“What is Price Action?”
This a question frequently asked by aspiring traders. Traders, who ask, feel it is a well kept secret when all they receive for an answer is: “Swing highs, swing lows, test of top/bottom, etc., are all price action.” The answer still leaves them in the dark. Understanding this concept enables a trader to minimize questionable entries and improve exits. However, this action can definitely be the footprint of the money!
In simple terms, it is a trading technique that allows you to read the market and make trading decisions based on the actual price movement on the chart, rather than relying on lagging indicators. Most indicators are derived from the actual prices on the chart, so they are in fact, giving you information on past price movements.
Why would you want to base your trades on past information, when the most important factor in trading is what prices are doing right now, and what they are most likely to do in the very near future? By using certain strategies, it can help you to learn what prices are most likely going to do in the near term, rather than trying to guess using lagging and misleading indicators.
A more technical explanation is .....
that Price Action is the movement of a security's price. This action is encompassed in technical and chart pattern analysis, which attempts to find order in the sometimes seemingly random movement of price. Swings (high and low), tests of resistance and consolidation are some examples of price action.
The candlestick and price bar are important tools for analyzing price action, since they help traders visualize of price movement. Candlestick patterns such as the Harami, engulfing pattern and cross are all examples of visually interpreted price action.
Price Action Traders
Price action traders keep things simple which can also be an effective methodology when it comes to trading. There are groups of traders known as price action traders who are a form of technical traders that rely on technical analysis but do not rely on conventional indicators to point them in the direction of a trade or not.
Intuition is Important
This type of trading should be at the forefront when it comes to day trading strategies. Everything you need to know about where prices are headed can be found directly in the price action. Unfortunately most people will never get to that point, as most traders are looking for, the easy way out. They try to find trading systems that solely rely on lagging indicators. They would rather let the indicators make their trading decisions for them.
However, when it comes to this trading technique, it involves more intuitive thinking. Price action strategies don't rely on stochastic crosses, price divergence on oscillators like an MACD. If you learn to read and understand the language of price action, there is no need for fancy indicators. You will soon learn to trade profitably using nothing more than a single, uncluttered chart. It’s the kind of trading strategy that requires knowledge of support and resistance lines, breakout points, and most importantly repeated patterns in price.
Instead of using indicators to base trading decisions on, you become the indicator. The only difference is that it takes some time to get used to this style as 99% of traders are used to covering their charts with needless indicators.
You don't need a fancy trading station with stacks of monitors, nor do you need any expensive and over used indicators that will simply confuse you and trick you into entering bad trades.
With price action trading, all you need is a single chart, a simple moving average and a few trend lines. Anything more than this and you will only make trading more difficult.
Using this type of trading method as your main trading tool will clean up your charts and remove the clutter that normally creates confusion and indecision for traders. Basing your trades on price action aids you in finding reliable reasons to enter a trade, while also giving you clear and precise trading information.
Price action trading is also very technical and deals with reading price history. Most traders think they know everything there is to know about support and resistance already, but the truth is reading price history isn't as easy as most people think.
There's a lot more that goes into understanding a chart than just drawing some basic support and resistance lines, and trading, this way, goes that extra step to explain not just what is happening but explain how and why it happens so you can make good decisions in the future. This enables the trader to read price history and make better analytical decisions in present and future trades.
Trading Price Action
Identifying the Main Area of Trade
The rectangle area is classed as the price action area. This actual trading area is the area preceding an “extended” price movement – often from some consolidation period as noted in this example.
In this case, relating to the price action area rectangle, there was a left side swing that consolidated between the swing low and resistance, which was evident where the sell swing last broke – observed by the yellow circle.
Pricing Action with Swing Highs and Lows
The First thing that we need to recognize is what is a Swing High and Swing low. This is probably the easiest part of this method of trading, and bar counting, although the whole process gets easier with practice.
A swing high is formed when the high of a price is greater than a given number of highs positioned around it. A series of consecutively higher swing highs indicates that the given asset is in an uptrend.
Swing highs can be used by traders to identify possible areas of support and resistance, which can then be used to determine optimal positions for stop-loss orders. If an indicator fails to create a new swing high while the price of the security does reach a new high, there is a divergence between price and indicator, which could be a signal that the trend is reversing.
A swing low is created when a low is lower than any other point over a given time period. Successively lower swing lows indicate that the underlying asset is in a downtrend, while higher lows mean it is in an uptrend.
