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 time 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.
What is Price Action
Price action is one of the trading techniques where price movements (increase and decrease 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.
What does price action tell you
Price action is the foundation for 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,
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 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 below-mentioned classic analysis tools to formulate a strategy.
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.
b. 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.
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, lt us see a few –
a. Pin Bar Pattern
It is a candlestick reversal pattern that shows that the market has rejected the price action at a particular time.
b. 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.
c. 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.
d. 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.
What are the advantages of price action trading
a. 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).
b. 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
a. 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.
b. Interpretations can go wrong
No two traders will view a given price movement similarly because each trader has their interpretations, rules, and financial knowledge, resulting in different results.
Risk Management in Price Action Trading
a. 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.
b. Need for diversification
Recognize the correlation between assets and decide how much diversification you want.
c. Know entry and exit points
Investors can predict entry and exit points using particular technical indicators to avoid losses.
Price action is a technique used to analyze a security’s performance by tracking its price movements. Experienced traders are most likely to benefit from this technique as they spot the patterns at a glance by perceiving specific shapes or past performance. However, price action trading also has its own set of limitations. Therefore, traders can use updated tools along with this strategy to validate indications.