Price action is used to describe the movements in the price of a security. The way to appropriate and analyse this movement is to look for changes in price in recent history.
In layman terms, price action refers to the strategy that lets the investors and traders analyse the market profoundly and make rational decisions that are based on recent price movements. Price actions give traders the freedom to provide beyond technical indicators.
Since the price action trading strategy focuses on recent price changes and ignores the fundamental aspects, it is majorly based on technical analysis tools.
Price action relies on high, low, open, and close of the recent prices, and tells you how the market is performing. If a trader learns every aspect of how price action trading strategies work, he or she can trade with clear and more systematic charts, and can precisely point out exit and entry spots.
How price action works in trading
Price action trading is based on trends and momentum. The idea is quite understandable, once the trend changes the price rises. And only when a more robust trend emerges on the opposite, the direction changes.
In the middle of the emergence of these strong trends, there will be instances of trading sideways, consolidation periods, and pieces will hop off the lines of resistance and support.
Core pillars of price action
Before we step ahead, we need to understand what makes up the price action. Here are four main concepts that pave the way to price action. It is essential to know how these concepts are related.
Candlesticks are one of the most popular charting techniques in current times. In the past, figure charts, points, line graphs have enjoyed their days of glory.
However, there are no hard feelings. You can choose any chart method that you like.
The candlestick chart lists the highest and lowest prices, opening and closing prices and tells if the prices are closed higher or lower with changing colour from red (or black) to green (or white). The thing to keep in mind with candlesticks is that you have to think of the market as various layers that it embraces – each candle is pouring out information, and a group of candles is also conveying something.
For most of the investors and traders, the bearish trend brings wrath. Selling your stocks and securities for lower prices is no fun. But if you are in for a more extended stay in the market, you must get accustomed to the bearish market. In a bearish trend, the prices of securities fall to the lowest, and the trends form at a 315-degree angle.
This is an easy point to identify in the market charts. A bullish trend develops when the price of the stocks keeps on increasing at a constant. It trends at a 45-degree angle.
At 70 percent of the time, the market runs on a flat trend. It is sporadic for stocks or securities to move in a particular direction all day long.
In flat markets, you ought to lose money. The reason would be that what you expect of the market and what the market produces does not match.
Who is most likely to use price action trading
Since the price action approach is used for predicting the prices and their movements, it is used by traders and speculators who are centered around retail, and by firms who tend to employ traders. The price action strategies can be used on a wide range of securities like forex, bonds, commodities, stocks, equities derivatives, and more.
The steps for price action trading
The traders who have been trading for a long time and are following the price trading action strategies will use multiple methods to identify the patterns of trade, entry and exit spots, and other observations.
Keeping just one strategy in mind will not prove fruitful. In most cases, a process of two steps is involved.
- Identification of a situation or a scenario like a price sweeping into bear or bull phase in the market, breakout, etc.
- Now within a particular scenario or situation, identification of trading opportunities.
The four stages in which the market moves
The trends, volatility in the market are the factors that result in constant changes in the price.
But if we look from a wide-angle, then we will realise that the market moves in a stage-wise system with being in accumulation, advancing, distribution, or declining stage.
- Accumulation stage
This stage comes in place after the price decreases and the market faces a downtrend. It occurs when the price has fallen over about the last four to five months. In this stage, the market will look like a range with resistance and support areas.
- The Stage of advancing
The advancing stage is depicted in an uptrend with higher lows and higher highs. It takes place after the resistance breakthrough in the accumulation stage. Here, you can see a visible series of lows and highs.
- The stage of distribution
This stage takes place when the prices have risen over the last four to five months or more. It would look like a market of multiple resistance and support areas. In the distribution stage, the market remains at equilibrium with both sellers and buyers at the same pace.
- The stage of decline
The decline stage depicts a series of lower lows and lower highs. This stage occurs after the breakthrough of support in the distribution stage.
Most popular price action trading strategies
- Support and Resistance
When using support and resistance in price action trading, it is essential to note that once a level of support is busted, it can be turned into resistance and conversely. Mostly, traders try to focus on volatile prices, but most of the time they trade sideways in a humble range.
When the price is in a firm range, it hops off the resistance at various times. But when an actual breakthrough takes place, it is signaling an uptrend.
- Outside bar (resistance or support)
Outside bar indicated the change of a trend on the price chart. It shows a two-day formation when the asset’s low and high prices of the current day exceed the low and high prices of the previous day. It can either pan out to be a bullish or bearish pattern.
