Price action trading is a popular approach that focuses on analyzing the movements of prices on a chart to make trading decisions. Analysis of price action is the interpretation and trading of price movements over time using raw price charts without the use of technical Indicators.
Suppose we learn to read the price action of a market. In that case, we can determine what the market’s directional bias is, as well as trade based on recurring price action patterns or price action setups that also reflect reversals or continuations for any given financial instrument. In other words, you are purely relying on the price bars on a “naked” chart for your trading decisions.
Price action can be visualized and interpreted using charts that represent prices over time. Traders use a variety of chart patterns in order to improve their ability to spot trends, breakouts, and reversals as well as to analyze them effectively. On the other hand, Candlestick patterns are commonly used by traders since they provide better visualization of price movements through Open, High, Low and Close in any given timeframe.
In today’s blog post, we will be looking at the different ways to analyze and interpret price action, what it tells us about a particular market, and how it can provide potential signals for trade setups.
Identifying Directional Bias through Price Action
Trends in the market typically fall into three categories:
- An upward trend represents a phase where buyers are in control, resulting in a bullish market.
- A downward trend, also called a bearish trend, occurs when sellers are in control.
- A sideways trend indicates a balanced market in which buyers and sellers are equally matched.
By solely observing the Price action of any given instrument, one can easily identify the trend of the market. When the market is in a sideways movement, the price will form equal lows and equal highs over a given period of time. When the market is in an uptrend, the price action will form higher highs and higher lows whereas when the market is in a downtrend, the price action will form Lower highs and lower lows. Let us illustrate this below for easier understanding:
Price action, therefore, allows one to identify the trend or directional bias of the market. It can be observed in all timeframes. A Swing trader or a Position trader would identify on larger time frames while a Day trader or a Scalper would identify trends on smaller time frames.
The High and Low structures created on a chart help us in identifying Demand and Supply zones or Support and resistance zones/levels respectively.
Identifying Structures and Order Blocks through Price Action
Support and resistance levels play a pivotal role in price action trading. They are areas on a price chart where the price tends to pause, reverse, or experience significant market activity. These levels act as barriers and can provide valuable insights into the market sentiment and potential trading opportunities. By understanding and identifying these levels, traders can make more informed decisions and improve their profitability.
Price will make consecutive higher highs and higher lows during an uptrend. Identifying structure correctly is crucial when trying to establish a trending market.
A structural price leg is the price action that occurs between higher highs and higher lows. As the price moves bullish, the low of this structure leg is protected and should never be broken, whereas the high is likely to be taken. If the structural low in an uptrend is broken it would signify a trend reversal for imminent bearish momentum. Once we have been able to identify structure legs, we can look for order blocks.
Order Blocks
Within these structural legs are order blocks – traders will focus their attention on these areas as points of interest for possible trade entries. In a bullish trend, an order block is formed with an aggressive bearish push and candle closure. The theory here is that the aggressive bearish movement in a bullish trend has a large volume of sell orders created by large financial institutions with the intention of ‘trapping’ traders into placing short positions.
Once the price continues to be bullish after this bearish push it stops these traders and creates the liquidity required to continue the bullish trend and generate higher highs. Let us now demonstrate how a bearish and a bullish order block can be identified on a chart for easier understanding:
Traders can take advantage of this market behavior by successfully identifying the price action legs and order blocks created within them. They can then wait for the price to retrace back to these order blocks to mitigate the orders before entering a long position in anticipation of a higher high in favor of the bullish trend. Let us now demonstrate this through the chart for easier understanding:
Analyzing Trends through Price Action
Trend analysis is an essential component of price action trading. Identifying and trading in the direction of the prevailing trend can significantly enhance the probability of successful trades. Traders often use various technical tools and indicators to determine the trend’s strength and direction, helping them make strategic entries and exits based on the market’s momentum.
Price patterns are repetitive formations on a price chart that indicate potential market reversals or continuation of trends. Recognizing these patterns, such as head and shoulders, double tops, or triangles, can provide traders with valuable insights into upcoming market movements.
Additionally, breakouts and breakdowns occur when the price breaches key levels, signaling potential trading opportunities. Understanding and effectively trading these patterns and price movements can lead to profitable outcomes. Let us now provide an example of a breakout through the chart for easier understanding:
Embracing Price Volatility and Selecting Trading Strategies
Price volatility is a crucial aspect of price action trading. Higher volatility often provides better trading opportunities, while lower volatility requires adapting to different strategies. Traders can employ swing trading strategies during high volatility periods to capture larger price movements or opt for range-bound trading strategies when the market is consolidating. Adapting to price volatility is essential for the successful implementation of price action trading strategies.
Utilizing Price Action Indicators and Signals
Price action indicators are tools that assist traders in interpreting and understanding price movements. While price action trading primarily relies on analyzing the raw price data, certain indicators or tools, such as moving averages or Fibonacci retracements, can complement the analysis.
These indicators or tools, when used in conjunction with price action signals, can help traders validate their analysis and identify potential entry and exit points with higher confidence. Let us once again demonstrate this on the chart below:
As can be seen in the image above, using other price action indicators, we can identify confluences as a further confirmation of our trade setup.
Use of candlesticks in Price Action trading
Candlestick patterns are a form of visual representation of price action in financial markets, including forex. Price action refers to the movement of prices over a specific time period, which is depicted through candlestick patterns on a chart. Each candlestick provides information about the opening, closing, high, and low prices for a given period.
By analyzing candlestick patterns, traders can gain insights into market sentiment, trend reversals, and potential future price movements. These patterns are formed by the interaction between buyers and sellers in the market and can help traders make informed decisions based on historical price behavior. Let us now once again provide an example through a chart below for easier understanding:
To conclude
Price action trading offers traders a powerful approach to interpret and capitalize on market movements. By incorporating technical analysis, understanding support and resistance levels, identifying trends, recognizing price patterns, embracing price volatility, and utilizing price action indicators and signals, traders can enhance their trading performance. With dedicated practice, continuous learning, and disciplined risk management, traders can unlock the full potential of price action trading and navigate the financial markets with confidence and precision.
