Price Action Trading 

What Is Price Action?  

Price action is the movement of a stock’s (or any asset’s) price as it develops on a chart over time. It’s raw data—the actual fluctuations of buyers and sellers. This price movement is the fundamental cornerstone of all technical analysis. 

Many traders who focus on short-term movements rely entirely on observing price behaves, patterns, and trends they see directly on the chart. They use this information to determine when to buy or sell. In fact, the entire idea of ​​technical analysis stems from studying past price action and using it to create calculations and indicators that help predict future trading opportunities. 

How to read Price Action?  

We often observe how a stock price moves over time in the form of a series of bar or line charts. When studying this “price action,” we typically focus on two main things. First, we want to determine the price direction. Second, we want to understand the trend in the number of shares traded (the volume). 

Now, suppose a stock price rises, and at the same time, trading volume increases. This typically indicates a strong belief in this upward movement, as many investors are willing to buy even as the price rises. On the other hand, if the price rises with trading volume declining, this may indicate that this price increase is not reliable. This could mean that many investors are not truly convinced that the current price is a good level to buy. 

Understanding Price Action  

You can understand price behavior by looking at charts that show price changes over time. To get a clearer picture of trends, breakouts, and when a trend might reverse, traders use different methods to prepare these charts. 

Many traders prefer Japanese candlestick charts because they give a better visual understanding of price movements. They show the starting price, high, low, and closing price for days when the price rose and fell. 

Specific Japanese candlestick patterns, such as the Harami Cross, the Engulfing Pattern, and the Three White Soldiers, are examples of how traders read price behavior visually. 

There are many other Japanese candlestick formations that arise from price action, and traders use them to get an idea of ​​what might happen next. These same formations can be seen on other types of charts as well, such as point-and-figure charts, box charts, box plots, and others. 

In addition to simply looking at the shapes on the chart, many technical analysts also use raw price data to calculate technical indicators. The goal here is to find some order in what may sometimes appear to be random price movements. 

Key Price Action Concepts  

Well, let’s explore those basic ideas about how prices move on a chart: 

Support and Resistance 

Support and resistance are considered critical areas on a price chart, where the market has historically struggled to break through. Support is a price level that acts as a bottom, preventing the price from falling further because buyers tend to enter it. Resistance, on the other hand, is a price level that acts as a ceiling, where the price often stops rising because sellers become more active. 

Traders closely monitor these “support and resistance” levels to see what might happen next. If the price breaks through a support or resistance level, it could signal a continuation of the current price trend. However, if the price reaches one of these levels and rebounds, it could indicate a change in the trend. 

Trends 

Simply, a trend shows the overall direction of the market. In an uptrend, the price continues to make higher highs and lows, demonstrating steady buying interest. In a downtrend, the opposite is true: the price makes lower lows and highs, indicating selling pressure. 

To spot these trends, traders look at “swing highs” and “swing lows.” A swing high is a temporary peak where the price rises and then falls. A swing low is a temporary bottom where the price falls and then rises. By connecting these valleys and peaks, you can understand the current trend. 

Trendlines and Price Channels 

A trendline is a straight line that can be drawn on a chart to connect a series of swing highs (in a downtrend) or swing lows (in an uptrend). This line helps you visualize the direction of the trend and can serve as a potential area where the price may find support (in an uptrend) or resistance (in a downtrend). 

When you draw two parallel trendlines—one connecting swing highs and the other connecting swing lows—you create what is called a price channel. These channels show the range in which the price typically moves. The price often bounces between the top and bottom lines of this channel. If the price breaks through the channel, it may be a sign that the trend is about to change. 

Candlestick Patterns 

Price movement over a specific time frame results in distinctive “candlesticks” appearing on the chart. These candlesticks are widely used in price action trading. Here are some common examples: 

– Pin/Hammer/Shooting Star Candle: Imagine a price rising or falling sharply and then suddenly retracing, ending near its starting point. This creates a candle with a long tail (wick) and a small main (body). This type of candlestick indicates that the market has strongly rejected those high or low prices, and that the trend may be about to change direction. 

