Price Action Trading: Strategy & Benefit

What Is A Price Action Trading Strategy?

In trading, price action analyzes the performance of a commodity, security, index, or currency to predict its future movement. Traders take a long position when the price action analysis indicates a price rise and a short position when it indicates a price fall. Understanding price action trading requires pattern analysis to identify key metrics that can influence your investments. Traders can use various price action methods to predict market movements and profit in the short term.

How To Learn Price Action Trading?

Most experienced price action traders keep several options to recognise trading patterns, entry and exit levels, stop-losses, and other related observations. Using only one strategy on one (or more) stock(s) may not provide enough trading opportunities. Most scenarios involve a two-step process:

1. Identify a scenario: For example, a stock price entering a bull/bear phase, a breakout, a channel range, etc.
2. Identifying trading opportunities: For example, is a stock likely to (a) overshoot or (b) retreat after a bull run? This purely subjective decision can vary from trader to trader, even when presented with the same scenario.

Price Action Trading Strategies

To develop trading strategies, most price action traders use tools such as breakouts, candlesticks, trends, and support and resistance theories. Some of the price action strategies are:

• Trend Trading

Most traders base their trading decisions on price trends. They use various techniques to monitor and follow market price trends. This trading strategy is ideal for new traders as it allows them to learn from more experienced traders. To capitalize on the trend trading strategy, take a short position during a downtrend and a long position during an uptrend.

• Pin Bar

A candle with a long wick is a pin bar pattern. When you see a pin bar on a chart, it is usually a sign of a price reversal or rejection. The wick represents the price point that investors did not accept. Price action traders believe that the pin bar indicates that the price may begin to move in the opposite direction and decide whether to go short or long.

• Inside Bar

This is a two-bar strategy where the inner bar is smaller than the outer bar and falls between the low and high ranges of the mother bar (or outer bar). The smaller bar is usually formed during market consolidation, but can also portray a market turning point and act as a red herring.

• Trend After A Retracement Entry

Traders simply adhere to the current trend in this price-action trading strategy. Traders may consider short-selling if the price is in a downtrend and consistently making lower highs. Similarly, traders can enter if prices begin to rise.

• Trend After A Breakout Entry

A breakout occurs when the market moves beyond the support or resistance levels. Most day traders believe that the stock market will fall after a price spike (in either direction). As a result, they use these opportunities to take either short or long positions.

• The Sequence Of Highs And Lows

Traders use a ‘highs and lows strategy’ to forecast emerging market trends. For example, if the stock price is trading at lower lows and higher highs, it indicates an uptrend, while lower highs and lows indicate a downtrend.

• Head And Shoulders Reversal

Markets are typically volatile, with frequent ups and downs. A ‘Head and Shoulders’ pattern occurs when the market rises and falls. It is one of the most common price action strategies used by day traders. To take advantage of the high point offered by the head, traders typically choose an entry point after the first shoulder and a stop-loss after the second shoulder.

Benefits Of Using Price Action Strategy

Price action trading has many advantages, including less research time and better entry and exit points than indicator trading. It can be tested on simulators and allows traders to choose from various strategy options.

Limitations Of Using Price Action Trading

Price action is often subjective and traders may perceive the same chart or price history differently and make different decisions. Another drawback is that past price action is not always a reliable predictor of future outcomes. Therefore, technical traders should use a variety of tools to check indicators and be prepared to exit trades quickly if their predictions turn out to be incorrect.