Price Action Trading Explained for Dummies: With Examples

To begin with, let us start by understanding what the Price Action actually is? When the random movement of the security’s price is visualized in the form of patterns in two dimensional charts, Price Actions generate. Price Action Trading is an abstract trading method in which all the trading decisions are taken with the help of a “naked” price chart or a stripped down price chart. All the major financial markets produce data from time to time about every minute movement of security prices. All this data is displayed on a price chart in the form of Price Action. This price action helps traders in speculating the future direction based on past trends and visible patterns. It is an elusive concept, as no two traders can analyze the price action in similar ways.

Also Read: 3 Most Accurate Chart Patterns you must know

The Price Action helps to predict the future of the market with a very high and reliable degree of accuracy, giving an opportunity to the traders to develop a profitable trading strategy. In Price Action Trading, we do not use the indicators such as MACD, Stochastics etc. Instead, we use Japanese candlesticks, trend lines and key support/resistance levels . Price action trading shifts the focus from just the indicators to the more reliable movements of price.

Price Action Trading

Who uses price action trading?

It is mostly used by technical analysts who firmly believe in chart patterns for speculating future price movements. Along with them arbitrageurs, speculators and HFT trading firms also apply price action trading principles in their systems.

For which securities Price Action Trading used?

It is used for a wide spectrum of securities like Forex, Derivatives, Equities, Commodities, Bonds etc.

How is the Price Action Trading done?

Price action trading is done by recognizing visible patterns in price charts. Expert price action traders continuously observe various price parameters like entry and exit levels, stop-loss, targets etc. They develop their strategy on the basis of this observation. They know that one strategy for all the stocks may not offer best trading opportunities to them. Mostly the Price Action Trading follows a two-step process:

  1. Identify a scenario: Looking at the stock price and maintain its record if it’s getting into a bear or bull phase, what is its channel range and breakout etc.
  2. Identify trading opportunities: After identifying the scenario, identify trading opportunities based on it. Choosing the trading opportunity is purely a subjective choice and varies from trader to trader. For e.g. if a stock reaches at a high and retreats after some time to a lower level, a trader can assume accordingly  whether the stocks will go up to form a double top or drop down following a mean reversion. It is purely a matter of one’s judegement.

Price Action Trading Examples

Head and Shoulders

This pattern is characterized by two nearly equal peaks, with a higher peak between them. The two equal peaks are called “Shoulders”, and the higher peak is “Head” . The line joining trough between two shoulders is called neckline. If the price breaks the neckline after rising to second shoulder, then it signals bearish reversal in ongoing uptrend. The opposite variant of this pattern is called “Inverted Head and Shoulder”. It indicates bullish reversal during ongoing downtrend.

Double Top and Double Bottom

This pattern is also similar to Head and shoulders except for the fact that Head is missing. Double top is characterized by two nearly equal peaks next to each other. After making the second high if the price breaks the previous swing low between two peaks, then it signals a bearish reversal. Similarly Double bottom is characterized by two nearly equal troughs. Breakout from the previous swing high signals a bullish reversal.

Bullish and Bearish Engulfing Candlestick Pattern

engulfing

This is probably one of the most powerful candlestick patterns which is widely popular among traders. It is characterized by a short candle followed by a long candle. The long candle completely engulfs the short candle.The bullish engulfing formation consists of a short red candlestick followed by a taller green bodied candlestick that begins below and ends above the previous day’s trading range.This means prices on the second day opened lower than the first and closed higher.  This is a highly bullish formation and indicates a long position should be considered. A bearish engulfing pattern would be the opposite with a green bodied candlestick followed by a longer redbodied candlestick.  Here the signal is bearish and consideration should be made for selling short.

Also Read: Most Powerful Candlestick Patterns in Technical Analysis

Price Action Trading Jargons

As the Price Action considers past price movements, Price Action Trading takes into account all the technical analysis jargons like charts, swings (high and low), technical levels of consolidation and resistance, price bands, trend lines, break-outs, candlesticks, channels, volatility etc. It depends on individual choice of a trader that how he executes price action trading

Price Action Trades also depend on the behavioral and psychological interpretation made by the trader and the actions decided by the same. For e.g. watching a stock moving from 580 to 600 a trader may assume that it will move up for sure and he takes a long position, another trader may assume that once it hit the 600 marks there will be a price reversal and he takes a short position.

Also Read: 123 Trading Startegy: Most Profitable Chart Pattern

Conclusively, we can say that Price Action trading instead of depending on just the indicators follow a systematic trading practice. It uses all the detailed price history and technical analysis tool to develop a Price Action. Having observed all of this, a trader is free to take his/her own trading decisions.

One Comment

  1. Hello Sir, Had a query in amibroker, if I am testing a strategy on say a watchlist with say 100+ names and I run a portfolio backtest specifying the position size and max number of open positions. But am not using any ranking (positionscore). In that case how does Amibroker pick the stocks if more than max are meeting the criteria?

    This no one answered me till today sir,
    I hope u are top in India on amibroker so asking u here

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