– Engulfing Pattern: This occurs over two candlesticks. The second candlestick is much larger than the first and completely covers it. If the engulfing pattern is bullish (the second candlestick is up), it indicates that buyers are in control. If the engulfing pattern is bearish (the second candlestick is down), it indicates that sellers are in control. 

– Doji Candle: Imagine a candlestick where the opening and closing prices are very close together, making the main body very thin or even nonexistent. This shows that there was a lot of volatility during that period, but in the end, neither buyers nor sellers profited. A doji pattern can indicate that the current trend is losing momentum and that a reversal may be imminent, especially depending on its position on the chart. 

Chart Patterns 

Sometimes, price action takes on specific shapes on a chart over time. Traders watch for these patterns because they may provide clues about the price’s likely direction, whether to continue its current trend or reverse. Here are some examples: 

– Head and Shoulders: This pattern looks like three peaks. The middle peak is the highest (the head), and the peaks on either side (the shoulders) are lower and of approximately the same height. This pattern often indicates that an uptrend is about to turn into a downtrend (or vice versa if the pattern is a reversal). 

– Double Top/Double Bottom: Imagine that the price has tried to break above a certain level twice but failed to break through (a double top), or tried to break below a certain level twice but bounced back both times (a double bottom). These patterns indicate that the price may be about to reverse its trend because it was unable to break through that key level. 

– Triangles: You may see price action forming a triangle. These triangles can be symmetrical (where the highs fall and the lows rise), ascending (where the lows rise while the highs remain roughly constant), or descending (where the highs fall while the lows remain roughly constant). Triangles often represent a period of stability before the price “breaks out” in one direction or another. 

Breakouts 

Imagine a price attempting to break above a certain boundary, such as a floor (support), a ceiling (resistance), or even a trendline. When it finally breaks above this point, it’s called a breakout. This can be a sign that the price is gaining momentum and heading strongly in this new direction. Traders often watch for breakouts based on chart patterns, such as triangles or channels, as they can indicate potential strong moves. 

Reversals 

A reversal is when a market returns to its normal course. If prices have been rising, making higher peaks and higher valleys, a reversal occurs when they stop and begin to form lower valleys. Certain candlestick patterns or chart shapes, such as head and shoulders or double tops/bottoms, can often indicate these turning points. 

Retracements  

Imagine a price moving strongly in one direction, then temporarily pulling back a bit before continuing its original path. This temporary pullback is a retracement. Traders often use tools like Fibonacci levels to predict where these retracements might stop before the main trend resumes. 

Volume 

Volume shows the amount of trading volume of a particular asset over a specific period of time. Price action traders use volume to gauge the strength of a market movement. For example, if a price breaks through a key resistance level and there is significant trading activity (high volume), this indicates that the breakout is likely real and will likely continue. If the breakout occurs with little trading (low volume), this may mean that the movement is not very strong and may reverse. 

Volatility 

Volatility is the amount of movement in a price over time. Price action traders pay attention to this because it affects how they understand patterns and levels. During times of high volatility, prices can quickly break through significant levels. During times of low volatility, prices may drift within a narrow range. 

How to Use Price Action in trading  

Rather than viewing price action as a trading tool in and of itself, it is similar to the raw information upon which all other tools depend. 

Swing traders and trend-followers often focus heavily on price action. They tend to avoid fundamental analysis, relying instead on support and resistance levels to predict when prices will break out or consolidate. 

However, even these traders need to consider more than just the current price. The amount of trading taking place (volume) and the timeframes used to determine support and resistance affect the likelihood of their predictions being correct. 

Interestingly, many large financial institutions have begun using computer programs (algorithms) to analyze past price movements and automatically place trades when certain conditions are met. In a 2020 report to Congress, the U.S. Securities and Exchange Commission (SEC) highlighted that “the use of algorithms in trading is widespread.” 

These automated systems receive price action data and can identify potential outcomes and predict how prices will move in the future. 

Price Action Trading Patterns  

Price action continuation patterns  

When a clear trend appears, the price sometimes pauses and forms a triangle-like shape. If the primary trend was up before the triangle appears, the price is likely to break out of the triangle and continue upward. The same applies if the trend was down before the pattern forms, as the price is more likely to break out of it. Therefore, the strategy here is to identify the trend first, wait for the pattern to appear, and only trade if the price moves out of the pattern in the same direction as the original trend. 

