What is Price Action Trading?

Price action trading is adopted by many experienced traders and beginner traders will benefit from learning this short-term strategy.

To answer the question we get into the details to help you understand this strategy better, the benefits and downsides, and what are the best tools used by traders.

Let’s jump in!

Price action is a short-term strategy based only on the price action of an asset. It is the price movement of a security plotted over time. This trading strategy uses the trends and formations calculated from price movements. These movements allow traders to make trading decisions. 

Technical analysis involves using past prices in calculations to inform trading decisions. While it doesn't account for all market factors, it is an ideal method for beginners. It doesn't guarantee you profits, but it does make a great trading style to start with. 

Read on for a breakdown of this trading style, along with some insight into trading tools to get you started.

Understanding Price Action Trading

The price movement of an asset is the basis of price action. Traders follow the movement and trade at the actions they think are profitable. Many traders choose to incorporate other technical indicators. These will have little weight in their trading decisions though.

If a stock price starts to rise, this shows that more investors are buying the stock. On the other hand, a fall in prices shows that fewer investors are buying the stock. You assess the price action based on these buying patterns. Traders need to track historical charts of stock and real-time price information. 

True price action traders don't use technical indicators. A price action trader believes that your only trustworthy information source is the price movement of a security.

Who Uses it?

It is generally adopted by active day traders. These include swing traders and trend traders. Experienced traders will often work closely with price action. This allows them to predict breakouts and consolidation. 

It’s important to note that most experienced active traders will incorporate other factors into their strategies. The majority of traders tend to watch many factors other than only price movements. Factors such as volume of trading and changing sociopolitical climates have impacts on your prediction accuracy.

Price Action Tools

Price action is plotted on a chart to track previous changes over time. There is a range of different chart tools used by traders to detect trends.

The most common tools used by traders include trends, breakouts, and candlesticks. Traders use these tools for developing strategies to suit their trading preferences.

Financial assets are traded throughout the day which leads to prices rising and falling. Rising prices are known as bullish trends, and falling prices are known as bearish trends. These trends are tracked by traders. Traders make trade predictions based on these trends. 

Breakout

When an asset has a specific movement tendency, it alerts traders when there are breaks in its movement tendencies. This lets you monitor breaks for new trading opportunities. 

Breakouts occur in various patterns. These include flag patterns, ranges, and triangle patterns.

Candlesticks

A candlestick is a graphic representation on a chart. This shows important information including trends, opening and closing prices, and the price fluctuations of an asset. This is used by many traders in various strategies. 

Support and Resistance

Support and resistance levels are formed when the market's price action reverses and changes direction. Traders use old price support and resistance trends as potential trading opportunities. 

Support occurs when a stock price drops to a level that will prompt traders to buy. Reactionary buying during this period will cause a new rise. Resistance occurs when traders stop buying, leading to a new decrease in price.

Benefits

Less research time needed

Price action is about simplicity. To decide to enter the market, you don’t need to crowd your price chart with multiple technical indicators. It doesn’t need as much research as it is based solely on price movements. The only thing you need to monitor closely is price movements.

Signals are relatively easy to understand

The signals produced by price action are usually easy to interpret. You don’t necessarily need to be an expert in economics to understand price action strategies. All you need is some trading experience and the time to research the basic principles.

Easily testable on simulators

A big advantage to price action is that traders have a pure chart in front of them. This means that you don’t have to monitor multiple indicators. Multiple indicators often show contradictory outcomes when you run a situation through a simulator

Drawbacks

Often subjective

Different traders might interpret it in different ways. While one trader sees a bearish downtrend, another trader might see a potential near-term turnaround. This makes it difficult for you to be certain of making a profit on a trade.

Time period changes

The time period of the chart has a big influence on what tends you see. For example, a stock might have many intraday downtrends while still maintaining a monthly uptrend. Any trading predictions made using only price action are speculative. This is particularly important to remember for shorter time periods.

There is no guarantee of profits

The more tools you add to confirm your trading prediction, the better. While price action trading might be less time-consuming, you still take on risk for potential returns. The past performance of a security is not a guarantee of future movements. High-probability trades are still speculative trades. 

Conclusion

Price action involves making trades based on the price trends of an asset. Learning how to read and interpret movements is an important aspect of price action. This trading style is simple, requires little research time, and is easy to interpret.

It doesn't guarantee profits, but it makes a great trading style with enough time and practice.