What is Price Action Trading?
Price action trading means that you base your trading decisions only on price movement of an asset instead of using any external indicators like moving average, RSI, or MACD. This method emphasizes analyzing price data in its most basic form.
Price action trading is based on the assumption that all relevant news, events, sentiment, future price expectations, etc. become incorporated into price almost instantaneously. Consequently, traders seek to use a price's historical movement to forecast any future price action.
Fundamentals of Price Action Trading
- The price is everything: All information about the market is contained within price. Price action is a market's human emotion expressed, that prices which confirm what they expect to happen, both fundamentals, and technical.
- Trained on Past Events: Price action traders are concerned with things that have happened in the past, and like to find patterns between them that come around again. These levels serve as signs that predict future price fluctuation.
- No External Guides: Price action traders do not look to technical indicators to help their decision-making, unlike traditional technical analysis. Instead, they analyze the market using chart patterns, candlestick formations, and key price levels.
Some Famous Price Action Trading Strategies
Price action strategies traders use to benefit from price actions. Price action strategies, based on different elements of price action including candle patterns, trendlines, and supply/demand zones.
Breakout Strategy
A breakout is when the price breaks above or below a strong support or resistance level. This strategy is used by traders to enter the market, assuming that the price breaks out and prices continue to move in the direction of the break.
Essentials of Breakout Trading:
- Determine Key Levels: More experienced traders will look for horizontal support and resistance. These levels are where price has struggled to get above or below in the past.
- Volume Confirmation: A breakout that appears on high volume is usually an indicator of the strength of the move. When traders have volume confirmation, they can trade with more certainty that the breakout will continue.
- Entry Point: Price breaks above resistance or below support.
- If we are lucky and the breakout is false, stop-loss is placed just inside the broken support or resistance level.
Example:
If the price has been fluctuating between $50 and $55, a move above $55 on higher-than-average volume could indicate a precursor to an upward movement. Traders can enter long the asset at $55 and place a stop-loss just below $50.
Pin Bar Reversal Strategy
Essentially, the pin bar is a candlestick pattern that indicates a possible market bias change. A candle is made up of the physical body with a long tail (wick), meaning the price pushed heavily either up or down only to be rejected and pulled back.
Important Traits of Pin Bar Patterns:
- Long Tail/Wick: We can see its wick is price rejection, and its body is where price closed.
- Bullish Pin Bar: Bullish pin bar is at the bottom of a downtrend, which means price might reverse on the upside.
- Bearish Pin Bar: When a bearish pin bar is formed at the top of an uptrend, this indicates that a reversal of the price to the downside may occur.
Entry and Exit:
- Sell when a bearish pin bar forms at a resistance level.
- The strategy is to sell whenever we have a bearish pin bar and the bearish pin bar appears on the resistance level.
- Stop-loss: A stop-loss is usually set beneath the tail of the pin bar (for a bullish reversal) or above the tail (for a bearish reversal).
Example:
In a downtrend, when a pin bar is formed with a long wick in a downward direction, the price action shows that the price has rejected lower levels and may reverse upward.
Inside Bar Strategy
An inside bar is a candlestick pattern formed when a small bar is fully engulfed within the upper and lower range of the preceding bar. It represents consolidation, a sign of indecision in the market, where a breakout to either side will occur.
Important Points to Note about Inside Bar Trading:
- When the market is in consolidation, the inside bar is the price moving within a small range.
- Breakout: As traders await the breakout of the inside bar above or below the high or low.
- A breakout with strong volume gives confirmation of the price action and increases the odds that a trade will be successful.
Entry and Exit:
- Buy on a breakout above the inside bar high.
- Sell when the price goes below the inside bar low.
- Stop-Loss: Place stop-loss under the inside bar low (bullish breakout) / over the inside bar high (bearish breakout).
Example:
For example, if an inside bar retracement forms at a strong level of support, traders will look for a price breakout above the inside bar to enter the trade.
Price Action Trading: Keeping Risks at Bay
Risk management is one of the most important practices in price action trading. Even the best of the strategies could lead to a massive loss if proper risk management techniques are not followed.
Position Sizing
To clear any potential confusion, position sizing is figuring out how much capital you are willing to risk on a single trade. Never risk more than about 1-2% of your trade capital on a single trade as a rule of thumb. This is to not hit your account balance too hard with a streak of losers.
Stop-Loss Orders
It is important to set stop-loss orders to take care of your capital. Stop-losses are used by price action traders to leave losing trades before they incur too much loss. For a buy trade, the stop-loss can usually be placed below the swing low, and for a sell trade, above the swing high.
Risk-to-Reward Ratio
A good risk-to-reward ratio (RRR) is a must to become profitable in the long-run. A lot of traders look for a risk-to-reward ratio of at least 1:2, that is, they risk 1% of their capital to gain 2% in profit.
Expert Insights: Mastering Price Action Trading
Price action trading is not suitable for all as it is a patience-based and psychologically driven method. Here are some recommendations from the pros to enhance your price action trading strategy as you hone your skills:
- First Learn the Basics: You will learn from beginning the most common candlestick patterns, support, and resistance levels. Once you have the basics down, you can build on that with more nuanced techniques.
- Demo Trading: You can practice your strategies with a demo account, where you can trade without risking your money. In this way, you can practice without the financial pressure.
- Have Patience: A lot of price action trading is waiting for the right setup. No need to jump into trades—wait for the market to show you robust price movement in the direction you wish to trade.
- Take Enough Bet: It can get tempting to take lots of trades, but you could be overtrading, and that could make you make emotional decisions, causing losses. Stick to trades that qualify, not those that quantity.
- Trading Journal: Track your trades to review your wins and losses. It allows you to see patterns in your trading behavior and get better over time.
Coping and Key Takeaway: Is Price Action Trading for You?
Price action trading is a simple strategy that allows for flexibility. When you hone in on essentials such as breakouts, pin bars, and inside bars along with employing sound risk management techniques, you can be consistently profitable in the forex and financial markets.
FAQ
- When is the best time for price action trading?
There’s no universal answer. Using higher timeframes like the 1h, 4h, and daily charts, many traders confirm trends or look for higher probability setups. - Can I trade price action in all markets?
Yes, price action trading is versatile enough to be used on forex, stocks, commodities, and even cryptos. Where price movements are more pronounced, it can be especially beneficial in turbulent markets. - Is price action trading only for those with technical indicators?
No, price action trading does not consider anything but price movement. Technical indicators are optional, though some traders use them for further confirmation.