What is 'Price Action'

Price action refers to the movement of a security's price and is encompassed in technical analysis. For example, a trader might say that a security's price action lends credibility to buyout rumors. Many short-term traders rely exclusively on price action to make trading decisions. Technical analysis is a derivative of price action since it uses past prices in calculations that can then be used to inform trading decisions.

BREAKING DOWN 'Price Action'

Price action can be seen and interpreted using charts that plot prices over time. Most traders prefer to use candlestick charts since they help better visualize price movements by displaying the open, high, low, and close values in the context of up or down days. Candlestick patterns such as the Harami, engulfing pattern and cross are all examples of visually interpreted price action.

Many technical analysts use price action when calculating technical indicators or identifying chart patterns. The goal is to find order in the sometimes seemingly random movement of price. For example, an ascending triangle pattern may be used to predict a potential breakout since the price action indicates that bulls have attempted a breakout on several occasions and have gained momentum each time.

Interpreting price action is very subjective. It's common for two traders to arrive at different conclusions when analyzing the same price action. One trader may see a bearish downtrend and another might believe that the price action shows a potential near-term turnaround. As a result, many traders would be better off using price action as just one part of a larger strategy.

Price Action Trading

Price action trading involves placing trades exclusively based on price action rather than fundamental or technical analysis. Swings (high and low), support and resistance levels, and breakouts and consolidation are some examples of price action. For instance, a short-term trader may watch for a price to breakout from a prior price that occurred on high volume before taking a long position.

Price action trading is most common among retail and institutional traders, although it's becoming less popular with the rise of algorithmic and high-frequency trading. Many pattern day traders will place very large trades, often with the use of leverage, using price action as their only guide with the goal of generating a profit from very small underlying movements. Technical analysis and fundamental analysis aren't especially useful in these cases given the very short-term nature of the price movements, but price action can provide some helpful clues into supply and demand balances.

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