Swing lows are useful for an investor who holds a long position in an asset because swing lows can be used to determine strategic positions for a stop-loss order. One main tenet of the Dow Theory is that if a major average breaks below a previous low, this movement can be interpreted as the beginning of a downtrend. In the case of an indicator, if it fails to make a new swing low while the price continues to decline, a divergence occurs which could mean that the downtrend is coming to an end.
Contrary to popular belief there are actually three ways the market can go;
With the swing high/low definition now in mind we can start to build some layers on to the chart to identify these market phases and start to do a simple count of these swing highs and lows. In short.....
1. The market is going up when price is making higher highs and higher lows.
2. The market is going down when price is making lower highs and lower lows.
3. The market is going sideways when price is not making higher highs and higher lows OR lower highs and lower lows.
• HH - Higher High
• HL - Higher Low
• LH - Lower High
• LL - Lower Low
Let’s start with the very basics. The bars on the following chart are labeled as traders commonly referred to them.
Up Bar is a bar with a higher high and higher low than the previous bar. The bars marked off are in an uptrend. Notice how the close is higher than the open until what turns out to be the last bar of the trend where the close is lower than the open. There were more sellers than buyers on the last bar.
Down Bar is a bar with a lower high and lower low than the previous bar. The bars marked off are in a downtrend. Notice how the close is lower than the open until what turns out to be the last bar of the trend where the close is higher than the open. There were more buyers than sellers on the last bar.
Inside Bar, also called a narrow range bar, is a bar with the high that is lower than the previous bar and low that is higher than the previous bar. Some traders do not consider an inside bar that has either an equal high or an equal low as an inside bar, others do. Inside bars usually represent market indecision. As on any bar, the closer the open and close are to each other shows just how undecided the market is as neither the buyers or sellers are in control. Buyers are in control on the inside bar marked on the chart because the close is at the top of the bar.
Outside Bar, also called a Wide Range or Engulfing Bar, is a bar with a high that is higher than the previous bar and with a low that is lower than the previous bar thereby engulfing the previous bar. Since the open and close are close together on the marked bar, neither the buyers or the sellers are in control and the market is undecided which way to go.
When the open is in the bottom quarter/third of the bar and the close is in the top quarter/third of the bar, it is said to be bullish engulfing with the buyers in control. When the open is in the top quarter/third of the bar and the close is in the bottom quarter/third, it is said to be bearish engulfing with the sellers in control.
Another definition used for this bar – especially if candlestick charts are used – is that the open and close have to engulf the previous bars open and close and not just the high and low of the bar. With this definition, the wide range bar or engulfing bar does not need to have a higher high or lower low to qualify.
The first definition most probably came about with bar charts where it is harder to notice the open and close.
This may sound very simple and a statement of the obvious, but you will be surprised at how often people will forget these simple facts.
What every investor/trader needs to know is….. which way is the market going?
By doing a simple exercise you can see which way that price is going and decide on your trading plan and more importantly timing of a trade.
It may be that you are looking for a shorting opportunity as the overall trend is down but price on your entry time frame is still going up (making HH's & HL's). There is, at this stage, no point in trying to short a rising market until price action start to point down (making LH's & LL's.).
A Short or Bearish Bias Change occurs when the following sequence develops.
The bias change is confirmed when price moves below the last lower low made as highlighted on the chart.
Another way of saying this is 123 reversal and you are trading the pullback as your entry trigger (Red Line). There are a few variations of this pattern but this is quite simply a price trade action bias change in its simplest form.
A Long or Bullish Bias Change occurs when the following sequence develops.
The bias change is confirmed when price moves above the last higher high made as highlighted on the chart.
Another way of saying this is 123 reversal and you are trading the pullback as your entry trigger (Blue Line). There are a few variations of this pattern but this is quite simply a price action bias change in its simplest form.
Trending Price Action
After a bias change has been seen and confirmed, one of the phases that the market can then take is to start trending either up or down depending on the bias change previously.
In the chart below we can see what price ideally looks like when price action is trending up and trending down. Each phase shows price making HH's & HL's on its way up and LH's & LL's on its way down.
Ranging Price Action
Now this is where the chart can become interesting. By using the price trading action of counting the swing highs and lows you can know at a very early stage if price is going to start to develop range bound activity.
Price is not making new highs OR new lows on the move.
This does not mean all time highs/lows or new day/week/month highs/lows.....just simply a new swing high or low on the move.
Price will start to stall and not make a new swing high/low and typically will stay contained within the last swing high and low that was made on the chart.
