A guide to price action in trading
Price action focuses on reading an asset's price movement without using indicators. In this guide, you’ll learn price action trading strategies to help spot trends and reversals for more precise market entries and exits.
What is price action in trading?
Price action in trading refers to the movement of an asset’s price over time, and it forms the basis for all technical analysis. Unlike relying on indicators or external data, trading price action focuses on reading charts, applying candlestick patterns, and observing past price movements to make trading decisions.
Traders who use price action believe that all necessary information about an asset is reflected in its price, and they look for patterns or trends to forecast potential future movements. CFD traders often use price action strategies to react quickly to short-term market changes without relying heavily on lagging indicators. By analysing support and resistance levels, trends, and breakout patterns, traders can make more informed decisions in fast-moving markets.
Price action vs technical analysis: the differences
Price action and technical analysis are both key approaches in trading, but they take different routes to achieve similar goals. Price action focuses solely on interpreting price movement, while technical analysis uses indicators like moving averages or RSI.
Price action
Trading price action refers to analysing an asset’s price movement over time, without using any external indicators. Traders rely solely on reading price charts, identifying patterns such as trends, breakouts, or reversals, and using candlestick formations to make decisions. Price action is a minimalist approach, focusing purely on the market's raw price data, often referred to as ‘naked trading’.
Technical analysis
Technical analysis, however, is broader and includes price action as one of its components. In addition to looking at price movement, technical analysis involves using various indicators, such as moving averages, MACD, and RSI, to help forecast future price trends. These indicators are built from price and volume data, adding layers of analysis that help traders interpret market behaviour more quantitatively.
In summary, price action focuses on price movement alone, while technical analysis incorporates tools and indicators to provide a more comprehensive view of the market.
|
Aspect |
Price action |
Technical analysis |
|
Definition |
Focuses purely on the movement of price over time. |
Uses indicators and tools (eg, RSI, MACD) based on historical price data. |
|
Approach |
Minimalist, relies on reading price charts and patterns. |
Involves complex calculations and various indicators. |
|
Tools |
Candlestick patterns, trendlines, support/resistance levels. |
Indicators like moving averages, RSI, Bollinger Bands™, MACD. |
|
Timeframe |
Suitable for short-term and medium-term trading. |
Can be used for both short-term and long-term analysis. |
|
Complexity |
Simple in terms of tools, but requires skill in interpretation. |
More complex, relies on multiple layers of analysis. |
|
Common usage |
Often used in forex, commodities, and stock trading. |
Used across all asset classes, including shares and forex. |
|
Decision making |
Based solely on price movements, without external indicators. |
Combines price data with statistical tools to generate signals. |
|
Goal |
Identify patterns like trends, reversals, and breakouts. |
Predict future price movements using historical trends and data. |
Tools used for price action in trading
Tools used for price action trading include candlestick patterns, support and resistance levels, trendlines, and price channels. These tools help traders identify trends, reversals, and key price zones without relying on external indicators, allowing for more direct interpretation of price movements. By focusing on these patterns, traders can make informed decisions in real-time market conditions.
Candlestick patterns
Candlestick charts are central to price action trading. Patterns such as dojis, inside bars, and engulfing patterns help traders identify market sentiment, reversals, and continuations. The shapes and positions of these candlesticks are key signals for price action traders. Learn more about candlestick patterns.
Support and resistance levels
These horizontal price levels represent where the price has historically stopped and reversed direction. Price action traders use support (the lower boundary) and resistance (the upper boundary) to identify potential entry and exit points. Breakouts above resistance or below support can indicate a new trend forming.
Trendlines
Trendlines connect a series of price points, either highs or lows, to create a line that shows the direction of the trend. Upward trendlines indicate a bullish market, while downward trendlines suggest a bearish one. These lines help traders visualise the trend and potential areas of support or resistance.
Price channels
Price channels are created by drawing two parallel trendlines that contain the asset's price movement. Traders use these channels to identify areas where price is expected to reverse or continue within a defined range, helping guide their trading decisions.
Chart patterns
Price action traders also rely on chart patterns like head and shoulders, double tops and bottoms, and triangles to predict future price movements. These formations are identified through price movements alone, without the use of technical indicators.
