Price action trading is analyzing the movements of the price to make a trading decision. It fall under the category of technical analysis. Price action trading is focused on the relation of an instrument’s current price to its past prices. In another words price action is everything that a security’s price does. Price action is simply observing how prices fluctuate. It is clearly seen in the markets having high liquidity and price volatility. A price action trader normally uses clean chart without any fancy indicators. This does not mean that price action traders will not use any technical indicators, they use indicators less frequently. All the financial instruments generate information and are displayed on the price charts. Beliefs and actions of all participants trading in the market during a given period of time are printed on a market‘s price chart in the form of price action.
Price action trader believes that it is not necessary to analyze all the economic data and global news to trade the market profitably since all those factors are factored on a security’s price. Price discounts everything. It means price movements will provide you all the information needed to develop a profitable trading system. Price action trading includes recent price movements, technical analysis tools like charts, support /resistance, swing high/swing low, trend lines etc. The most commonly used tools in price actions trading can be break-outs, trend-lines, advanced combinations involving candlesticks, volatility, channels etc. Two traders will never have the same interpretation of the price action. It depends on the trader what tools to use for developing price action trading systems. Some of the simple price action methods (strategies) are discussed in the rest of this article.
Buy Low Sell High
This is a trend following strategy. This is the most common and simple price action trading method. Its implementation with proper discipline, this method can be very rewarding. However many traders fail to maintain self discipline and they blame the system (strategy). This strategy is very simple and powerful yet it is underestimated. Now let’s discuss about this simple price action strategy with real time charts.
The concept of this strategy is really easy and simple. This method is based on the philosophy that –‘Trend is your friend.’ We will be looking daily charts for knowing the direction of major trend of the market. Once the direction of the trend is established on the charts we will be looking for the entries in the lower time frames to finely tune the entry. This example can be illustrated with the real time EUR/USD chart below.
In the above chart we can clearly see that the EUR/USD is down trending on daily chart. So we will be looking for sell signal and we will use lower time frames i.e. hourly and 4 hour chart to finely tune our entry level. In a falling market lower lows and lower highs are formed. The main idea of this strategy is to buy low and sell high. So in a down trending market we will be selling at lower highs. In above EUR/USD down trend market we can see that the market is forming lower lows and lower highs. When focusing to the recent price action on the above chart we can see market is probably forming another lower high so our plan is to sell the pair. Let’s see 4 hour chart during that time.
While we analyze the 4 hour chart we realized that the pair is falling so we would wait for the pullback and enter in the market. After waiting for certain time we would sell the pair on another peak. In this example our short position would be a hugely successful trade.
No doubt price action trading is trading on a naked chart without any colorful indicators. But using some few moving averages to figure out potential support and resistance level is not a bad idea at all. EMA 20 is an effective tool for the entry confirmation in a trending market. The idea is finding out the major direction of the trend like we did in our previous strategy and opening position in the market when the EMA 20 and the price cross each other.
Trading In Sideways Market
When the market condition changes our strategy should also be changed. The methods we use to trade in trending market may not be useful to trade in sideways market. But there are really simple methods to trade in all market conditions. Given below is an example of the sideways market of USD/CAD. It is a 4 hour chart.
In the ranging market we set the high and low price of the range by two horizontal lines like shown in the above figure. In a sideways market price usually bounce between these two horizontal lines. The main idea of this strategy is to go long when the price touches the support level (i.e. down horizontal line) and to go short when the price touches the resistance level of the range (i.e. upper line of the range). This is the most simple and the most effective way of trading in a flat market.
Trading the ABCD Pattern
This is another simple approach to price action trading. This pattern doesn’t often occur in the real time market but when it occurs it is most likely to work. In a ABCD pattern there are three waves among them two of them are impulsive in nature while one of them is corrective. As shown in the figure below BC usually retraces 61.8% or 78.6% of the wave AB. Wave CD extends 127% or 161.8% of the wave BC. Time taken to form wave AB should be nearly equal to the time taken to form CD wave. Idea of this method is to enter in the direction in which the corrective wave is heading or against the impulsive wave. In the figure below, on the left side we have a bullish ABCD pattern that is we will be looking for long opportunities when we see such bullish ABCD pattern. Wave BC is corrective in nature whilst Wave AB and CD are impulsive. So our trade will be in the direction of BC. The case is exactly the opposite for the bearish ABCD pattern.
Now let’s have a look at the ABCD pattern in real life market.
Above is a EURJPY four hour chart. Presented example of ABCD pattern is not a perfect one though and perfect pattern rarely exist. Deviation to some extent is considerable.
Trading Triangle Break Out
Another simple and effective way to trade is triangle break outs. When price squeezes triangles are formed. Triangles can be obtained in charts simply by drawing the trend lines as shown in the figure below. Idea is to enter in the direction in which the break out occurs. Usually the probability of winning is high when the break out occurs in the major direction of the trend.
Trading the Channel
When the price moves in a particular direction within two parallel lines the channel is formed. Channel can be up, down and sideways. The idea of trading the channel is simple. When the price touches the upper trend line we look to sell the pair and when the price touches the down trend line we look to long the pair. When the channel is broken in a particular direction it may indicate the trend change.
In the above NZD/USD weekly chart we can see that the channel is working beautifully. If we had bought and sold following the rules of the channel we would have nice gains. We can also see that the channel is broken to downside and price moved pretty lower after breaking the channel. So channeling is simple and effective way of trading price action.
Trading with Andrew’s Pitchfork
Andrew’s pitch fork consists of three parallel lines. This tool can be used to detect profitable opportunities and swing opportunities in the market. On the broader term view it can be used to identify and analyze the over all cycle of the market. The two (upper and lower) lines acts as a support and resistance levels and the mid line can serve as both support and resistance level. It is believed that market price action is likely to gravitate towards the median line 80% of the time. In order to apply Andrew’s pitchfork effectively a trader must first identify a high or low that has recently occurred on the chart. The first pivot will be drawn at peak or trough and is labeled as point A. Once the point has been figured out, trader must identify both a peak and a trough to the right side of the first pivot. Once these three pivots are set the trading platform will automatically draw Andrew’s pitchfork for you. The pitchfork will look like this:
Above is the perfect example of Andrew’s pitchfork. Notice how the price gravitated towards the midlines and how price respected the lower trend line. Lower trend line would work as support level while the upper trend line would work as resistance level. Generally we will be looking to long the pair when the price touches the lower trend line and vice versa. This is a great tool to use.
So these are the some of the trading strategies using trend lines and price actions. We don’t need fancy indicators to trade profitably in the market. Keep it simple. Self discipline is the key. These simple lines are enough to make a profitable trading life.