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Markets are constantly changing, which can be an uptrend, a downtrend, low volatility, or high volatility. So how do you know what the market is doing? When can an investor predict entry and exit times with better precision? Several methods for predicting and speculating the market include indicators, fundamentals, algorithms, blockchain methods, price action, etc. In this article, let us explore different dimensions of Price Action and Price Action trading.
Key Takeaways
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Price action analyses a security's past price movements to discover trends and potential reversals.
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Price action trading is completely dependent on chart data, with no indicators or external news inputs.
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Breakouts, candlestick patterns, and trend structures are common techniques used to predict entry and exit levels.
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Price action is effective for short to medium-term trading, but it has limits because it is completely dependent on previous price behaviour.
What is Price Action?
Price action is a trading technique where price movements (increases and decreases in a stock price) are plotted over a specific duration.
For simple understanding, price action is the movement of the price that is depicted through various types of charts. Some examples of bullish candlestick patterns are Hammer, Inverse Hammer, and Piercing Line, and bearish candlestick patterns are Hanging Man, Shooting Star, and Evening Star.
Also Read more about Hanging Man Candlestick Pattern
What Does Price Action Tell You?
Price action is the foundation for the technical analysis of stocks, including assets and commodities. Technical analysts use price action on charts to explore patterns or signs that can assist in predicting how a stock will behave in the future so that they can time the entry and exit points of trades accordingly. Additionally, many traders use this technique to determine key price levels and trends and formulate risk management strategies.
What is Price Action Trading?
When the price action technique is used to make trading decisions for any securities, such as stocks, bonds, currencies, commodities, and derivatives, it is known as price action trading. It is an approach to price predictions, speculation, and finding entry and exit positions. As the price is extracted from the price chart, it is also known as 'clean chart trading,' 'naked trading,' or 'raw or natural trading. ' In this trading strategy, the decisions solely rely on the security’s past performance and not on the news or any other data.
What is Price Action in the Stock Market?
Price action in stock market describes how the price of a security fluctuates over time. Instead of depending on outside signs or news, it entails charting historical price fluctuations to spot patterns, trends, and turning moments. Price action trading relies on the "naked chart" as its major source of data, with chart patterns, swing highs/lows, and breakout levels serving as the foundation for trading choices rather than derived technical indicators.
Who Uses Price Action Trading?
Price action trading is utilised by traders who depend on price movements rather than indicators. It supports many trading strategies because it focuses on trend structure, reversals, and breakout levels.
Users of price action trading include:
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Intraday traders monitoring short-term fluctuations.
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Swing traders identifying multi-day trend movements.
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Positional traders using long-term chart structures.
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Speculators using chart patterns to forecast price movements.
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Arbitrageurs studying pricing differences across markets.
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Proprietary trading businesses using rule-based pricing behaviour in internal models.
How is Price Action Different From Technical Analysis
Technical Analysis is dependent on price action as well as other factors such as option prices, open interest analysis, volume analysis, etc. On the other hand, price action only focuses on the movement of the price. Thus, price history and technical analysis tools, at the trader’s discretion, form the foundation of price action trading.
Different Tools Used for Price Action Trading
Along with employing a core price action strategy, a trader uses any of the following classic analysis tools to formulate a strategy.
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Breakouts
When a stock follows a particular trend, it tips off traders of a potential new trading opportunity when the trend is broken. For example, if a stock has been traded between ₹2700 and ₹3000 for the last 30 days and then moves above ₹3000, it alerts traders that the sideways movement has possibly ended and that a possible move to ₹3200 has begun.
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Candlestick Chart
It is a type of financial chart that graphically describes the price movements of a security, derivative, or currency in different time periods, both individually and collectively. Bullish/bearish engulfing lines and bullish/bearish abandoned baby top and bottom are some examples of candlestick patterns.
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Trends
A stock may be traded all day, with prices constantly rising or falling; this change is known as a trend. Traders refer to these upward and downward trends as bullish and bearish.
