Price Action Trading – Why it can be Important
Price action trading is an analysis technique for price predictions and speculation. Traders, speculators, and different trading firms often use this approach. Oftentimes, traders who use price action strategies do so to generate a quick profit.
The popularity of this trading approach might leave many new traders wondering, “What is price action trading?”
Unlike things like algorithms and fundamentals, the price action strategy tells you what the market is going to do, not what you think it should do.
With that said, price action may not be your Holy Grail. However, understanding how it works can come in handy as a trader. As a result of learning about this technique, you will deal with charts that are much cleaner and concise. This will allow you to be better able to choose your entry and exit positions.
So, let’s get into it.
Table of Contents
What is Price Action Trading?
Price action involves the study of price changes in the market. Traders who use this technique believe that price changes represent everything there is to know about the market. This means no complicated mathematical indicators are used in this approach.
There are a few exceptions where, in addition to the price, a few averages are tracked to identify support and resistance trends. Other than that, trading decisions are largely based on price movements.
When talking about price action, the two most common indicators are:
These two variables are represented on a chart that is known as a “naked” or “clean” chart. This is because there are no other variables other than the price and time on it.
On a price chart, the price indication shows the conditions of the market. What this means is that if the prices are moving up, buyers are in control. Similarly, if the prices are going down, sellers are in control. When the market is moving sideways, there is no common connection between sellers and buyers.
How Does Price Action Trading Work?
The way price action trading works is simple. It usually involves two basic steps for recognizing trading opportunities. Those two steps are given below.
- Identify the Current Market Conditions
There are three ways in which a market behaves: uptrend, downtrend, and sideways.
Traders are quickly able to tell what phase of the price action the market is in at a given time by noticing asset prices.
- Recognize an Opportunity to Trade
After the trader has identified the market phase, they then identify any opportunities that may be present.
For example, in an uptrend, the price action would let the trader know whether prices will keep on climbing higher, or whether they should expect a retracement or correction of the trend.
Tools Used for Price Action Trading
As mentioned above, price action takes price and time into account. Therefore, all technical analysis tools, such as charts, support, resistance, consolidation, trend lines, etc., are used. Additionally, psychological patterns are also observed by price action traders.
So, price action trading is a systematic trading approach that is helped by technical analysis tools and the latest price history. Traders are free to use this approach however they choose to make their decisions.
Indicators of Price Action Trading
As mentioned earlier, the only indicators in price action trading are price and time. This makes a price chart the most important factor in this kind of trading. These charts are very detailed.
Often, the type of charts used in price action trading are called candlestick charts. A candlestick chart usually displays the highest, lowest, opening, and closing prices over a period of time.
Usually, a candle with a closing price higher than the opening price is in the color green; this usually represents an uptrend. Conversely, a candle with the closing price lower than the opening price is in red, and this represents a downtrend. However, it’s not necessary for the candlestick colors to always be green or red. They may differ depending on every trader’s preference and the availability they have regarding their chosen trading platform.
Thanks to this comprehensive price information, a trader can tell a lot about the participants of a market. They can tell how those participants will behave and act. All of this works together to prepare a price action trader to make better decisions.
Does Price Action Trading Actually Work?
This is a question that many people have. The truth is price action trading can work. But learning these precision scales can take time.
In any case, for price action to actually work, the trader using it should have a strategy that largely depends on the trader using it. This sort of approach requires a lot of patience, practice and knowledge to successfully navigate the markets.
Price action traders usually look for very specific things on their charts. And they should develop an entry and exit plan. The trader should stick to that plan no matter what happens to avoid losing trades and money.
How Accurate is Price Action Trading?
No one strategy is going to be perfect 100% of the time. The same is also true for price action.
However, price action strategies are usually quite accurate. In fact, in many setups, this strategy has been shown to have a success rate of 75% or even higher.
The head and shoulders pattern is the most accurate one in price action trading. This setup has more than 83% accuracy in providing desirable results.
Price Action Trading Strategies
The use of price action involves studying the psychology of the market and its participants. To perform this reading, we notice the price changes that are occurring throughout the market. Below are some of the most reliable and accurate price action trading strategies.
1. Long Wick Candles
Long wick candles are a favorite among price action traders.
A body and a wick represent a candle in the market. The body shows the distance between the closing and opening prices. And the wick represents the extremes i.e., the highs and the lows.
Let’s say that a candle (body) with a long wick indicates that buyers tried to push the prices up over a period of time, and that sellers pushed back on that attempt and brought the prices close to the opening price. Now, having this information, a price action trader can support the sellers again in the subsequent period. Or the trader can wait for confirmation.
In any case, long wick candles are an extremely effective price action strategy.
2. Trendline Trading
This strategy involves the use of lines. These lines represent the best points of entry to trades in trending markets.
Traders use trendlines to connect different price series together. The resulting line then gives the trader a clear idea of which direction the value of an investment is taking.
In essence, trendlines show the traders the best fit of some data using only one line or curve. They help them determine the direction market prices are going to take.
It is important to remember that the time period and the exact points used to create trend lines differ from one trader to another.
3. Inside Bar Strategy
The inside bar can be an extremely useful price action strategy. An inside bar pattern in price action is a candlestick pattern and it contains two bars:
- The inside bar
- The previous, or prior, bar
The inside bar is smaller and within the high and low extremes of the previous bar. What this simply means is that the high of the inside bar is lower than the previous bar’s high. In the same manner, the low of the inside bar is higher than the previous bar’s low.
By looking at the signals of this bar, traders can successfully predict the future movements of the price. They are also better able to time their entry points with low risk by using this strategy.
The Bottom Line
Price action trading can be a powerful tool for identifying market conditions and recognizing trading opportunities. It is a trading approach that is better for short-term or medium-term traders instead of long-term ones.
Many traders make the mistake of thinking that the market follows a random pattern. However, that is not entirely true. If you combine the technical analysis tools with recent price history, you can identify profitable trading opportunities.
Many successful traders trust price action trading due to its effectiveness. At the end of the day, no matter what strategy or system you use, having a solid understanding of price action can make you a better trader. It removes all unnecessary variables from your charts and gives you a clear vision. After that, it is up to you, the trader, to make the best of the tools you have.
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