A Guide to Price Action Trading

A Guide to Price Action Trading

Price Action Explanation & Definition

Price action trade manages the financial markets using mere price (and price change) to make successful trading decisions.

Tape or price has been around for centuries. Many of the great traders of years past would track demand and price changes to decide where the market really wanted to go.

This method of using price action analysis to gauge market sentiment is still a very popular trading technique. It can become a powerful tool in your trading toolkit when mastered.

While pure technical analysis is more concerned with detailed graph trends, price actions are a more systematic approach to price reading and forecasting possible price movements.

Amongst other factors, price behavior traders should consider:

  • Why price has changed to its present position
  • Did the price move fast?
  • How did the price respond to help or resistance?
  • What did the price do from the open?
  • How does price respond to other linked markets?
  • How did price pass under bullish or bearish news?
  • Has the market laid out any bull or bear traps?
  • Where is price dependent on recent happenings? (for example, at new heights, inside weekly range)
  • How do most market participants feel, and what is their position?

Price action can be used on a short-term basis (often referred to as tape reading). Or used on a higher time frame for reliable day trading or swing trades.

The benefits of trading a price action technique are that they can be used in any market, under any variables. You’re not only confined to one asset or one kind of market, like a bull or bear market or range-bound.

What Markets can I trade?

The great thing about price action is that it can be exchanged virtually in any market that openly trades and has natural price discovery. Common price action trading markets include:

  • Forex – GBP/USD, EUR/USD, USD/JPY
  • Stocks – APPLE, FACEBOOK, TESLA, HSBC, TESCO, BP
  • Indices – FTSE 100, DAX 30, DOW 30, NASDAQ 100
  • Treasuries – Gilts, Bund, Bobl, US 10yr
  • Commodities – Gold, Silver, Crude Oil

Price Action Indicators

Many believe that market action is just to be carried out on an empty graph. While this is true for many successful price action traders, others still use indicators as an additional trading price guide.

(Nevertheless, these measures are often used to measure price movements. They will only serve as additional information instead of using their own.)

For instance, – a price action trader will watch a strong market shift, expecting a price pullback to join the trend. The trader should be well-aware of the type of pullback he’s looking for but will still use a moving average to get a picture of how far away the price really is from the moving average. Then he will use the moving average to help him more accurately time his entry.

Likewise, a price action trader may also use an oscillator such as an RSI, CCI, or Stochastic to help time a position entry or prevent it from pulling the trigger too early on his counter-trend trade if searching for a mean reversion style setup (fading a step deemed too stretched and due for an unwinding).

That aside, price action trading is about having a deep understanding of how the market works, what causes it to move in its manner, and using price (and price change) to decide when the next trade will take place.

Example of the Setup

Let’s say you are on a lookout for a quick trade at the market.

You have determined that a level of 5,000 is a level of resistance based on your chart analysis, and now you’re going to see how price reacts when it reaches that point:

Scene A:

Price reaches 5,000, breaks through, and starts to embrace this new peak, consolidating above the point of resistance.

Scene B:

Price breaks through the point of 5,000 but trades down very quickly to about 4,995.

Scene C:

Price surges to the point of resistance but can’t quite reach the amount of 5,000. It stops and stays just below.

What trading situation is most appropriate to initiate a short position for the market action trader?

It’s Scene B, but why?

Okay, let’s be aware that we are looking at a hypothetical scenario and understand that there are several variables at stake, so let’s speak about exactly why, from a short trader’s perspective, this will be more beneficial.

Let’s also remember that most traders can perform basic technical analysis on a chart and establish a 5,000-level resistance. But the edge that a price action trader has is to be very conscious of how price responds to that point and guide you on your entry. Or even send you a notice with a red flag that allows you to move on a trade that looks like a loser.

  1. Price breaks by 5,000 signaling energy.
  2. There will be a lot of textbook traders buying the breakout.
  3. This triggers a small pop up from the amount of resistance.
  4. Then price retraces pretty fast as consumers tire. They do not want to pay higher prices.
  5. The stock is dropping down below 5,000 and has not only caught buyers in breakouts but has also run out of sellers.

The price action trader can see this situation and can be more comfortable hitting the market with a short trade than someone unaware of price action complexities.

But the added benefit of a price action strategy is that there is always an undeniable place to join a stop-loss, thus considerably improving the risk management process.

What is Price Action in Forex?

In Forex, price action is similar to many other markets. The definition is still the same whether you swap GBP, USD, JPY, AUD, or any other pair.

A price action trader will be watching closely and seeing how the market reacts to previous highs, lows, and any economic news expected. He must determine how the stock is doing at the moment. In addition to whether he wants to enter the move in expectation of a prolonged rise or if the market gets exhausted and may reverse.