Price action reversals  

Trend reversals occur when the fundamental rules that define an uptrend or a downtrend are broken. Once one of these fundamental rules is broken, the trend is in a risky position. If both rules are broken, this strongly suggests that the trend will change, based on the price waves you observe. 

Imagine an uptrend where the price keeps making higher swing highs and lows. If the price suddenly makes a lower swing low, this is a signal that something may change. If the price also makes a lower swing high, this is a strong signal that a reversal has begun. It is important to remember that the price could still rise again and resume the original uptrend. However, the evidence at that point suggests that a trend change is the most likely outcome. The Tesla (TSLA) chart below illustrates how the price trend could reverse from up to down, then back up again, based on these price action principles. 

Advanced Price Action Strategies 

Price rejection trading strategy  

Imagine a price trying to break through a significant barrier on the chart—perhaps a level that sellers have been pushing through before, or a point where a price pattern has indicated a possible breakout. The price may reach that level directly, or even briefly rise above or below it. 

But then, this momentum falters. The energy behind the movement isn’t strong enough to sustain it. Instead, the price loses momentum and begins to reverse, often quite sharply. 

On a candlestick chart, you’ll often see a candle with a long “tail” or “wick” at the point where the price attempted a breakout and failed. This long tail visually represents those last failed attempts to maintain upward or downward momentum. 

Once the price begins to move decisively in the opposite direction after this rejection, it can represent a trading opportunity. 

The EUR/USD chart, which shows supply and demand, shows several clear examples of this. In each case, you can see those long-tailed candles, indicating failed breakout attempts. 

Renko price action strategy  

Renko charts form blocks. Each new block only appears after the asset’s price moves a specific amount. These blocks always form at a 45-degree angle. They also remain the same color until the price direction changes significantly. A significant change, or reversal, occurs when the price moves two blocks in the opposite direction. 

Renko charts are particularly useful when the market is in a clear trend. If the blocks on the Renko chart remain the same color and the trend continues in that direction, traders are more likely to hold onto their positions. However, if the color of the blocks reverses, it may indicate that it’s time to close the position. Remember the Tesla chart we looked at earlier? You can see it again below, but this time using Renko blocks. Using these blocks would have kept the trader in a profitable position throughout the price rally that began in March. 

Price action scalping strategy  

Scalping is a rapid trading technique in which traders aim to make small profits or limit losses very quickly, often within a few minutes. In the forex market, this might involve setting a stop loss of only 3 to 5 pips and aiming for a profit of 5 to 10 pips. In stock trading, it might mean risking only a few cents per share, aiming for a similarly small profit. The basic idea of ​​scalping is to enter and exit trades quickly, attempting to capitalize on small price changes—however small the change may be in the underlying asset. Many scalpers closely monitor one-minute price charts. 

Traditional scalping strategy involves trading with the general trend and attempting to enter a trade when the price briefly pulls back and then begins to move in the direction of the main trend. To identify these entry points, traders often look for engulfing patterns. This occurs when a candle moving with the trend completely covers the previous candle that was moving against the trend during the pullback. 

On the 1-minute chart of Alcoa (AA) stock, the arrows point to examples of these engulfing patterns, which could indicate potential entry points for scalpers. While this engulfing pattern strategy is just one method of scalping, it’s worth noting that all the trading strategies and ideas we’ve discussed previously can also be applied to this fast-moving style of price action trading. 

Price action strategy for swing trading  

All of the swing trading strategies we’ve discussed can involve price action analysis. Swing traders typically look at charts showing 24-hour, 4-hour, and daily price movements to identify potential trades. They may sometimes use 15-minute or 5-minute charts to more accurately time their trade entries. 

Let’s take an example using supply and demand with the overall trend. On the 4-hour chart of the USD/CAD pair, you can see that the overall trend is down. The price rises, forms a swing high, then declines and begins a short-term downward movement before rising again to the previous high. Since the primary trend is down, and the price has reached an area with potential selling pressure (a supply zone), this could be a good opportunity to place a short trade (bet on a price decline). 