Range-bound rule definitions:-
1. Price doesn't make a new high or low on the move:
2. If price stays contained within the last swing high and swing low to be made, price will remain range-bound until it makes new moves to highs or lows.
3. Price confirms the range when a lower high and a higher low is made within the previous swing high and low.
In the chart below you can see that from the left side of the chart, price is making LH's & LL's all the way to the first blue arrow, which in real time would be the latest lowest low. Price then moves higher to make a HH. These two swing levels have been highlighted.
At the point of the chart, in real time, price needs to either start moving higher past the last swing high (red Arrow) making a new high OR, move lower past the last swing low (blue arrow) making a new low. Until either of those things happen, price will most likely remain range bound.
As price unfolds on the chart, price made a higher swing low and a lower swing high within the previous swing high and swing low highlighted, confirming that price action was moving into a consolidation phase.
Some considerations for identifying ranges at an early stage in real time are;
1. That price could be creating a pullback or bias change and as the chart unfolds for you a new high or low could be made voiding the potential range.
2. There are several definitions of a range. One of the more common ones is that you are looking for a double touch of support and resistance. Actually, in many cases, this could be a little too late in the game as price may not create the double touch in the example above. With this pricing action method you can identify the possibility of a range developing very early without having to worry if price does or does not give you the double touch.
As you can see with that definition you would interpret that price is not range-bound at all but, you can clearly see visually that price is moving sideways without any definition.
Summary.....What Has Been Revealed.....
1. A simple rule defined method to identify swing highs and lows,
2. How to use this swing high/low definition to interpret price action market phases,
3. How to identify a bias change,
4. How to identify trending price action, and
5. How to identify Range-bound price action.
Comparison of Trading Methods
At the moment it seems price action has the advantage with the comparisons made.
Price action trading:
• Is free! - a trader does not need to have extra software. Candles, bars, dots or any other chart price symbol will provide ample information for price action traders.
• Can be used on any market at any time under any circumstances (E-Mini S&P, Forex, stocks, other commodities, futures and currencies).
• Can be used with any trading software (NinjaTrader, TradeStation, MetaStock, etc.).
• Is fast - price lag is irrelevant, old data will not obstruct your trading.
• Is versatile - price action trading methods can be combined for a coherent trading system that is free of conflicting data.
• Must take time to learn, and understand how to trade it. Education is needed to master the methods and practice is the key.
• Is not free - most indicators are commercial.
• Lags behind price - data based on the past is unlikely to be of assistance in the present and the future in an ever-changing market. Until data can be transferred instantaneously across any distance, this will be a consistent outcome.
• Often produces conflicting signals and hesitation of when and how to perform trades.
• Compatibility is dependent upon the indicator's programming; only certain markets and/or trading software may be supported.
• Subject to the “law of overuse” - the more traders that use an indicator, the more a market will adapt "in retaliation" to its overuse, thus rendering it ineffective. Price action is free from such boundaries as it is based on watching the resulting changes in price.
• Easy to use, and follow. A no-brainer, nothing to think about and only following the signals is needed.
No two people will analyze every bit of price action the same way, and that is why a lot of traders find the concept of price action so elusive. Quite literally, price action is everything that a security's price does, and just like every other facet of analysis, it is purely subjective.
If we had to pick just one word to describe price action trading it would be "simplistic". This type of trading is probably the most simplistic trading method available, yet it is consistently considered the most consistent and accurate.
You are not likely to become a millionaire overnight with price action trading, but when used correctly it can help you to become a better trader and make better decisions in your trading. The simplistic strategies and concepts can be understood by nearly anyone which makes it an extremely attractive way to trade. While it doesn't have the reputation among new traders for being as "glamorous" as indicators, this actual trading has a reputation among advanced and professional traders as being the strategy to use no matter which direction the market is moving.
So before you jump into your next trade, do yourself a favor and educate yourself more on this trading method so you can make better analytical decisions in your trading.
While "Price Action" trading may be free, it may take a trader quite a while of practice (and a few losses) to determine what works.
The logical next step in preventing losses is pursuing a form of day trading education. Indicators are a dime a dozen and most focus on following the herd. Beginner to advanced educational programs are available and some even feature "Private Mentorship", a one-on-one trading from an experienced price action trader. Some programs include exact instructions on scalping methods, filtering trades, trading the news, and much more.
Also, I suggest you spend one day, doing nothing but looking at a chart with no indicators. Just follow the price movement all day long. You'll start to see patterns where you weren't seeing them before.
Best of Trading,
Director of Stock Options Made Easy