Price Action analysis helps traders make informed decisions on trading, based on how prices have behaved in the past, and how they are behaving right now.
There are a few main schools of thought when it comes to analysis charts. A trader can analyse the charts based on:
- Price Action
- A mixture of 1+2
- Gut feel (almost like tossing a coin)
Without talking about 2-4 and their merits or demerits, let's just focus on #1. I may talk about 2-4 in other posts later on.
What is Price Action?
This is a form of analysis that is based on the how prices move on the chart, without the use of indicators. We observe how fast or slow prices move, how they react at certain price levels, etc.
This form of analysis will give us a good idea of how price will tend to move. To put it differently, we are using historical price movement to predict what can happen.
Does Price Action Trading Really Work?
Let's get it this out of the way first: there is no 100% certainty for anything in trading. This is something that you need to accept, no matter what trading methods or systems you use.
If someone tells you that they have a 100% sure-win system, they are likely trying to sell you something. Beware!
When we use historical chart movements to try to forecast the future, there is no guarantee that the future will respect history.
For example, just because prices have stalled at a certain price level in the past doesn't mean that prices will stall there in future.
In addition, you must remember that the Market will always do its own thing. It doesn't purposely move to cause you to lose trades, but it also won't intentionally move in your favor either.
Trading is a probability game. So when we trade, we want to trade in the direction of the higher possibilities. Why is this relevant? It's because when prices move, they tend to move in a way that they have done in the past.
History Repeats Itself
Let's say that in the past prices have gone up until a certain level (or a zone), before turning around and heading back down. When prices again approaches this level, what do you think will happen?
Due to various reasons (such as trapped traders), there is a good possibility that price will again turn around at this level, at least for a short while.
In the chart above, notice how prices keep rising up until it meets the yellow line before turning back.
Price Action Is The Best Way To Trade
Sometimes I test indicators to see how they perform but then I always return to using Price Action (and Volume, which I shall talk about in another post).
Why is this so?
Indicators are based on Price Action
Indicators are mathematical interpretations of how price move on the charts. These are then plotted on the charts to give a hopefully helpful visual to help traders make decisions.
Instead of relying on mathematical interpretations, I prefer to go back to the source, which is Price Action.
Most Indicators are laggy
Because indicators work by calculating prices of the past, they are laggy. That is, they lag behind the current prices that you can see happening right now on charts. This is a common reason why some folks don't use indicators (although indicators do have their uses in certain scenarios).
An Indicator-free chart is a clean chart
If you use indicators to form your analysis, you will most likely not just use one indicator. You'll use quite a few.
One issue with charts using multiple indicators is that the chart becomes messy, making it harder to analyse.
In addition, the indicators may send conflicting signals, so you need to filter them out mentally.
Trade based on what is happening right now
If you combine how prices behaved in the past with how prices are currently moving, you can have as complete a picture as possible. This is all you basically need to make informed analysis on how prices will behave in the future.
How To Learn Price Action Trading
To analyse charts using price action alone requires a lot of studying, chart time and patience. It's both easy and hard. The principles are easy, but the practice and patience are hard.
But the good thing is, if you persevere, you should see much improved trading results.
Because this is such a wide field, it is impossible to go into detail in this one post. I will be adding bite-sized posts to teach it.
Here are some key principles:
- Support and Resistance
- Candle Structure and Formations
- Trends and Ranges
- Supply and Demand (almost similar to #1, but with Volume added).
One on the best sites to learn trading is babypips.com, which is free and where I started from. Don't try to trade immediately after going through the site though, because trading is a lot more than that.
There Are Many Price Action Trading Systems
When you know the basics of analyzing price movements on charts, you should already an idea of what to do when price behaves in a certain way, eg head towards a Support zone.
There are as many ways of interpreting charts as there are different trading systems. These systems make it easier to spot potential trade setups and may have a formalised framework or set of rules. These rules help the trader to determine when and where to enter trades, and where to exit trades.
For many folks, having a set of rules to follow makes things easier and less confusing. I will be presenting some trading systems in future, some of which I have modified to fit my own needs.
Trading systems can be useful, but nothing beats being able to read Price Action, understand what it is telling you and making your own analysis. Then you will be able to know when to use a trading system and when it is not suitable.