If you wait for the price to fully enter this supply zone, it may rise slightly from the previous high. If your plan is to short the stock, you can enter the trade when you see a bearish engulfing pattern (a specific pattern that indicates a potential price decline) or when the price consolidates and then breaks out of the consolidation to the downside. The arrow on the chart shows where this downward breakout from the consolidation occurs, which would be your entry point. 

Limitations of Price Action  

Understanding the meaning of price movements is highly subjective. Two traders looking at the same price chart often have different opinions about what’s happening. One may see signs of a continued price decline (a bearish trend), while the other may believe the price is about to rise (a possible reversal). 

The timeframe you look at also makes a big difference. A stock may experience several price declines within a single day, but remain on an overall rise over the course of a month. 

It’s important to remember that any predictions you make based on past price movements, regardless of the timeframe, are just speculative. The more diverse the analytical tools you use to support your predictions, the more confident you will be in it. 

Ultimately, a stock’s past trading history doesn’t guarantee how it will trade in the future. Even trades that appear likely to succeed are still bets—that is, traders are taking risks in the hope of making a profit. Remember, price action analysis doesn’t directly take into account broader economic factors or other non-financial news that may affect a stock’s price. 

Tools Used for Price Action Trading  

Price action trading relies on analyzing current price history and past movements. Traders who use this approach utilize a variety of technical analysis tools based on their personal preferences and overall trading plan. This includes elements such as charts, trend lines, price ranges, identifying resistance at peaks and support at valleys, periods of sideways consolidation, and pivot points. 

The specific tools and patterns a price action trader monitors range from simple price bars, price ranges, breakouts, and trend lines to more complex combinations that include candlestick patterns, volatility analysis, and channel identification. 

More importantly, psychological interpretations, behavioral assessments, and the resulting trading decisions are all essential components of this trading style. 

Take this example: A trader might set a personal benchmark of 600 for a particular stock. If the stock, after fluctuating around 580, breaks above 600, this trader might anticipate further price increases and decide to buy (a long position). 

Conversely, other traders, anticipating the same event, might interpret the stock reaching 600 as a potential turning point, leading them to anticipate a price decline and therefore sell (a short position). 

This illustrates a key difference: individual interpretation is paramount in price action trading. Each trader operates according to their own analysis, their own rules, and their own understanding of market behavior. This contrasts with standard technical analysis, where a specific signal, such as a stock’s 15-day moving average crossing its 50-day moving average, is likely to trigger similar buys actions from many different traders. 

At its core, price action trading is a structured trading style that utilizes technical analysis tools and up-to-date price data. However, within this framework, traders have the autonomy to make their own trading decisions based on the specific situation. Price action traders initiate their trades based on their own personal analysis, assumptions about market behavior, and their own psychological perspective. 

Price Action Trading Steps  

Experienced price action traders don’t rely on a single approach. They have a variety of methods to spot chart patterns, determining entry and exit times, setting stop-loss orders, and making other key observations. Sticking to just one strategy for a stock can limit trading opportunities. 

Most trades involve two main steps: 

• Spotting a situation: Traders first identify a specific scenario, such as a stock price beginning an upward trend (bullish phase) or a downward trend (bearish phase). 

• Finding Trading Opportunities in This Situation: For example, if a stock is in a bullish phase, traders consider whether it is likely to rise further or decline. Predicting the direction of price movement is a subjective assessment that may vary from one trader to another, even if they are looking at the same situation. 

Here are some examples: 

Imagine a stock has reached what the trader believes is its peak and then declines slightly. Once this scenario occurs, the trader may believe the stock will either form a double top and rise, or it will decline further due to a mean reversion. 

Another trader might identify a price range (floor and ceiling) for a stock, anticipating low price volatility without significant breakouts. If the stock price remains within this range, the scenario is fulfilled. This trader can then place trades betting that the floor and ceiling will form support and resistance. Or, they might expect the stock to break beyond this range in any direction.  

