Price Action
Price Action Trading Is The Key To Accurate Setups

Price action day trading is a visual representation of how price fluctuates on a trading chart over a certain period of time. There is a constant battle between buyers and sellers trying to figure out which way any particular market should be going. Understanding price action is one of the ways that traders become proficient in market trading strategies.

This creates phases where markets could either be trending or consolidating. When a market trends it simply means that there are more buyers than sellers (in an uptrend) or more sellers than buyers (in a downtrend). Think of it as a period of imbalance, where a larger amount of traders have the same directional bias than the opposing side.

During a consolidation phase the exact opposite happens. These are periods where the amount of buyers and sellers balance each other out causing price action to consolidate for a while. Consolidation phases can last anywhere from a few minutes, days, weeks or even months (depending on the timeframe you are looking at), but as soon as there is an imbalance again then a market will either resume its previous trend or change direction completely. Many price action trading setups happen before consolidation periods.

Price action therefore depicts the behavior of market participants and if you were to closely study price action you will come to realize that these behaviors are repetitive in nature. Traders continuously look for ways to exploit the repetitive nature of price action as a means of “predicting” future price movements to give them an edge.

Technical analysis is widely used as a means of determining where price might be heading in the near future and include the use of indicators. The only problem with technical indicators are that they can only show you what has already happened, they provide you with information after the fact which is also known as a “lagging” effect.

Technical indicators certainly have their useful place in trading but the study of price action can provide a trader with better clues of future market behavior and a leading indication of what to expect.

Here are 3 price action clues to look for when making trading decisions

1. Corrective Price  Action Patterns

Markets do not only move in one direction up or down. They do so in a series of moves that we call waves. Whether a market is trending upward or downward there will come a time that price moves in the opposite direction of the main trend causing a correction. Luckily for us these corrections tend to materialize at certain areas of support and resistance and have repeatable characteristics, allowing us to determine which correction we are likely dealing
with. There are many types of corrective patterns and below is an example of one of them called the Single ZigZag Correction.

 

From what we can see it is evident that the market above is in an upward trend, shown by the green arrows. After the first green arrow to the left this particular market made a correction downward (blue box), opposite to the main trend and we labelled it A-B- C, forming what is known as a Single ZigZag Correction. As soon as the correction ended, price resumed higher in the direction of the original trend again (second green arrow).

So the first clue to make better trading decisions would be to identify corrections, know what their characteristics are and have a way of finding where they are likely to end.

2. Loss of Price Action  Momentum

Momentum as it relates to trading, is a way of measuring the velocity or power at which price is moving. When a trend or a correction starts out there will typically be plenty of momentum, but when they come to an end then momentum tends to dry up.

When price continuously moves in one direction but the momentum at which it is doing so is decreasing we call it momentum divergence. For us to be able to read momentum and what it is doing in relation to price action we would need to look at an indicator. Remember when I said that indicators do have a place in trading? This is one such case but it is how you use it in conjunction with price action strategies that makes it useful.

The chart image above shows an upward trending market (green arrow) and below that a momentum indicator that shows how the momentum of the uptrend is slowing down as price keeps making higher highs. This opposite relation to market direction is what is called momentum divergence. Many traders use it to signal a change in trend but if you were to look closely at the chart above then where would this trend have ended if you were only
looking at momentum divergence? Basing your trading decisions on momentum divergence only is a dangerous thing to do.

The second  clue to make better trading decisions would be to identify momentum divergence but to do so effectively it would require you to know when and where within price action that momentum divergence has the highest probability of a signaling a change in price direction.

3. Price Action Reversal Patterns

If you were to look at any chart of any market and identified most of the major high or low swings historically, then you will notice that the candlesticks that created those major swings tend to occur over and over again. Sometimes they signal the change of a trend on their own or in conjunction with other candlesticks. Candlesticks are a direct measure of what price is doing during a time period of our choosing called a time frame. During the formation of a candle they tell a story of what buyers and sellers are doing and the end result (before a new candlestick forms again) causes repeatable shapes and sizes. Some of them is important to take not of because they like forming at the areas where price tend to stop and reverse in the opposite direction
again.

Above is one such reversal candlestick pattern called the Engulfing Reversal candle. The red oval on the left is a bullish engulfing candle and the red oval on the right is a bearish engulfing candle. They are named engulfing candles because they are much larger than the candle before them, engulfing them in size. The engulfing candle typically carries an increased amount of momentum going in the

The engulfing candle typically carries an increased amount of momentum going in the opposite direction of the previous candles and therefore signals a potential change in trend.
There are many more types of reversal candles and knowing which ones occur over and over again at important swings make them powerful patterns to take note of.The third clue to make better trading decisions would be to identify reversal

The third clue to make better trading decisions would be to identify reversal candlestick patterns. The trick is to know when they will give you the best signal that price is ready to reverse.

These are only a few clues that I look for when making important trading decisions as part of my overall strategy. Timing in trading is everything that is why we use price action indicators and if you ever wanted a way of joining the market at the most opportune time with the highest probability of success then check out my trading strategy and course here.

Until next time, happy and profitable trading,

Richard K