What Is Price Action Trading
Price action is one of the popular methods in technical analysis, and it is used heavily in the financial markets. It is also known as price behavior. Because price action is a broad subject that several books — let alone a few articles — could not fully cover, this article gives a simple introduction to trading with price action.
What is price action?
Price action: a trading approach in which the price chart is used without any add-ons or indicators, meaning the chart is left completely bare, in order to analyze the market and estimate where price may move next.
Although economic data and global news events are among the catalysts that affect price movement, you do not need to analyze that data in order to trade with price action. The reason is simple: all the economic data and global news that move price are ultimately reflected on the chart, which lets you analyze them through price action.
Because price action reflects every variable — and you can recognize them through the price action patterns that show up on the chart across any time frame — many price action traders consider technical indicators such as the Stochastic, MACD, and the Relative Strength Index (RSI) to be a waste of time.
Read also: Best day trading strategy — the top 10 strategies.
Bare charts versus charts crowded with indicators
To show the big difference between a bare chart and one that carries a set of technical indicators, look at the following two figures.
The first figure shows a bare chart, free of the many technical indicators that create clutter and can leave you distracted and unable to make the right decision about your trades.
It is worth remembering that a chart loaded with indicators makes you give up a large part of the space set aside for price movement, which can make the picture unclear, as shown in the two figures above.
If you look carefully at these charts and think about which is easier to analyze and trade, the answer is that bare charts are easier to read than a chart loaded with indicators. The reason is that adding a group of technical indicators shows you several possibilities for the next move, and you will not be able to tell which one is correct — unlike bare charts, which are clear and point to a single possibility.
An example of trading with price action
Look at the figure above. You will see that price was falling until a reversal pin bar appeared, which turned the direction to the upside. After that, price failed to form a reversal pin bar — which is normal, because no method guarantees a 100% accurate forecast. You will then notice that a continuation pin bar formed, and the trend kept climbing as it was. Price then started a small correction, but an inside bar soon appeared supporting the move up, and price indeed rose again.
Note: before going deep into price action, you should study the Japanese candlesticks first.
How to identify the market direction
One of the most important basics in the price action school that you need to learn is how to identify the market direction, because trading with the trend is your path to making profit in the forex market.
There is no difference of opinion among analysts who use price action, unlike other schools of analysis. With Elliott waves, for example, there can be more than one scenario for the expected move, whereas with price action the direction is clear: once a high appears above the previous high, that signals an uptrend, and conversely, once a low appears below the previous low, that is evidence of a downtrend.
Look at the following figure.
In the figure above you will notice that price makes a higher high and a higher low, which is clear evidence of an uptrend.
Look also at the following figure.
In the figure above you will notice that price makes a lower low and a lower high, which is also clear evidence of a downtrend.
Trending moves versus sideways moves
As mentioned above, an uptrend is identified when a higher high forms, and a downtrend when a lower low forms.
A sideways (ranging) move can also be identified when the highs and lows are roughly equal.
Beyond identifying the trend, you can also work out the likely direction after a sideways move ends, and that is one of the useful features of price action.
The direction that follows a sideways move is worked out by watching the momentum that occurs during that move. To make the picture clearer, look at the following figure with me.
The chart above is on the British pound versus the US dollar (GBPUSD). You will notice that price formed equal highs and lows, which shows that the current move is inside a sideways range (within the red box), where the upper part is a support area and the lower part is a resistance area. You will see that price rose and fell several times, but the drop was weak — shown by the large size of the candle wicks — which points to weak downward momentum. Price then broke the range upward, and the sideways move turned into a rising, trending move.
How to trade with price action
There are several ways to trade with price action, such as combining it with support and resistance and trend lines. Let us take an example of that; look at the following figure.
The chart above is the pound-dollar pair (GBP USD) on the daily time frame. You will notice that we have drawn the support and resistance lines where price bounced nearby. After that, you will see price action patterns appear, such as the pin bar and the inside bar. At that point, trades could be taken after any of these patterns appeared near the support and resistance levels.
Conclusion
Price movement is generally not viewed as a trading tool in the way an indicator is; rather, it is the source of data from which all tools are built. Day traders and trend traders tend to work closely with price movement, avoiding fundamental analysis in favor of focusing on support and resistance levels to anticipate breakouts. Accordingly:
- Whatever strategy or system you trade with, having a solid understanding of price action is a big addition to the way you trade.
- One of the most important basics in the price action school that you need to learn is how to identify the market direction, because trading with the trend is your path to making profit in the forex market.
- Before going deep into price action, you should study the Japanese candlestick patterns first.
- A chart loaded with indicators makes you give up a large part of the space set aside for price movement, which can make the picture unclear.
- Because price action reflects every variable that affects this market on the chart across any time frame, using technical indicators such as the Stochastic, MACD, and the Relative Strength Index (RSI) is considered a waste of time.
Pros and cons of the price action strategy in forex trading
A brief look at the pros and cons of the price action strategy in forex trading, meant to help traders understand the positive and negative sides of this strategy before applying it in practice.
| Type | Point | Description |
|---|---|---|
| Pros | Simplicity | Does not require complex technical indicators, which makes it easy to understand. |
| Flexibility | Can be applied to different markets and time frames. | |
| Strong analysis | Gives a good understanding of the factors that move the market. | |
| Cons | Human error | Exposed to psychological influences and hasty decisions. |
| Needs experience | The strategy’s success depends heavily on experience and the ability to read the market correctly. |
Read also: Types of price action strategies.
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Disclaimer: This article is for educational purposes only and is not investment advice or a recommendation to trade. Trading forex and CFDs carries a high level of risk because of leverage and can lead to the loss of your entire capital. Price action patterns describe what the market has already done; they do not guarantee future outcomes, and any signal can fail. Only trade with money you can afford to lose, and consult a licensed financial advisor if needed. This site may earn a commission from broker links at no extra cost to you.
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