What is price action trading and what does it mean?
What is price action?
Have you ever looked at a chart full of indicators and thought — what a mess? While technical indicators can be a useful tool and key component of a trading strategy, having too many of them can lead to conflicting signals, and lead to traders losing oversight.
This is where price action trading comes in.
What does price action mean?
Price action simply refers to the movement of a specific instrument over time. It is the most basic element of a chart — without price action, the chart would be nothing more than a blank image.
Price action is commonly plotted in the form of candlesticks, which have established itself as a popular form of visualizing price movements. However, it can also be in the form of a bar chart or other similar variations.
That being said, candlesticks are useful because they display additional information based on which the trader can make a decision. For example, while a simple line chart could also help you identify support/resistance levels, you would miss out on the information that can be derived from a candlestick pattern.
When someone says, "I am trading the price action", that means that the trader does not use any technical indicators or supporting tools but rather focuses on the actual price movement. The trader could be relying on simple candlestick formations or support/resistance levels.
Furthermore, price action trading means that fundamental analysis is excluded. Instead of analysing data releases or news, the trader will ignore all the noise and instead focus on the price action. The thinking behind this is that the price action already incorporates all this information.
How to use price action in trading
The most important tool needed for reading price action is a chart — as this is where the price movements are recorded. Traders may use different ways to visualize price movements, but the most popular are candlestick charts.
The reason for this is that candlesticks visualize price action in a better way, since they display the high, low, open and close price for the specific time period. The candlesticks can be used to generate entry/exit signals and can indicate a trend reversal or continuation.
Not only that, but candlesticks can give insights into market sentiment. Let’s compare a simple line chart with a candlestick chart.
Example: USD/JPY - same chart, different story
For illustrative purposes only.
While a line chart shows you the price movements, including the high and low, it does not tell you the "story" like a candlestick can.
Another key component is understanding the concept of support and resistance. These can come in the shape of simple lines (horizontal support and resistance), representing a specific price level, or in the shape of a chart pattern such as a triangle or pennant. A breakout could indicate a trend reversal or continuation, and traders often watch price action closely near these levels.
That being said, it is always crucial to first understand whether the market is currently in an uptrend, downtrend, or consolidating. Since price action traders do not use technical indicators, they usually do this simply by observing the chart.
If the price is making higher highs and higher lows, it’s in an uptrend. If it’s forming lower highs and lower lows, it’s in a downtrend. If the price remains within a range, that points to consolidation.
Bullish vs. bearish price action
Bullish price action suggests that an instrument's price is moving higher. This is usually characterized by the formation of higher highs and higher lows, indicating a trend.
Candlestick patterns can also signal bullish price movements. For instance, a bullish engulfing pattern is a powerful indicator of growing buying pressure. Other bullish candlestick patterns include hammer patterns and morning stars.
Bullish price action can also come in the form of breakouts — for example, a breakout above a falling trendline or a key resistance level.
Example: Gold — bullish price action
For illustrative purposes only.
On the other hand, bearish price action indicates that an instrument's price is trending downward. This is typically reflected in lower highs and lower lows, forming a downtrend.
Some candlestick formations that strongly indicate a bearish trend:
Bearish engulfing: indicating that selling pressure is significantly increasing.
Shooting star: indicating that buyers have lost control and selling pressure is intensifying.
Evening star: a formation consisting of three consecutive candlestick patterns that indicate a trend reversal.
Bearish price action also appears in the form of breakouts. For example, a breakout below a rising trendline or a below a key support level.
Example: BTC/USD — two major, bearish breakouts
For illustrative purposes only.
Advantages of price action trading
A key advantage of price action trading is a "clean" chart. While indicators can be useful, they can also lead to conflicting signals, especially when too many of them are used. A clean chart can help traders to focus and make clearer decisions.
For illustrative purposes only.
Price action reflects real-time market conditions, whereas indicators rely on past data and are therefore lagging.
Price action works in all market conditions, which means it can be used both in trending and ranging markets. Many strategies that involve indicators depend on a specific type of market environment, which limits opportunities or requires adjustments.
Furthermore, price action strategies can as easily be used on shorter timeframe charts as they can be on longer timeframe ones.
Many price action traders also find relief in not having to focus on fundamentals, such as continuously monitoring news and data releases. While some traders might still follow them to stay "in touch" with the markets, it is not a component of their strategy.
Disadvantages of price action trading
The major disadvantage that often comes up when price action trading is being discussed is its subjectivity. Ask ten traders to interpret a chart and you might get ten different answers.
For example, what defines a "key" resistance level? Most traders would agree it is a level that the price has failed to breach on several occasions. But how many times — 3, 4, 5, 6? Again, there are no set rules.
This can even extend to the drawing of trendlines or other chart patterns. Where one trader might see a specific chart pattern, another trader does not see anything.
The lack of "clear rules" and price action being open to interpretation might be challenging to some, particularly beginners.
Furthermore, reading price action will require experience and patience. Traders who have been monitoring the charts for a long period of time will have an easier time to spot patterns or read the charts.