A bullish outside bar comes into being when the low of the current day is more than the low of the previous day, but the stock still closes at a higher price than the last day.
In a bearish trend, the exact opposite happens.
- Inside Bars (breakout)
Inside bars are for the aftermath of a breakout. Inside bars are indicated when a lot of candlesticks are stacked together, and the price starts to fold at support or resistance. At a swing spot, the candlesticks will fix themselves into the low and high because major traders for the stock dominate to build up more shares.
The bars might also take place before a breakout which increases the chances of a stock falling into the resistance of breakthrough.
Inside bars provide you with clean bars where you can smoothly place stops. You don’t have to place your stops on one indicator or candlestick.
- Spring (support)
Spring refers to when the stock is in low range but rapidly comes back into the zone of trading. Springs mostly take place later in the trading range and give traders some time to test the supply before the whole trend is alive.
- Long wick candles
The set up of long wick candles consists of gap high or gap low during the day start, then witnesses a considerable push which then withdraws. This kind of price action is likely to produce a long wick, and price action might be tested for more times.
The MAE formula for Price Action trading
The MAE formula is a proprietary technique with market structure, area of value, and entry trigger.
- Market structure
The foremost thing to do is to identify a market structure because it will give you directions and tell you how to operate. You need to ask yourself if the market is downtrend uptrend, or flat. When you can identify the market structure in clarity, you’ll be able to give direction to your trade with the least resistance. For example, if the market is in a downtrend, you’d only sell, but if the market is in range, you can both sell and buy.
- Area of value
Just identifying and defining the market structure won’t serve a purpose. It is also essential to understand where to put your trade. One must trade in the area where she or he can buy low and sell high.
- Entry trigger
Now that you’ve identified the structure of the market, the area value, the finality of this process would be to analyse when to enter. Many traders like to join the market when it is functioning in reverse.
How to escape the false setups in price action trading
The market is a big game with numerous players who are trying their best to realise maximum profits. And as much as competition is prevalent in the market, so are the false setups.
A price action trader cannot trust indicators that are off-charts for getting hints that a formation is falsely set up. Since price traders focus on the present and what is happening at the moment, they must have clear rules and be disciplined about when to get out of the trade.
One can use ‘time’ as a technical indicator in this case. The chart formation should give you the first signals of false setup, but if they’re blurry, the time can act as a defense factor.
How to protect your trade against head fakes
There are a number of ways in which you can protect yourself from head fakes. The first way to not get caught up in head fakes is not to assimilate your money in one position. Leave yourself some contingency in the game.
Let time be your friend. It can be seen that traders lack patience and want to act quickly. But one must sit and watch how a stock will pan out after hitting a resistance or support level for at least some minutes.
Challenges of using price action
- When you are waiting with patience for price trends to go through a support or resistance level, you can end with a low number of trades.
- Traders who use price action strategies get caught up in the shifts that the market witnesses. This signifies that prices don’t come back to the levels of their trade. Some traders go on to chase the price to the highest.
- Some strategies that we explained in the article might be overwhelming for traders. These strategies can, many times, imbibe false flags and can prove to be expensive in the long term.
- Different traders might have different opinions while looking at the trends in the chart. Some would want to go long, and others would cut short. These decisions are mostly formulated based on technicals and Fundamentals take a back seat.
Advantages of price action trading
- The self-defined price action strategies provide flexibility and can be applied to a wide variety of assets and securities.
- These strategies work smoothly with any software, applications, and portals that facilitate trading.
- Any strategy can be easily backtested on the historical data.
- Traders feel in control as the price action strategies give them freedom of their actions rather than just following a set of stubborn rules.
- When combined with technical analysis tools, these strategies can garner great results and can be of vital support to the community if trading.
If you can learn the nuances of price trading strategy thoroughly, it will help you improve your trade management by imbibing clarity in your entry and exit points, your stop spots, and more. The price action strategy has good potential if making high profits for the trader, but one must also look for all the risks that come with it. It totally is in a trader’s hands how he or she pursues the market and what meets his or her requirements for making profits.
If you are looking for genuine brokers and financial service providers to facilitate price action trading, then you can bank on Primefin and T1 Markets. These brokers are authorised and legal service providers and deal in a variety of assets and securities like indices, forex, commodities, and more.