One of the best ways for traders to predict the near-future or distant-future price of a particular asset (such as a currency or a stock) is to look at the price. Rather than depending upon technical indicators alone, price action traders look at price movements in order to determine whether the underlying asset is likely to increase or decrease in value. When paired with technical analysis, price action trading strategies can be extremely effective.
There are many reasons price action trading has been growing in popularity. Both the directness and subjective flexibility of this particular trading strategy make it compatible with many different trading profiles across many different markets. To put it simply, knowing where the price is and how the price has been moving is one of the most effective ways to determine where the price will likely end up.
Due to its straightforward and direct nature, price action trading is very popular with forex day traders and other short-term traders, but the principles behind most price action trading strategies can be applied in almost any trading circumstance. Additionally, the way price action trading strategies are applied can be very customizable—timeframes, technical indicators, position triggers, and other factors can all vary tremendously among price action traders.
While price action trading, like all types of trading strategies, is by no means risk-free, it is one of the most effective methods for controlling one’s exposure to risk. In this article, we will discuss some of the most important things to know about price action trading. By taking the time to better understand this simple, yet profound approach to the market, you may be able to improve your trading outcomes.
Price Action Trading: A Direct, yet Personal Approach
Price action trading is something that is both objective and subjective. Traders will look directly at the price, look at technical indicators related to the price, and will use this information to either buy, sell, or hold their current position. The current and recent prices of an asset represent objective information that anyone can easily access—directly applying this objective information to a broader strategy makes it easier for traders to justify any given position.
While all price action traders will agree on this objective data—for example, it is easy to recognize that a stock is currently trading at $100 per share and was trading at $95 per share three hours earlier—the ways in which this information is interpreted (and applied) will vary tremendously by an individual. While one trader might consider a bullish trend a sign that an asset is likely in the process of “taking off” and perhaps doubling its value, another price action trader might view the bullish rally as an indicator the asset has overshot its “true value” and, thus, is on the verge of experiencing a trend reversal.
Ultimately, this means that price action trading should be considered a form of speculative trading. Unlike some strictly technical trading strategies where one might automatically take action once one moving average crosses over another, price action traders will consider many different variables at once (the most important of these being recent price movements).
Technical Indicators Used in Price Action Trading Strategies
As suggested, price action trading combines both speculation and technical indicators. While a specific technical indicator event may not necessarily cause a price action trader to take action, using multiple indicators is an excellent way to get a broader view of the current market and adjust your positions accordingly.
Some of the most useful forms of technical analysis include:
- Market Geometry: while markets often seem random, there are actually many common patterns that are produced over time. By keeping an eye out for these recurring patterns—including waves, pitchforks, and Fibonacci retracements—you can trade with greater confidence and reduce your exposure to risk.
- Price Bands: price bands, such as Bollinger Bands, make it possible for traders to identify an asset’s “typical” price range. As the price approaches the edges of these bands, either a breakout or price reversal is likely to occur.
- Moving Average Convergence Divergence: the MACD plots multiple different averages, enabling traders to detect possible trends before they fully play out.
If you are new to price action trading, consider experimenting with multiple technical indicators and see which ones you are most comfortable with. Having more information available is never a bad thing.
The Keys to Price Action Trading
Perhaps paradoxically, developing an effective price-action trading strategy is something that is both simple and difficult. It is simply because this particular form of trading is highly focused on recent price movements, allowing you to narrow your scope and make relatively quick decisions. However, it can also be difficult because there will never be a single point in time where you can be absolutely confident that now is the time to open or close a position—this is why price action traders will often react quite differently to the same underlying market conditions.
Keeping this in mind, here are some of the most useful tips for price action traders:
- Use candlestick charts. When compared to ordinary price charts, candlestick charts offer a much fuller picture. During any given trading period, you’ll be able to see the high price, the opening price, the closing price, and the lowest price.
- Know what you’re trading and know your indicator. Price action trading can be applied to many markets and can be compatible with many technical indicators. However, many traders are overly ambitious and will tend to use (unnecessarily) complicated indicators and try to trade in every market. If you can’t explain what you’re trading and why you believe the price is about to move in a specific direction, it will be very difficult to become a price action trader.
- Manage your emotions. Price action trading often requires you to make subjective decisions, which can be very difficult when the forces of trading psychology—particularly fear and greed—are at play.
- Backtest your strategy. You might think you’ve found the keys to trading, but how does your current approach measure up against history? Back testing your trading strategy enables you to see how you would fare if you had used that strategy under various market conditions.
By practicing, continuing to learn more, and understanding what causes the price to move, developing a successful price action trading strategy is something that can be well within your reach. Though price action trading can certainly present its challenges, it is something that traders of all kinds can eventually master.