What are the Different Price Action Patterns
Out of the numerous patterns available, let us see a few -
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Pin Bar Pattern
It is a candlestick reversal pattern characterized by a small body and a long wick (tail). The long wick indicates that the market rejected a specific price level, suggesting a potential reversal in the opposite direction.
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Inside Bar Pattern
This is depicted by a 2-bar pattern where the outer or bigger bar is referred to as the mother bar. The mother bar's high and low values completely encompass the smaller bar. However, an inside bar pattern might be observed when a market consolidates.
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Three Candle Reversal Pattern
This pattern signals a reversal. It is made up of three candles that appear in a particular order: a bearish candle (red), a candle with a lower high and a higher low, and a bullish candle (green). The third candle must close above the high of the second candle and have a higher low.
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Head & Shoulders Reversal Pattern
The security price grows, declines, and rises to a lower high before a slight decline resembling a head-and-shoulder pattern.
Price Action Trading Steps
Here are the key steps traders often take when applying price action strategies to charts:
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Identify the market scenario: Determine the market trend by observing if the price is making greater highs, lower lows, or going sideways.
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Spot trading opportunities: Once the trend or market scenario is evident, consider how the price may react, such as forming a reversal pattern (e.g., a double-top), continuing the trend, or consolidating.
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Mark support and resistance levels: See where the price has previously responded or reversed.
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Wait for confirmation from price patterns: Before acting, use chart patterns such as inside bars or pin bars to check that buyers or sellers have gained control.
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Decide trade entry/exit and risk management: Make a systematic plan by setting entry, exit, and stop-loss levels according to how the price moves in these zones.
Best Price Action Trading Strategies
The following are some of the most popular price action trading strategies that assist traders in analysing market structure and short-term movements:
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Trend trading: This strategy entails determining whether the market is trending upward or downward and then trading in the direction of that trend. Traders use higher highs and lower lows to confirm momentum.
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Inside bar breakout: An inside bar occurs when a candle remains within the preceding candle's range. Traders utilise this setup to predict breakouts following periods of consolidation.
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Pin-bar reversal: A pin-bar indicates significant rejection of a pricing level. Its extended wick indicates a potential reversal, helping traders to predict turning moments.
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Pullback entry strategy: Traders wait for a brief pullback against the trend before entering when the price recovers to the main direction, with the goal of maximising risk-reward.
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Breakout Trading: A breakthrough occurs when the price rises above resistance or below support. Following confirmation, traders want to get in on the new price move as soon as possible.
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Head and shoulder reversal: This classic chart pattern indicates a weakening trend and a possible reversal. Traders use its formation to determine trend fatigue.
What are the Advantages of Price Action Trading
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Helps in decision-making
Using the price action trading methodology, you can enhance your trading decisions by using past prices (open, high, low, and close).
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Benefits of short-term investment
Instead of long-term investments, price action trading is best suited for short to medium-term profits on trades.
What are the Limitations of Price Action Trading
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Depends solely on past price
Price action trading depends on the security's history, but it is only sometimes a reliable indicator of future results.
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Interpretations can go wrong
No two traders will view a given price movement similarly because each trader has their own interpretations, rules, and financial knowledge, resulting in different results.
Risk Management in Price Action Trading
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Risk tolerance
Before you place the trade, be aware of your maximum risk tolerance or the loss you are willing to accept on each deal.
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Need for diversification
Recognise the correlation between assets and decide how much diversification you want.
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Know entry and exit points
Investors can predict entry and exit points using particular technical indicators to avoid losses.
Conclusion
Price action trading evaluates a security's previous price movements to better understand market behaviour without relying heavily on indicators. However. despite its benefits, price action trading has limits. It is primarily based on previous price data, which may not always precisely forecast future moves. Interpretations differ among traders, which can lead to contradictory results, especially in tumultuous markets. Many traders use price action alongside additional approaches such as volume analysis or trend confirmation to validate signals and decrease subjectivity.
