What is Price Action?
Price Action is a form of Technical Analysis in which you focus entirely on price and how it changes over time. In other words, you are trading momentum and movement in the market – and nothing else.
For this, you are using a clean chart that means a chart with no indicators, like the one you see below. Having said that, you might want to add a simple moving average or a couple of support/resistance lines but that’s it.
This chart is the sort of chart I would be looking at for my Price Action analysis. If I was actually trading this, I would be zooming in on a smaller section of the chart so that the latest bars would appear much clearer. You still need to be able to see some bars and patterns from the past trading action, but half or less of this chart would probably suffice. The important thing is to be able to clearly see where each bar opens and closes, and where it places itself in relation to the previous couple of bars.
When you trade using Price Action as your tool, you don’t worry about news, rumours, key numbers etc., and you don’t look at how macroeconomic or geopolitical factors could be influencing your market. It’s all about gauging whether price is likely to go up – or down – within the next few bars, based on an analysis of the bars leading up to this point in time. The idea behind Price Action is to try to get a sense of how market participants as a whole are thinking and what they are likely to do “more of” next – is it buying or selling?
This of course doesn’t mean that news and data are irrelevant to trading but only that they are already reflected in the prices and moves you see in the chart. In that sense we aren’t ignoring those factors, only we don’t look at them directly or attempt to interpret them. Instead, we are focusing on how price is reacting over time, and trade accordingly.
If this still sounds a bit vague to you, here is an example of how I would go about analysing a chart:
- Breakout Bar. We close below the last 18 bars. This bar could signal a massive sell-off. The question is whether this will stick or fail? The relatively long tail to the downside may indicate that there is doubt as to whether this is an actual trend reversal, or perhaps that we hit a point in the uptrend when a lot of sell orders were triggered?
- The next bar is a Confirmation Bar for the former bar in that it is a bear bar that closes at its low. Momentum is now definitely down so I would sell here. This bar is followed up by two more down bars which could be a place to add to my sell position.
- Clear bearish trend in this area: Red bars close at their lows, and both green and red bars have long tails on the upside, indicating lack of conviction in the few attempts at rallying. Sellers rule the game here.
- Double bottom. There’s a climax in the selling, followed by another red bar that closes 75% up. Then, there is a green bar with a fresh attempt to push the price down even further, but this fails and we end up with a green bar whose body occupies the top fourth of the bar. In the next bar we make yet another attempt at going down, then form a double bottom; this is followed by two massively green bars. These facts put together tell me that the sellers have now been swept away, and it’s time for a rally.
- Number 5 hasn’t been drawn into the chart but after point no. 4, a reverse head and shoulder can be noticed. It’s made up from (3) forming the left shoulder, (4) marking head and on the way up to the right is the second shoulder. What this tells me is that the rally has further to go.
In contrast to doing a fundamental analysis, in which you often will end up disappointed when your market refuses to act accordingly, Price Action is a straightforward method. All you need to look at are the candlestick patterns, then assign to the market the probabilities of the market moving up, down or sidewards. You then place a bet on what you deem as being the most likely outcome.
As you can see this is a highly mechanical way of trading, without regard for news, macroeconomic events, or even for the very instrument you are trading. All it is, is a game of probabilities – and the challenge is to evaluate the chances of the different outcomes correctly.
One of the greatest strengths of the price action method is that it makes it much easier to identify trends and trend reversals; that was the thing that caused me the most problems when I began trading. After the fact, I would easily recognise the trend, but I rarely would as it was unfolding. I would feel uncertain about getting onboard a move which I perceived as maybe being the start of a trend – and when I finally did the market would turn against me in a flash. This left me with the familiar sense that the market was out to get me, waiting for my every move, only to do the opposite in the next minute.
By looking at the market bar by bar, I have been able to overcome this issue, as it has enabled me to come much better to terms with the dynamics of the market. Nowadays, I am usually onboard when the market turns and a new trend starts to develop. Personally speaking, it would have been nice if I had learnt this art of trading much sooner than I did. Especially, seeing as I am not equipped with Warren Buffett’s talents of spotting opportunities, aided by his intuition.
If this has spurred your interest in Price Action as a tool of trading, you can sign up for an online course on this page. This course deals with this subject among a lot of other things, such as the crucial subject of trading psychology. If you are having a sense of constantly picking the wrong direction in your trades, then I would particularly advise you to do this course.