Some traders make decisions based on the price movements of an asset. This is the premise of price action trading—following the movement of prices and trading based on the actions they think are most profitable.
Most price action traders don't use technical indicators, such as moving averages or Bollinger bands, but if you do, you should give them very little weight in the trading decision process. A price action trader believes that the only trustworthy source of information comes from the price itself and its movements.
If a stock price begins climbing, it shows that investors are buying. They then assess the price action based on the aggressiveness of buying; the historical charts; and real-time price information such as bids, offers, volume, velocity, and magnitude.
Price Action Trading Tools
Preferred tools for price action traders are breakouts, candlesticks, and trends. They also use theories such as support and resistance. Traders use these tools and ideas for developing strategies that work with their preferences.
When an asset's price moves with a specific tendency, it alerts traders to a new possible trading opportunity once it breaks that tendency. For example, suppose a stock has traded between $11 and $10 for the last 20 days, then moves above $11. This change in tendency alerts traders that the sideways movement has possibly ended and that a possible move to $12 (or higher) has begun.
Breakouts occur from many different patterns, including ranges, triangles, head and shoulders, and flag patterns. A breakout doesn't mean the price will continue in the anticipated direction, and it often doesn't. In that case, is called a "false breakout" and presents a trading opportunity in the opposite direction of the breakout.
Candlesticks are graphical representations on a chart that show the trend, open, close, high, and low price of an asset. Traders use candlesticks in various strategies. For example, when using candlestick charts, some traders use the engulfing candle trend strategy.
An asset can be trading throughout the day, with prices continuing to climb or fall. Traders refer to these fluctuations as "bullish" trends, where the price is rising, or as "bearish" trends, where the price is dropping.
Support and Resistance
Related to all of the above, traders use price support and price resistance regions to identify good trading opportunities. Support and resistance areas occur where the price has tended to reverse in the past. Such levels may become relevant again in the future.
Price Action Trading Strategies
There are many trading strategies from which to choose. A few of the most popular are:
- Spring at support
- Inside bars after breakout
- The hammer
- The harami
Traders often name their strategies for the visual created by the indicator used on a chart. For instance, "spring at support" refers to a sudden rise in an asset's price after it hit or came close to its support price, or the lowest price the market will support for that asset.
"Inside bars after breakout" refers to the bar in a candlestick pattern between the previous bar's range, after a breakout occurs. "The hammer" is a candlestick that looks like a hammer. It forms into this shape because the open, close, and high are close to each other, while the low is long, simulating a hammer handle. Traders generally view a hammer as a reversal of a trend.
The harami is characterized by an upward or downward trend with a corresponding fall or rise in opening and closing prices. A smaller candle is next to it, with a price movement opposite the trend direction and a smaller gap in the opening and closing prices. Haramis generally signify trend changes.
All new traders can benefit from learning price action trading. Learning to read and interpret price chart movements becomes a trading system on its own. It can help if you decide to implement other analysis tools, such as statistics, indicators, or seasonality.
If you're learning to trade, you only need to learn one method to start. Become profitable with your chosen strategy before trying to learn more. Price action trading doesn't guarantee profits, but it makes an excellent trading style with time and practice.