TECHNICAL ANALYSIS TECHNICAL ANALYSIS BASIC EDUCATION

An Introduction to Price Action Trading Strategies

By SHOBHIT SETH | Updated Jun 25, 2019

Price action describes the characteristics of a security’s price movements. This movement is quite often
analyzed with respect to price changes in the recent past. In simple terms, price action is a trading
technique that allows a trader to read the market and make subjective trading decisions based on the
recent and actual price movements, rather than relying solely on technical indicators.

Since it ignores the fundamental analysis factors and focuses more on recent and past price movement,
the price action trading strategy is dependent on technical analysis tools.

[ Many day traders focus on price action trading strategies to quickly generate a profit over a short time
frame. For example, they may look for a simple breakout from the session's high, enter into a long
position, and use strict money management strategies to generate a profit. If you're interested in day
trading, Investopedia's Become a Day Trader Course provides a comprehensive review of the subject
from an experienced Wall Street trader. You'll learn proven trading strategies, risk management
techniques, and much more in over five hours of on-demand video, exercises, and interactive content. ]

Tools Used for Price Action Trading

Since price action trading relates to recent historical data and past price movements, all technical
analysis tools like charts, trend lines, price bands, high and low swings, technical levels (of support,
resistance and consolidation), etc. are taken into account as per the trader’s choice and strategy fit.

The tools and patterns observed by the trader can be simple price bars, price bands, break-outs, trend-
lines, or complex combinations involving candlesticks, volatility, channels, etc.

Psychological and behavioral interpretations and subsequent actions, as decided by the trader, also
make up an important aspect of price action trades. For e.g., no matter what happens, if a stock hovering
at 580 crosses the personally-set psychological level of 600, then the trader may assume a further
upward move to take a long position. Other traders may have an opposite view – once 600 is hit, he or
she assumes a price reversal and hence takes a short position.
No two traders will interpret a certain price action in the same way, as each will have his or her own
interpretation, defined rules and different behavioral understanding of it. On the other hand, a technical
analysis scenario (like 15 DMA crossing over 50 DMA) will yield similar behavior and action (long position)
from multiple traders.

In essence, price action trading is a systematic trading practice, aided by technical analysis tools and
recent price history, where traders are free to take their own decisions within a given scenario to take
trading positions, as per their subjective, behavioral and psychological state.

Who Uses Price Action Trading?

Since price action trading is an approach to price predictions and speculation, it is used by retail
traders, speculators, arbitrageurs and even trading firms who employ traders. It can be used on a wide
range of securities including equities, bonds, forex, commodities, derivatives, etc.

Price Action Trading Steps

Most experienced traders following price action trading keep multiple options for recognizing trading
patterns, entry and exit levels, stop-losses and related observations. Having just one strategy on one (or
multiple) stocks may not offer sufficient trading opportunities. Most scenarios involve a two-step
process:

1) Identifying a scenario: Like a stock price getting into a bull/bear phase, channel range, breakout, etc.

2) Within the scenario, identifying trading opportunities: Like once a stock is in bull run, is it likely to (a)
overshoot or (b) retreat. This is a completely subjective choice and can vary from one trader to the other,
even given the same identical scenario.

Here are a few examples:

1) A stock reaches its high as per the trader’s view and then retreats to a slightly lower level (scenario
met). The trader can then decide whether he or she thinks it will form a double top to go higher, or drop
further following a mean reversion.

2) The trader sets a floor and ceiling for a particular stock price based on the assumption of low volatility
and no breakouts. If the stock price lies in this range (scenario met), the trader can take positions
assuming the set floor/ceiling acting as support/resistance levels, or take an alternate view that the stock
will breakout in either direction.

3) A defined breakout scenario being met and then trading opportunity existing in terms of breakout
continuation (going further in the same direction) or breakout pull-back (returning to the past level)
As can be seen, price action trading is closely assisted by technical analysis tools, but the final trading
call is dependent on the individual trader, offering him or her flexibility instead of enforcing a strict set of
rules to be followed.

The Popularity of Price Action Trading

Price action trading is better suited for short-to-medium term limited profit trades, instead of long term
investments.

Most traders believe that the market follows a random pattern and there is no clear systematic way to
define a strategy that will always work. By combining the technical analysis tools with the recent price
history to identify trade opportunities based on the trader’s own interpretation, price action trading has
a lot of support in the trading community.

Advantages include self-defined strategies offering flexibility to traders, applicability to multiple asset
classes, easy use with any trading software, applications and trading portals and the possibility of
easy backtesting of any identified strategy on past data. Most importantly, the traders feel in-charge, as
the strategy allows them to decide on their actions, instead of blindly following a set of rules.

The Bottom Line

A lot of theories and strategies are available on price action trading claiming high success rates, but
traders should be aware of survivorship bias, as only success stories make news. Trading does have the
potential for making handsome profits. It is up to the individual trader to clearly understand, test, select,
decide and act on what meets his requirements for the best possible profit opportunities.

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Related Terms
Technical Analyst Definition
A technical analyst, or technician, is a securities researcher who analyzes investments based on past market prices
and technical indicators. more

Filter Rule Definition and Example

A filter rule is a trading strategy in which a technical analyst sets rules for when to buy and sell an asset based on
percentage changes from prior prices. more

Ascending Channel Definition

An ascending channel is the price action contained between upward sloping parallel lines. Higher highs and higher
lows characterize this pattern. more

Flag Definition
A flag is a technical charting pattern that looks like a flag on a flagpole and suggests a continuation of the current
trend. more

Trend Trading Definition

Trend trading is a style of trading that attempts to capture gains when the price of an asset is moving in a sustained
direction called a trend. more

Swing Trading Definition and Tactics

Swing trading is an attempt to capture gains in an asset over a few days to several weeks. Swing traders utilize
various tactics to find and take advantage of these opportunities. more

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