In simple terms, price action is a trading technique that allows a trader 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 them information on past price movements.
Why would traders want to base their 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, past information can help the trader to learn what prices are most likely going to do in the short term, rather than trying to guess using lagging indicators.
A more technical explanation is:
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 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. Price action traders are a form of technical trader who rely on technical analysis but do not rely on conventional indicators to point them in the direction of a trade.
These traders rely on a combination of price movement, chart patterns, volume, and other raw market data to gouge whether or not they should make a trade. This is seen as a "simplistic" and "minimalist" approach to trading but is not by any means easier than any other trading methodology. It requires a sound background in understanding how markets work and the core principles within a market, but the good thing about this type of methodology is it will work in virtually any market (stocks, foreign exchange, futures, gold, oil, etc.).
The purest form of price action trader is a “tape reader”. Good tape readers don't need charts, although some may glance at a chart occasionally, especially if they're in a position - they may be looking for support or resistance areas to take profits. However, it is rare to find a tape reader using any indicators or oscillators. Their primary tools will be the Time & Sales window and perhaps their Depth of Market (DOM) if they can multi-task. Nothing else is needed. Trades are taken on the basis of order flow, so that in essence they are trading pure price action.
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 that 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. A price action trader goes that extra step further to look for the explanation about not just what is happening now, but why it happens, so that they can make good decisions in the future. This also enables the trader to read price history and make better analytical decisions in present and future trades.
Advantages of price action trading:
- It is free! - A price action 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.
- It can be used on any market at any time under any circumstances (E-Mini S&P, Forex, stocks, other commodities, futures and currencies).
- It can be used with any trading software (NinjaTrader, TradeStation, MetaStock, etc.).
- It is fast - Price lag is irrelevant, old data will not obstruct trading.
- It is versatile - Price action trading methods can be combined for a coherent trading system that is free of conflicting data.
However, a trader must take time to learn, and understand how to trade it. Education is needed to master the methods and practice is the key.
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 steady and accurate.
Price action traders are not likely to become millionaires overnight with price action trading, but when used correctly, it can help them to become better traders. 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 using 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.
An Example of trading price action
In this scenario, the main area of trade is identified.
The green 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.Price Traders
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