When a clear breakout occurs, a trading opportunity arises. Traders can choose to trade as the breakout continues (expecting the price to continue moving in the direction of the breakout) or as the breakout declines (expecting a return to the level prior to the breakout). 

While technical analysis tools are useful in price action trading, the final trading decision rests with the trader. This provides flexibility rather than a rigid set of rules to follow. 

The best indicators for price action trading  

While most traders who focus on price action don’t rely on indicators, some may resort to them. These indicators help identify optimal entry points, place stop-loss orders, and set profit targets. Additionally, they can serve as a confirmation tool, ensuring the validity of what the trader observes in price action. 

Fibonacci retracements for support and resistance 

Fibonacci retracement levels are valuable tools on price charts, accurately identifying potential support or resistance areas during a trend continuation. To apply them, you need to identify two extreme points: a significant low and a subsequent high in an uptrend, or conversely, a significant high and a subsequent high in a downtrend. The tool then automatically creates horizontal lines at key Fibonacci ratios: 23.6%, 38.2%, 50%, 61.8%, and 100% of the identified price movement. 

The depth of a retracement can provide clues to the strength of the prevailing trend. Shallow retracements, which often find support around the 38.2% level, typically mark strong trends. Deeper retracements, exceeding the 50% and 61.8% levels, are more common in less strong trends. 

Let’s assume a moderate uptrend in crude oil prices. By placing the Fibonacci retracement tool on the low and high of the most recent upswing, with the 100% level at the low and the 0% level at the high, we can anticipate potential pullback areas.  

Remember, this trend reverses when analyzing a downtrend. 

In this specific example of crude oil, a pullback beyond the 50% retracement level is expected. Traders will then look for a confirmation signal, depending on their chosen trading strategy. The chart shows a strong upward movement after the price drops below the 61.8% Fibonacci level, representing a potential buying opportunity. 

Relative strength index (RSI) for momentum  

The Relative Strength Index (RSI), a momentum oscillator, measures the magnitude of recent price changes to assess overbought or oversold conditions in an asset’s price. When calculated over a 14-period price range, an RSI reading above 70 indicates that the price is trading at the top of its recent range, potentially signaling overbought conditions. Conversely, an RSI reading below 30 indicates that the price is at the bottom of its recent range, potentially signaling oversold conditions. 

To identify trends and confirm trades, traders often monitor movements of the Relative Strength Index (RSI) outside these extreme zones. In an established uptrend, a trading strategy might involve opening a long trade “buy position” when the RSI drops below 30 and then rises above this threshold, indicating a temporary pullback followed by renewed upward momentum. Conversely, during a downtrend, a short trade “short position” might be considered when the RSI rises above 70 and then falls below it, indicating a potential surge in short-covering before further price declines. It’s important to note that these RSI signals are typically used in conjunction with other price action analysis techniques or indicators, such as Fibonacci retracements, to enhance the reliability of trading decisions. 

Consider the crude oil chart, which now includes a 14-period RSI. The RSI’s decline below the 30 level and subsequent bounce above it coincided with price action signals and Fibonacci retracement levels, also indicating a favorable entry point. 

Stochastic oscillator for identifying trend reversals  

To identify potential turning points and validate price action signals, traders can use the stochastic indicator, an indicator with a function similar to the Relative Strength Index (RSI). This indicator displays two lines: the stochastic indicator itself and a slower-moving signal line, which is essentially a moving average of the stochastic indicator. 

For traders who focus on price action signals, it may be useful to monitor the interaction between the stochastic oscillator lines. When considering a long position, a trader might look for a prior price action signal followed by the stochastic oscillator crossing over its signal line. As with the Relative Strength Index (RSI), the stochastic oscillator provides similar insights on a crude oil price chart. 

While indicators provide complementary information to price action signals, the price action signal usually appears first. Relying on lagging indicators for confirmation can lead to delayed trade entries and reduced profitability. Therefore, the benefit of confirmation comes with the potential to miss an earlier entry point. 

In conclusion, price action enables traders to make informed decisions based on fundamental market information. Ultimately, however, successful price action trading depends on a trader’s ability to observe, interpret, and strategically respond to the ongoing evolution of the price itself. 

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