bar. The inside bar and previous bar usually referred to as the mother bar.
In other words, the inside bar focuses within the light to a low range of the mother bar. Therefore, this price action strategy gets commonly used as a break out of the pattern in trending markets.
However, it can also be traded as a reversal signal if it is forming at a critical chart level
The pin bar pattern
• Pin bar comprises of a single candlestick, and it shows rejection of price and a reversal in the market.
The pin bar signal works excellent in a trending market, range-bound market and can also display a counter-trend from a key resistance or support level.
The pin bar indicates that price might move opposite from the direction the tail is pointing, as it is the tail of the pin that shows rejection of price and a reversal.
• The fake pattern consists of a false breakout of an inside bar pattern. In other words, in an inside bar pattern break out briefly but the reverse and close back within the area of the inside bar or mother bar, you have a fake key.
It gets called fakey because it fakes traders out, the market looks like its breaking one way but then comes back in the different direction and sets off a price movement in that direction.
Price Action Trading Benefits.
By definition, there are some definite advantages of using this method to trade. Below are some of the benefits;
It is a simple way to trade.
The advantage of this is that trading becomes very easy as there are no indicators creating clutter. Traders won't need to include so many technical indicators to make selling or a buying decision.
If traders were to consider all the available indicators, then they will be stressed as they shall suffer information overload.
Many people end up trading emotionally because they wasted so much time thinking of other possibilities to get to a point where they make any decision to move along.
With the price action, all your focus on are the candles sticks charts, and you will only centre on what is happening in the market.
Easy to understand signals
Price action signals are also easy to understand. Traders do not need to be a professional trader to interpret the signals to make the right trading decision.
Therefore, with price action, traders can recognise the trends in the market, which make it possible for investors to trade with the market rather than against it.
Drawbacks of price action trading
The low number of trades
The price action trading requires patience. Because it needs the trader to wait for confirmation at the resistance and support level.
The confirmation could be in the form of an engulfing pattern or pin bar. Therefore by waiting for confirmation, traders tend to miss trading opportunities when price bounce and go.
Waiting for your level
Price action traders always wait for the price to come to their levels. Some of these levels could be support and resistance, or previous resistance turned support.
However, in a trending market, often, price does not come back to retest these levels to the strong underlying momentum.
This causes price action traders to be on the sideline while the market is making a directional move.