Updated: Jul 27
(Listen this article in audio format)
(voiced by - Sharmila R Udupa)
Did you know that most of the technical indicators are derived from the price? Besides, price action trading plays a crucial role in all types of trading? Be it scalping, intraday trading, breakout trading, or positional trading.
This article will cover all the aspects of price action trading, starting from the basic definition to the application part, which is beneficial to forex, commodity, equity, and derivatives traders.
What is Price Action?
'Price Action' means price fluctuations of a script in the given market.
On any trading day, from open to close, the price keeps on changing. This variation is nothing but price action (market action).
What is Price Action Trading?
It is a trading technique in which traders make trading decisions by looking at the naked price chart
Price Action traders don't use any technical indicators
They look at only 'Price' and 'Volume' information on the chart
PA is a powerful trading technique
The famous trader John Murphy has mentioned in his book "Technical Analysis of the Financial Markets", that technical analysis is the study of market action using charts, aiming to forecast future price movements.
He also suggests the best way to learn about the stock market is using only two components - 1) Price and 2) Volume.
Why Price Action Trading is the Best?
Price dictates indicators and not vice-versa.
The price contains all the information.
Even after knowing fundamental knowledge of stock, traders have to trade with the price.
Indicators Ignore Human Psychology.
Indicators Overcomplicate Trading.
What Does Price Action Mean in Trading?
Removed all of the Moving Average (MA), Bollinger Band (BB), PSAR indicators?
Removed all the underlying indicators like RSI, Stochastics, MACD, ADX?
Do you think you would be able to trade? Some traders may ask how to trade in the stock market then?
It might look impossible, but don’t forget most of the indicators derive their existence from one thing – ‘PRICE.’
A fluctuation in the price will also bring variations in those indicators. Isn’t it?
Then which is better to study? The PRICE, or Indicators? one can think for some time.
The three essential components in share market trading are (in the same order):
Price—it advertises all the opportunities.
Time—it regulates all the opportunities.
Volume—it measures the success or failure of all the advertised opportunities.
Volume is essential as 80% of the trading volume is given by 20% of the big players.
Price Action Indicator
As the name suggests, any ‘Indicator’ gives the indication. But they don’t dictate the price. In fact, any changes in the price will cause variations in most of the indicators.
It is widespread to hear many misconceptions about indicators in the stock market community.
For example, many traders say, ‘RSI is reached 30, which is an oversold zone, and hence the price will bounce back now’. But the price doesn’t know (or care) whether RSI has reached 30 or not, and it just does what it has to do! If the price shows more fall, then the RSI value will also fall (but relatively slow below 30).
It doesn't matter whether a trader uses a bar chart, line chart, point & figure chart, or Heiken-Ashi chart. It is always better to give top priority to price action. In fact, ‘Price’ is the topmost Price Action Indicator in the world of trading!
How to Learn Price Action Trading?
Remove all the indicators from the chart
Draw support & resistance lines
Observe the price behavior near support or resistance
Plan a long trade if the price fails to break the support
Plan a short trade if the price fails to break resistance
Trial your stop-loss
Price Action Trading vs Indicator Trading
In the trading world, the debate between 'Price Action Trading' vs 'Indicator Trading' is old as Trading itself!
Below are the 4 important factors which highlight the importance of price action trading over indicator-based trading:
Indicators Ignore Human Psychology
Indicators Don't Dictate the Price
Indicators are lagging in Nature
Indicators Overcomplicate Trading
Watch the video to know more.
What does a candlestick chart show?
The price is represented in many forms- line chart, bar chart, or candlestick chart.
But candlesticks charts are the most appealing and powerful representation of the price. Hence we dig a little deeper with candlestick charts.
The candlestick chart reveals open, close, high, and low levels in a user-defined time.
If a user selects a daily chart of a stock, then the above-displayed candles represent a full day's worth of trading.
The low and high price levels indicate the highest price and lowest price made on the trading day
In a bullish candle, buyers have won the battle because the closing price is higher than the opening price.
In a bearish candle, sellers have won the battle because the closing price is lower than the opening price.
It is the primary way to analyze the price using these candlesticks. There are 6 powerful candlestick patterns that often occur in all the markets and in all the timeframes.
Before we look at them, let's first look at where they work best.
Some traders also use chart patterns to plan their trades. Some of the popular patterns are:
Cup and Handle
Double top and Double bottom
Inverse Head and Shoulder
Price Action Forex Trading
As price action trading involves the analysis of price and volume (predominantly price), it can be used in all financial markets. It includes the forex, commodity, bonds, derivatives, and equity market.
However, the forex market has extra advantages as compared to other markets, such as:
It is the largest financial market in the world, so no liquidity issues
It will be open 24 hours a day, five days every week
Forex brokers offer good leverage.
The 6 Most Powerful Candlestick Price Action Patterns
We have millions of candlestick patterns. Studying all of them is foolish because it’s difficult to understand all of them and difficult to implement in the live market.
We need to pick them based on the below parameters:
If any candlestick formation has less impact, then it is not useful.
Similarly, if there is a powerful candlestick formation, but if it doesn’t occur very often, again it’s of no use.
Based on these parameters, I have shortlisted 3 candlestick formations:
Engulfing - Bullish Engulfing and Bearish Engulfing
Harami - Bullish Harami, Bearish Harami
Hammer/Hangman - Hammer comes in an downtrend, whereas, Hangman comes in a uptrend
These candlestick patterns help swing traders, trend traders, and even day traders as well.
Engulfing candles tend to signal a reversal of the current trend/swing in the market. This specific pattern involves two candles, with the latter candle ‘engulfing’ the entire body of the candle before it.
The engulfing candle can be bullish or bearish depending on where it forms in relation to the existing trend. Hence, we have two types of Engulfing:
If you look at the above image, the price showed a Bullish Engulfing pattern.