A Comprehensive Guide to Price Action Trading

There are many methods you can adopt, and then master, to make informed trading decisions, manage risk effectively, and generate returns in the stock market. In this article, we will explore one of the most widely used online share trading techniques — price action trading. The term “price action” is an important concept every chart-scanning trader must know. This approach looks past the clutter and noise and focuses on the most relevant thing — the price itself.

What is Price Action Trading?

As mentioned above, price action trading is a technical analysis method that focuses on analysing and making trading decisions based solely on the price movements displayed on a chart. So, a trader adopting this approach does not rely on technical indicators or complex formulas. Instead, they analyse raw, unfiltered price data, which involves observing historical price patterns, trends, support and resistance levels, and other key market factors. 

A price action trader will study candlestick patterns, trends, support and resistance levels, and other market factors to understand market sentiment and predict future price movements. Based on these observations they take positions and manage risks. This approach is based on the belief that price patterns repeat themselves, providing traders with opportunities to predict and profit from stock market trends. Moreover, indicators like the moving average are also actually derived from the price action. 

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Types of Price Action Trading Strategies

Price action trading is versatile and can be applied to various markets, including stocks, currencies, commodities, and indices. So, let us take a look at the different types of price action strategies. 

Pin Bar

The pin bar is a widely recognized price action pattern that can provide valuable insights into potential market reversals. It consists of a single candlestick with a long tail — also called a wick — and a small body. The tail represents rejection of price levels, while the body indicates the opening and closing prices.

When a pin bar appears at a key support or resistance level, it suggests a possible change in market sentiment. For instance, a bullish pin bar at a support level may signal a reversal from a downtrend to an uptrend, while a bearish pin bar at a resistance level might indicate a reversal from an uptrend to a downtrend. 

Inside Bar

Similarly, inside bars occur when the length of a candle is completely engulfed by the length of the preceding candle. This pattern represents a temporary consolidation or indecision in the market. Inside bars are typically observed after a strong price move or during periods of low volatility and hint at potential continuation or reversal signals. 

Trend Trading

Moving on, trend trading is a price action strategy that aims to profit from sustained directional moves in the market. Price action traders identify and ride trends by analysing the series of higher highs and higher lows in an uptrend or lower highs and lower lows in a downtrend. To distinguish trends, traders may draw trendlines and also use price action derived indicators like moving averages.

Once a trend is established, traders look for pullbacks or retracements to enter trades in the direction of the trend. Trend trading allows traders to capture significant price movements and maximise profits by staying in trades as long as the trend remains intact.

Range Trading

Range trading, also known as sideways trading or mean reversion, is a strategy employed when the market is consolidating within a defined range. A range-bound market — or the range — is determined by strong support and resistance levels; the price oscillates between those established support and resistance levels. 

Traders look for the opportunities to buy at support and sell at resistance; they also look for other price action indicators, such as pin bars or inside bars, to identify potential reversals at/near the support and resistance levels.

Breakout Trading

In contrast to range trading, which focuses on trading within the range, breakout trading is the strategy employed when the price breaks above the range. Here, the key resistance level is identified, and the trader takes their long positions when the price cuts above the resistance with convincing volume and momentum. In the case of shorts, key supports are identified, and the trader takes their positions when the support is broken. 

Head and Shoulders

Lastly, the price action can also give shape to distinct patterns, one of which is the head and shoulders pattern. This pattern is a reversal pattern that signifies the end of an uptrend and the potential start of a downtrend. It consists of three peaks, with the middle peak (the head) higher than the other two (the shoulders), forming a shape resembling a human head and shoulders; hence, the name. Traders may consider exiting their long positions if the neckline — the lows of the two shoulders — of the pattern is breached.

Conclusion

In conclusion, the price action can offer a powerful framework for analysing market dynamics and making informed trading decisions. By understanding the language of price movements, you can gain insights into market sentiments, predict future price trends and employ various price action strategies. 

However, regardless of strategy, often, you may want to wait for confirmation, such as a subsequent candle closing in the anticipated direction, before entering a trade based on a pin bar pattern. It is essential to invest time in studying different price action strategies, practising with historical data, and continuously refining your approach.