As with any trading strategy, strategies based on price action can lead to false signals, which is why it is crucial to use stop-loss orders.
Price action trading strategies
1. Pin bar
A popular price action strategy which is based on a candlestick pattern called the pin bar. It has a small body and long wick, which tells you that there has been a strong rejection of a price at a key support or resistance level.
A bullish pin bar can be found at the end of a downtrend, e.g. at a key support level. The long wick is indicating that sellers were trying to force a breakout, but failed, and buyers took over control.
On the other hand, a bearish pin bar is spotted at the end of an uptrend, e.g. at a key resistance level. The long wick is indicating that buyers were trying to achieve a breakout above the resistance level, but failed, and sellers are now in control.
2. Inside bar
Another popular strategy that is based on the inside bar candlestick pattern. This pattern consists of two candlesticks — the mother bar and the inside bar.
What we are looking for is a candlestick that is completely falls within the range of the mother bar, which indicates consolidation.
When used as a continuation pattern, traders will be anticipating a breakout above the mother bar if the instrument is in an existing uptrend or a breakout below the mother bar if the instrument in in an existing downtrend.
3. Range trading
With this strategy, traders usually pick an instrument with low volatility, as this reduces the chance of a false signal.
Traders will be looking for an instrument that has no visible trend — meaning the price is bouncing between a key support and a key resistance level. With this strategy, traders are looking to buy at or ahead of the key support level, anticipating that the price will return towards the upper part of the range. Or they will be looking to sell at or ahead of the key resistance level, in anticipation of a reversal towards the lower part of the range.
While some traders will simply use the horizontal support or resistance level to trade the range, others will be looking for particular candlestick patterns for additional confirmation, such as the engulfing candlestick pattern.
For illustrative purposes only.
4. Breakout trading
A popular strategy that involves buying or selling an instrument after it breaks above or below a key resistance or support level.
For this, traders may simply use horizontal support or resistance levels, or they might use trendlines or chart patterns such as triangles, flags, and pennants.
Ideally, there should be a consolidation ahead of the breakout and price should have already tested the key support/resistance level at least twice and failed.
While some traders choose an aggressive entry method by buying or selling immediately upon the breakout, others will wait for a confirmation in form of a candlestick pattern and then enter, although this increases the chance of a missed opportunity if price moves too fast.
For illustrative purposes only.
5. Trend following
This strategy involves trying to capitalise on an existing trend. In an uptrend, traders look for buying opportunities, whereas in a downtrend, they focus on selling opportunities.
Traders using purely price action might use:
- trendlines — buying once the price reaches a rising trendline or selling once the price reaches a falling trendline.
- candlestick patterns such as the bullish engulfing, bearish engulfing, three white soldiers, three black crows and shooting star.
- chart patterns such as flags, wedges, and cup & handle patterns.
For illustrative purposes only.
6. Trend reversal
A strategy with which traders aim to capitalize on spotting a reversal of the current trend. Trend reversals can look obvious in hindsight, but it is difficult to identify them in real time, and there is a high risk of false signals.
Popular trend reversal strategies often include candlestick patterns such as the hammer or shooting star, as well as chart patterns like the head & shoulder and double top/double bottom formation.
Conclusion
Price action trading involves focusing purely on the price action and ignoring technical indicators as well as fundamental analysis. The idea behind this is that price action already incorporates all the information in the market and that keeping the chart "clean" will help traders focus on the price action itself — without getting distracted by indicators and market noise.
Price action trading has its benefits — ranging from the clean charts that can help traders to focus and make clearer decisions to being able to use them in all possible market conditions and timeframes. However, price action can be highly subjective, which makes it more difficult for traders to master the execution and exit of the trade. Furthermore, reading price action requires experience and patience.
Price action strategies are straightforward in nature, with options available for every market condition. As always, risk management is crucial, as false signals can occur at any time.
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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation and needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability with regard to the accuracy and completeness of the content in this publication. Readers should seek their own advice.
FAQ
What is price action?
Price action refers to the movement of a specific instrument over time. It is the most basic component of a chart.
How is price action displayed?
It can be represented as a line chart, bar chart, or candlestick chart, with the latter being the most widely used.
How do you trade using price action?
Price action traders rely solely on price movements and the patterns they form, such as candlestick formations and support/resistance levels. They do not incorporate indicators or fundamental analysis into their strategy.
Is price action trading better than trading using indicators?
Indicators are derived from past data and tend to lag behind price movements, which can be a drawback. However, they can still be useful for traders with specific strategies or preferences — meaning neither price action nor indicators can be considered better or worse than the other.
What are the advantages of price action trading?
Keeping charts "clean" can help traders to focus better and make clearer decisions. Price action trading also works in all market conditions and on all timeframes.
What are the disadvantages of price action trading?
Price action can be interpreted in different ways, and this subjectivity can be a challenge, particularly for new traders. Learning to read price action requires both time and experience.
