Price action refers to the movements in an asset's price plotted on a chart. It is the basis for all technical analyses, so it is a key term to understand as a trader. In this article, we'll discuss what price action trading is and how to use it to craft a successful trading strategy.
What is price action?
Price action refers to how the price of an asset changes over time. Instead of relying on technical indicators, traders using price action analyse chart signals and their own understanding of the market's movements.
Short-term traders often exclusively use price action to make trading decisions, identifying formations and trends in the price movements. Technical analysis is based on price action as it uses past prices.
Key points about price action:
- Price action generally refers to the changes in the price of an asset over time.
- Different chart perspectives and timeframes help highlight price action trends.
- Technical analysis and chart patterns derive from price action.
- Tools like moving averages are derived from past price action to predict future scenarios.
- Price action doesn't guarantee future results, even though it's used to predict them.
How does price action work?
Traders widely use price action to analyse markets and make decisions. To be successful with this strategy, it is essential to know how to read a price chart. A price chart shows the price movements of an asset over time, eliminating many of the “noisy” indicators that can distort the analysis.
Traders look for repeated patterns or particular formations on price charts to predict how the market will move. These configurations include patterns such as double tops/bottoms, false breakouts, and trendlines.
Price movement strength can be determined with the use of many tools, such as volume analysis.
Since the strategy focuses on historical price movements, traders must be disciplined and patiently wait for price action patterns to form before making a trading decision. Traders must also have a good understanding of the concepts of support and resistance, as well as risk management and emotional control to maximise their trading opportunities.
Although price action strategies can be effective, they also have some drawbacks. By focusing on historical price movements, traders may miss the opportunity to consider other factors that may influence the price, such as economic data and news. In addition, since the strategy depends on the subjective interpretation of the price chart, it can be difficult to consistently generate positive results.
What is the difference between price action and trading with indicators?
The reason why indicators are so popular is that they feed the new trader's belief that the indicator can help predict future price movements. To properly understand indicators, traders must understand how indicators are built and project their information. However, 99% of all indicators are built using old price information to create a lagging indicator.
For example, a moving average is created using previous prices to create a moving line that traders can use in various ways. The main problem with indicators is that they are always created “lagging” and not “leading”, so traders use past information to make decisions.
People tend to think that anything worthwhile can't be simple and new traders often spend a lot of time trying to complicate trading by adding fancy indicators to their trading strategy thinking that the more indicators they use, the better they will be able to predict the direction of the price. However, this is exactly the opposite of what traders should do. This mentality is a pitfall that is very easy to fall into because the trader can quickly find themselves adding more and more indicators as they start to lose more and more.
What ends up happening is that the trader, from the beginning of their trading journey, uses so many indicators on their charts that they end up in a state of analysis paralysis. The trader ends up having so many indicators on their charts that contradict each other, so they can no longer trade because they are so confused about what to do next. So, what should they do? The simplest and least complicated trading method is price action. All that is needed to trade based on price action is a price chart.
The main difference between indicators and price action is that, with indicators, old and lagging price information is used to try to predict the future; with price action, the price is continuously read as it is printed on the chart. There are no indicators or external influences used to trade based on price action. Basically, trading on price action is the ability to read the price and make trades on any chart, in any market, in any time frame and without the use of any indicators, as seen in the following example.
Training and commitment are necessary to be successful with price action trading just like any other useful trading method or system. The reason why stock price action trading is so successful and why many professional traders use it is because it simplifies the trading process and the mindset needed to be profitable.
Tools used by price action traders
There are three essential elements to price action strategies. They are essential to be able to anticipate price increases and decreases, as well as to inform trading decisions.
Support and resistance
The first tool is support and resistance. Here is what they mean:
- Support levels, the lower line, are related to the lowest price recorded and will indicate how far the value of the asset could “drop”. Despite this, it can sometimes break and mark even lower price points.
- On the contrary, resistance levels, the upper line, are related to the highest price recorded and will indicate how far the value of the asset could “rise”. As with resistances, these can break and mark higher price points.
The price line can be interpreted by traders and classified as one of the following:
- Bullish: which presents a constant increase in price.
- Bearish: where the price decreases constantly.
- Sideways market: relatively horizontal price movements; these occur when supply and demand are nearly equal for a period of time.
Understanding these trends helps traders make the right decisions. For example, identifying a bullish market could present you with the opportunity to acquire an asset at the current price and sell it once it goes higher (near the resistance level, for instance).
Japanese candle patterns
The third element of price action analysis is the Japanese candle pattern that forms at support or resistance levels. There are a large number of candle patterns that form and are a preamble to a decrease or increase in the price of the asset.
How to view price action on a chart
The steps are general as it depends on what platform you decide to use for your price action strategy. However, in general, this is how you can plot the price action on a chart:
- Open the chart and remove indicators or grids.
- Set the time frame depending on your trading objectives and preferences (such as hourly).
- Draw support/resistance lines at the highest and lowest points of the price.
At this point, you can select one or more indicators or tools to confirm the signal. In general, it's recommended to keep the chart as clean as possible.
Platforms for price action trading
A good trading platform is an indispensable support for the trader when it comes to analysing the chart with a price action strategy. We tend to attach great importance to the type of broker, their costs and conditions, without looking at the type of tools available.
On the other hand, it is worth remembering that not all brokers have their own trading platform, there are brokers who provide third-party software.
