Prices of securities move up or down constantly in the market, making it difficult for traders to predict whether the market will perform well or otherwise. How will a trader accurately predict the entry and exit time? - There are several methods for speculating market movements, including fundamentals, technical indicators, volume indicators, etc.
However, using many indicators can make things confusing. Price action trading is a discretionary trading strategy that relies on technical analysis and recent price history. Traders use these tools to identify potential trading opportunities and make decisions based on their own interpretation of market data. Their analysis is influenced by subjective factors such as behavioral assumptions and psychological state.
What is price action trading?
Price action trading is a strategy that involves analysing and interpreting market behaviour through recent and actual price movements to make trading decisions. Instead of depending heavily on technical indicators, traders focus on price patterns, trends, and key levels of support and resistance to anticipate market direction and plan their trades.
While traders also use price action to forecast prices in the future, there is no guarantee that their predictions will come true.
What is price action in the stock market?
Financial experts define price action as an important technique of trading where a trader plots the increase and decrease in prices over a particular time frame. It plays an important role in charts and technical analysis. One can calculate moving averages from the price action, which helps make informed decisions.
Difference between price action, technical analysis & indicators
The points below will illustrate the features and differences between price action indicators and technical analysis:
- Price action indicators illustrate trading activities on a chart which helps any trader understand the emergence of a trend. Even amateur traders can quickly analyse price action indicators to use them for investment decisions
- Technical analyses use different types of indicators for predicting future price movements; however, price action focuses solely on the price movements of an asset. Many traders use technical analysis tools and price history for price action trading
- With technical analysis, traders use numerous calculations to predict market movements, while price action analysis is far more simplistic
Best price action trading strategies
Listed below are various price action strategies:
1. Trend trading
This trading strategy is ideal for new traders because it helps them learn from experienced traders. Here, traders utilise various methods to analyse trends in the market. They can take a short position during a downtrend and a long position during an uptrend to reap quick profits.
2. Inside bar
There are two bars in this trading strategy. The outer bar holds more significance than the inner one. Lying between the low and high range of this outer bar, the inner bar forms during market consolidations. Its formation can indicate a change in the market. Experienced investors analyse the inner bar to understand whether there is a turning point and consolidation.
3. Pin bar
Financial experts call this a candlestick strategy because of the way it appears. While each bar shows the reversal or rejection of a particular price, the pin bar pattern resembles a candle with a long wick.
The wick stands for the price range, which represents a reversal or rejection. The price of an asset moves in the opposite direction of the wick. Traders analyse the movement and decide whether a long or short position will be beneficial.
4. Trend after a retracement entry
Traders follow the existing trend in this price action strategy. They can consider short selling if the asset price is on a downtrend. But, when the price increases, they will typically buy in.
5. Trend after a breakout entry
If there is a price movement outside the support line, it is referred to as a breakout entry. With this trend, traders can map market movements if they predict that a price increase will lead to a retracement.
6. Head and Shoulders reversal trade
The head and shoulders pattern is a widely recognised price action strategy, named for its resemblance to a head flanked by two shoulders. Traders often enter a position after the formation of the first shoulder and set a stop loss after the second shoulder. This strategy capitalises on a temporary peak, represented by the head, and anticipates a reversal in the market trend.
7. The sequence of highs and lows
The sequence of highs and lows strategy helps traders identify emerging market trends. Higher highs and higher lows indicate an uptrend, while lower highs and lower lows suggest a downtrend. Traders can use this sequence to determine entry points by buying at the lower end of an uptrend and setting a stop loss near the previous high or low.
Different tools used for price action trading
Beyond the core price action strategy, traders often incorporate the following classic analysis tools to refine their approach:
a. Breakouts
A breakout occurs when a security's price moves beyond a previously established resistance or support level. This can signal a potential change in trend. For instance, if a stock has been trading between ₹2700 and ₹3000 for a month and then breaks above ₹3000, it suggests that the sideways movement may have ended and an upward trend may be starting.
b. Candlestick Charts
Candlestick charts provide a visual representation of price movements over specific time periods. They offer insights into market sentiment and potential trend reversals. Examples of candlestick patterns include bullish/bearish engulfing lines and bullish/bearish abandoned baby tops and bottoms.
c. Trends
A trend is a sustained upward or downward movement in a security's price. Traders identify bullish trends when prices are consistently rising and bearish trends when prices are consistently falling.
Benefits of price action in trading
Here are the benefits of using price action trading:
- Traders can use price action in trading to make more informed trading decisions
- Price action trading is a suitable strategy for short to medium-term profits on trades
While price action trading has its benefits, traders must be aware of their maximum risk-taking ability before finalising a deal. It is important to understand the mutual relationship between assets before deciding on diversification. It is a trading strategy suitable for traders who prefer simplicity in their analysis.
Conclusion
Price action trading offers a straightforward approach to trading by focusing on price movements rather than a plethora of technical indicators. Its simplicity makes it accessible to both novice and experienced traders. By employing strategies like trend trading, inside bar, pin bar, and trend after retracement or breakout entries, traders can make informed decisions based on market behaviour. While price action trading provides opportunities for short to medium-term profits, traders should always consider their risk tolerance and understand the dynamics between different assets to effectively diversify their portfolios. This method is particularly advantageous for those seeking clarity and directness in their trading strategies.
