Price Action Trading: Meaning, Strategies & Limitations

Investing is like getting into a relationship with a person for who they are, their personality, their upbringing, how aligned your views are, and so much more. Trading, on the other hand, is more like a blind date. You look at the person, find out superficial details about them, and wing it! The debate of which is better is extremely obnoxious, in all honesty. To each their own; it is their money, after all. Dating, however, opinions and advice on that are better found in different places.

Well, most investors lead their lives believing trading is a volatile exercise, bound to fail. Well, to add to their horror, there is an engagement with the stock market that uses far less data and is even more affected by a person's psyche than available information. Meet Price Action Trading!

Price action describes the characteristics of a security's price movements. In light of recent price changes, this movement has been widely investigated. A trader can read the market and make arbitrary trading decisions based on current and actual price moves using the price action trading technique, which does not primarily rely on technical indicators.

Since the price action trading strategy ignores the fundamental analysis components and focuses more on recent and previous price movements, it depends on technical analysis tools.

What does Price Action Mean?

Price action is a trading strategy where investment instruments are bought or sold for a short-term period, based solely on the movement of the instrument's price. It does not involve technical analysis like other trading techniques.

The pattern or nature of how the price of a security or asset behaves, frequently in the short run, is referred to as price movement. When price activity is graphically plotted over time, frequently in the form of a line chart or candlestick chart, it can be examined.

Technical analysts use price movement on charts to time the entry and exit points of trades and seek patterns or signs that can assist in predicting how security will behave in the future. Moving averages and oscillators are examples of technical tools that use price action to project the future and provide information to traders.

Price Action Trading Tools

All technical analysis tools, such as charts, trend lines, price bands, high and low swings, technical levels (of support, resistance, and consolidation), etc., are taken into consideration depending on the trader's preference and the strategy's suitability because price action trading is based on recent historical data and previous price movements.

Simple price bars, price bands, breakouts, trendlines, or sophisticated combinations like candlesticks, volatility, channels, etc., can all be used by traders as observation patterns and tools.

Deals involving price action require critical behavioural and psychological interpretations and trader-determined follow-up actions. For example, suppose a stock trades at ₹580 and crosses the trader's psychological threshold of ₹600. In that case, the trader may predict that the price will continue to rise and open a long position regardless of what transpires. On the other hand, some traders may think that the price will turn around when the ₹600 level is reached, in which case they will take a short position.

Because every trader has interpretations, rules, and behavioural knowledge, no two traders will read a given price movement similarly. Nevertheless, many traders exhibit the same behaviour and activity in a technical analysis scenario.

Price action trading is built on technical analysis methods and recent price history. Traders can choose their trading positions within a given system based on illogical, irrational-behavioural, and irrational-psychological states.

When you trade using only the prices you can see in front of you, this is referred to as "naked price action" or "pure price action." It resembles driving while the navigation system is off. You place your trades utilising your market knowledge rather than relying on complex formulae and time-consuming studies.

Price action signals are easily recognisable patterns in a market that can be utilised to forecast future market behaviour. They are also known as price action patterns or price action triggers. By recognising particular patterns or repeats in historical performance, seasoned traders can occasionally identify these signals in a look.

What distinguishes price action from technical analysis indicators?

The appearance of a trend is indicated by price action indicators, which are flashes of activity on a trading chart. Experienced traders may quickly identify these signs and use them to make well-informed real-time market wagers.

Future price fluctuations are predicted using various methods in technical analysis. Price action, in contrast, solely considers changes in an asset's price that occur during the trading term you have chosen.

While price action enables traders to adopt a more conventional gut-based trading approach by detecting price movement indications and acting on them, technical analysis attempts to bring order to the seemingly chaotic world of trading.

Price Action Trading Strategies

Most seasoned traders that use price action trading retain a variety of tools at their disposal for identifying trading patterns, entry and exit points, stop-loss levels, and related observations. One technique on one (or more) equities might not provide enough trading chances. In most cases, a two-step process is involved:

1) Finding a scenario, such as when a stock price enters a bullish or bearish phase, a channel range, a breakout, etc.

2) Identifying trading opportunities within the scenario can involve determining whether a stock is likely to (a) overreach or (b) recede once it enters a bull run. It is a wholly arbitrary decision that can differ from trader to trader, even in the case of an identical event.

Here are a few illustrations:

• According to the trader's perspective, a stock reaches its peak before declining to a little lower level (scenario met). After that, the trader can choose whether they believe it will form a double top to rise further or fall further after a mean reversion.

• Based on the presumption of low volatility and the absence of breakouts, the trader establishes a floor and ceiling for the price of a particular stock. The trader can take positions assuming the installed base and roof are support and resistance levels. Alternatively, they can adopt the opposite perspective that the stock will break out in either direction if the stock price is inside this range (scenario met).

• Upon fulfilling a predetermined breakout scenario, a trading opportunity in the form of a breakout continuation (moving forward in the same direction) or breakout pullback (returning to the past level) will arise.

As can be seen, technical analysis tools are an essential part of price action trading. Still, the ultimate trading decision rests with the trader, providing freedom rather than imposing a rigid set of rules.

How popular is Price Action Trading?

Price action trading is better suited for short- to medium-term restricted profit deals than long-term investments.

Most traders believe that the market acts arbitrarily and that there is no set, systematic method for creating a strategy that will always be successful. However, due to the use of technical analysis tools and recent price history to find trade opportunities depending on the trader's interpretation, price action trading is well-liked worldwide.

Self-defined strategies offer traders flexibility, apply to a wide range of asset classes, are easy to use with any trading platform, application, or trading site, and make it simple to backtest any given strategy using historical data. In addition, the traders feel in control due to the method since they may pick their activities rather than blindly follow the rules.

Retail traders, speculators, arbitrageurs, and even firms with in-house traders use price action trading for price forecasts and speculation. It can be applied to various securities, such as stocks, bonds, currencies, commodities, and derivatives.

Limitations of Price Action

Price movement is frequently arbitrary, and traders may have somewhat different interpretations of the same chart or price history, leading to varying outcomes. Another drawback is that pricing history is not always a reliable indicator of future results. Technical traders should therefore use a variety of instruments to confirm indicators and be ready to promptly quit transactions if their predictions turn out to be inaccurate.

The Bottom Line

Numerous price action trading theories and techniques claim to have high success rates. Still, traders should be cautious of survivorship bias because only successful stories make the headlines. There is a chance to earn profits by trading, but it is each trader's responsibility to thoroughly comprehend, test, choose, and take action on whatever satisfies the criteria for the best possible profit chances.

Have you ever used price action for your investment decisions? Let us know in the comments if you have any unique price action techniques that people should know about.