TradingView is a social trading and technical analysis platform for investors and traders. It offers advanced charts, real-time market indices, trading ideas from users and analysts, as well as the ability to interact and follow other traders. TradingView supports many asset classes, including stocks, forex, commodities, and more. The platform is accessible both from the web and from mobile apps and is available via several online brokers, including Eightcap, Pepperstone and ActivTrades.
MetaTrader 4 (MT4) is a very popular online trading platform, mainly used for forex trading. It offers advanced charts, technical indicators, customisation options, trading automation through the MQL programming language, and the ability to execute trades through an intuitive interface.
Additionally, MT4 offers a wide range of analytical tools and the ability to integrate third-party plug-ins and scripts. The platform is available for both PC and mobile devices and supports various operating systems. MT4 is available via several brokers, including Eightcap – click the button below to visit the broker.
Trader Workstation (TWS) is the proprietary trading platform of Interactive Brokers. TWS offers a wide range of advanced trading features, including advanced charts, technical indicators, trading automation, advanced risk management options, and a wide range of markets, including stocks, options, futures, forex, and indices.
The platform is highly customisable and offers many display and layout options, as well as the ability to use a wide range of analysis tools. TWS is designed for experienced and professional traders who require advanced features for their trading. The platform is available for both PC and mobile devices.
Have a look at our Interactive Brokers review.
Trading with price action: what does it mean?
Price action strategies are used to determine the right moment to buy or sell. For this, it is key to determine the support and resistance levels. There are several signals you can identify, such as:
- The price does not rise above a relevant resistance level: When the price repeatedly struggles to move beyond a known resistance level, it often indicates a point where sellers are active. Traders might see this as a selling opportunity, expecting the price to potentially reverse downward from that resistance level.
- The price rises above a relevant support level > This movement might present a buying opportunity as it suggests that buyers have gained control and the support level has potentially turned into a new level of potential price support.
Price action applied to forex markets
In its most basic form, forex price action describes how currencies move, including their trends and major support and resistance levels. However, trading forex with price action also includes buy and sell signals. When we combine these signals with key levels and momentum, we get a simple and effective trading style. Trading forex with price action means watching the market and then reacting accordingly.
The advantage of price action trading is that it gives you an idea of where the buy and sell orders are located. We use the upper and lower shadows of the Japanese candles to visualise these buyers and sellers. Once again, it is about using the price patterns on the chart to decide whether to act or not.
Price action: best strategies and examples
Here is a simple 3-step approach:
- Step 1: Trace support and resistance levels The first thing you should do after opening a new chart is to trace the key support and resistance levels. These can include trend lines, horizontal areas, and even patterns such as ascending and descending channels. Once the critical areas on your chart are identified, you can proceed to the next step.
- Step 2: Wait for the US session to close Patience is key. It is no coincidence that this is also the point where most traders fall. To trade on the daily time frame, you must wait for the US session to close. Another key moment is the opening of the UK session and the European pre-opening session, be aware of the stock exchange trading hours.
- Step 3: Observe the buy and sell signals of price action When it comes to candle patterns, the pin bar and the engulfing candle are among the most interesting. The pin bar is a candle with a long upper or lower shadow, also called a tail. This is what makes this pattern so profitable. When buyers push the market above key support, it suggests an increase in demand.
The same goes for a pin bar that occurs at a resistance level. But in this case, that long upper tail signals an increase in supply.
You should look for bullish pin bars on support and bearish pin bars on resistance. Make sure to pay attention to market volatility as well. First, let's take a look at the following chart.
Both of the above signals offer incredibly favourable risk/reward ratios. Note how the pin bar's tail fits perfectly with the price action. Although of different shapes, the engulfing candle is similar to the pin bar in that it suggests an increase in demand or supply. The engulfing candle is an excellent tool to identify the weakening of a trend.
Finally, how to identify price momentum? Price action gives us extremely accurate indications. Using the daily time frame, identify the swing highs and swing lows. You are looking for turning points in the market. The amount of time between these points can vary from a few weeks to a few days. As long as the market records higher highs and higher lows, it is in an upward trend.
If a market, on the contrary, is producing lower highs and lower lows, it is in a downward trend.
These highs and lows often form a trend line.
Learn more about trading
- Technical analysis
- Trading guide
- Trend indicators
- Best trading platforms
- Best brokers for intraday trading
Advantages and disadvantages of price action
|Easy to use
|Does not take into account economic news
|Subject to different interpretations
|Based on chart analysis
|Not suitable for scalping
|Quick and intuitive
|Real-time trading signals
Is price action trading suitable for all markets and timeframes?
Yes, price action trading can be applied across various financial markets, including stocks, forex, commodities, and cryptocurrencies. It's adaptable to different timeframes, from short-term (like day trading) to longer-term strategies (such as swing trading or investing).
Can price action trading be combined with other trading strategies or indicators?
Yes, price action trading can complement other strategies or indicators. Some traders combine it with tools like moving averages or Fibonacci retracements to validate their analysis or confirm potential trade setups. However, the key is to maintain clarity and not overload the analysis with conflicting signals.
How can beginners start learning price action trading?
Beginners can start by understanding basic price action concepts like support/resistance, trend lines, and chart patterns. They can practice on demo accounts to identify and interpret these patterns on various charts.