The popularity gained by stock trading today has helped it to rapidly become one of the top career choices for young professionals. There are many concepts and trading strategies that need deep understanding for having a successful portfolio. Price action trading is one of many such concepts that are often used by seasoned traders to understand and navigate market fluctuations. The meaning of price action and its related details are given below.
Read More: How are stock prices determined?
What is price action trading?
Price action trading is a form of technical analysis of an asset or a security’s price. This strategy focuses on analyzing the price movement of the asset and interpreting it to find potential trading opportunities. Price action trading is the study of patterns and trends in price movements and understanding the support and resistance levels. Trades use this information to make effective trading decisions. Price action traders rely solely on the raw price data and not on traditional indicators or chart patterns for trading.
What are the four stages of market movement and why are they important?
There are four important stages of market movements that a security or an asset usually goes through. These stages are accumulation, advancing, distribution, and decline. Given here is a brief explanation of these stages.
This is the stage where the general market is still largely bearish and seasoned traders and investors are buying an asset at relatively low prices. The volume being traded is relatively low and the price movement is mostly sideways. This stage is known as the accumulation stage as the asset is still in the nascent or the initial of asset movement in terms of its price and volume.
This is the next stage where the market starts to trend upwards. The prices of the asset at this stage begin to rise more rapidly. This leads to an increase in volume and volatility as more investors become interested in the asset also facilitating an increase in the momentum of the market.
This is the third stage of the market movement where seasoned traders and investors begin to sell their holdings to the general public at higher prices. This is the result of the market being overbought. The volume at this stage decreases resulting in a price movement that is mostly sideways or slightly downward.
This is the final stage where the market sees a reversal of the ongoing trend. Prices at this stage begin to decline rapidly as more investors start to sell. There is a significant increase in the volume as well as volatility as the momentum builds to the downside.
Traders need to thoroughly understand these four stages in order to make better trading decisions. These stages are also crucial in identifying the market position and its overall trend thereby analysing the next move. By analysing price and volume movements during each stage, it becomes easier for the traders to determine when to enter or exit positions, and what strategies to use in different market conditions.
What are key price action trading strategies?
There are several price action trading strategies that can be adopted by traders in understanding the market movement and creating their portfolio. Some of the key price action trading strategies are discussed below.
This is the easiest strategy that can be adopted by any trader. It requires the traders or the investors to simply follow the current market trend and to buy and sell securities in correlation to the same. Traders can use many supporting indicators to back their analysis and to have confirmation of the ongoing trend. The risk is lower in this type of trading as the price action is backed by the ongoing trend.
Price action patterns
This strategy requires the traders to identify various price action patterns like triangles, wedges, or other similar patterns. It is important to understand these patterns to identify potential trend reversals and take suitable actions.
Support and Resistance
The key analysis in the price action strategies is to correctly determine the entry and exit points for maximising the returns. Therefore, it is critical to understand the support and resistance levels of the asset based on past performance to determine the optimum entry and exit points for such an asset. Traders should also use stop loss while taking suitable trading positions to limit their losses irrespective of a long or short position.
There are numerous candlestick patterns that can be used by traders in analysing the price action of an asset. Identifying the size and the colour of the candle is instrumental in understanding the price and volume movements of the asset thereby taking a suitable buy or sell decision. Candlestick patterns can also help in identifying potential trend reversals or confirmation of the ongoing trend.
Breakouts are opportunities for traders to tap into the early movement of the asset. It is crucial to understand the key support and resistance levels to understand possible breakouts at either level. It is important to note that before taking a buy or sell decision at breakouts, traders should have a clear understanding of the market and the price or volume movement of the asset as this can be a high-risk and high-reward situation.
What are the benefits of price action trading?
Some of the key benefits of price action include,
Price action trading is a relatively simple and straightforward approach to technical analysis. Traders do not need to understand complex algorithms or formulae that are required in understanding various indicators. This makes it less time-consuming for traders and investors to take necessary actions.
Price action trading is quite versatile and can be used on any asset or market condition. Therefore it becomes easier for traders to adopt this strategy to different timeframes and trading styles. Traders can therefore customize their strategy to fit their individual preferences and risk tolerances.
Price action trading involves analysing the naked prices or the raw price data. Therefore, it can be a highly accurate approach to trading and there is no reliance on lagging indicators or other factors.
Traders can use price action trading and understand real-time price data. This can help traders identify potential trading opportunities instantly without any delay. Therefore, price action trading can aid traders in making informed decisions about when to enter or exit a position by closely watching price movements and patterns.
Traders can use stop loss for limiting their potential losses and to protect their capital. This helps in effective risk management while using price action trading.
What are the limitations of price action trading?
There are various limitations in price action trading. Some of these limitations are mentioned below.
The study of price action analysis is quite subjective. The interpretation of the chart patterns can be different for different traders. This leads to inconsistent trading decisions which can also result in huge losses.
Inability to account for fundamental factors
Price action trading does not consider the crucial fundamental factors that affect the market movements as well. These fundamental factors include economic or political changes, financial reports, competition or industrial factors, etc.
The basis of price action trading is analyzing historical price movements. This type of analysis has limited scope as it may not always accurately reflect future market conditions.
Lack of predictive power
A price action analysis is used to gain insights into past market behavior. However, it does not necessarily predict future price movements with high accuracy.
Price action does not rely on indicators but solely on the price movements of the asset. This can lead to emotional biases for traders that can severely cloud their judgment and lead to poor trading decisions.
Price action trading can be a powerful approach to trading that allows traders to make informed decisions based on the price movements of a stock or any other asset. By consistently using price action trading strategies, traders can potentially increase their accuracy, reduce their risk, and improve their overall trading results. However, it is also important to gain huge market insights before solely relying on price action. Hence, this strategy is best suited for seasoned traders and investors rather than beginners.
Some of the top trading strategies using price action signals are the pin bar strategy, inside bar strategy, trend line trading, support and resistance trading, etc.
The top users of price action trading are speculators, retail traders, and trading firms, and can also be used in dealing with many securities like equities, forex, derivatives, and commodities.
The term naked price action also refers to the use or sole reliance on price movements of the asset to make trading decisions and not using any other indicators.
Breakouts provide potential signals for trend reversals or can also be seen as confirmation of ongoing trends. The support and resistance levels are crucial for understanding breakouts and use the same as potential entry and exit plans.