Volume
Although price action focuses primarily on price movements, volume data can be an additional layer of confirmation. Increased volume often confirms the strength of a price movement, helping traders gauge whether a trend is likely to continue.
Price action trading steps
Price action trading involves analysing price movements on charts to make informed trading decisions. The steps include identifying market trends, marking support and resistance levels, spotting key price patterns (like pin bars or engulfing patterns), waiting for confirmation, placing trades, and setting stop-loss and take-profit levels.
Identify market conditions
Begin by analysing the overall market trend. Is the market trending upwards, downwards, or moving sideways? Recognising whether you're in a bullish, bearish, or ranging market is key to framing your trading approach. Use tools like trendlines and support/resistance levels to assess this.
Mark key support and resistance levels
Draw horizontal lines at recent swing highs and lows, or at significant historical price levels. These will act as reference points for potential price reversals or breakouts.
Look for price patterns
Analyse candlestick formations such as dojis, pin bars, engulfing patterns, and others to detect potential reversals or trend continuations. These patterns could provide signals for the next move, whether entering or exiting a trade.
Wait for confirmation
After identifying a pattern, wait for confirmation before entering a trade. This could come in the form of a candlestick closing above or below a support or resistance level, or a strong candlestick formation in the direction of the trend.
Enter the trade
Once the price action confirms your analysis, it provides a possible window to place a trade. If you're trading a breakout, this could mean entering after the price breaks above resistance or below support. If trading a reversal, this may be achieved through entering based on candlestick signals like a pin bar at a key level.
Set stop-loss and take profit levels
A possible way to manage your risk is by setting stop-loss orders below the most recent swing low for long positions, or above the swing high for short positions. Potential take-profit targets could be set at the next major support/resistance level or based on a measured move of the price pattern.
Monitor price movements
After entering the trade and in order to better manage your risk, it’s advisable to continue monitoring the price action to adjust your stop loss or take profit levels if necessary. Watch for new patterns that might require an early exit.
Exit the trade
Consider closing your trade once your take-profit level is hit or if the price action shows signs of reversal against your position. Exiting based on price action patterns like inside bars or a failed breakout can preserve profits or minimise losses.
Price action trading strategies
Price action trading strategies focus on interpreting market movements directly from price charts. Here are a few effective strategies that traders commonly use:
Trend trading
In trend trading, traders identify the direction of the market (uptrend or downtrend) and follow it. By drawing trendlines connecting higher lows in an uptrend or lower highs in a downtrend, traders look for opportunities to enter the market when the price retraces to these levels. Candlestick patterns like engulfing bars or pin bars can be used to confirm the trend continuation before taking a position.
Breakout trading
Breakout trading focuses on identifying key support and resistance levels where the price has consolidated. When the price breaks above resistance or below support, it often signals the start of a new trend or a continuation of the existing one. Breakout traders place their trades just above the resistance level (in an uptrend) or just below support (in a downtrend), waiting for confirmation from a solid breakout candle before entering.
Reversal trading
Reversal trading looks for points where a trend is likely to change direction. Traders often use chart patterns like head and shoulders, double tops/bottoms, or triangles to spot potential reversal points. Reversal strategies are confirmed by specific candlestick patterns like doji or hammer formations that signal market indecision or a shift in momentum.
Range trading
In range-bound markets, where price oscillates between support and resistance without a clear trend, range trading is effective. Traders buy at support and sell at resistance, taking advantage of the price bouncing within a defined range. Inside bar and pin bar formations can be useful in timing entries in these scenarios, as they signal potential price reversals within the range.
Pin bar strategy
The pin bar is a single candlestick formation with a long wick and a small body. It signals a sharp rejection of a price level, indicating that a reversal might occur soon. Traders enter when the market moves in the opposite direction of the long wick, confirming that the rejection has led to a shift in momentum.
Inside bar strategy
The inside bar strategy involves a two-bar pattern where the second bar (the inside bar) forms within the range of the previous bar. This pattern signals consolidation and typically occurs before a breakout. Traders wait for the breakout in the direction of the dominant trend before placing trades.
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