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,
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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, they assume 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
their 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:

 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 they think it will
form a double top to go higher, or drop further following a mean reversion.
 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.
 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 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 the requirements for the best possible profit opportunities.