You might have heard of technical and fundamental analysis for share trading. Technical analysis helps identify the future price movements of stocks, while fundamental analysis helps understand the financial performance of a stock. Price action trading is a proven technique in share trading, which also forms the base for technical analysis. Continue reading to understand what is price action trading in detail.
What is Price Action Trading?
Price action trading is a technique widely used by stock investors. The price movements of a particular stock are plotted within a given timeframe in price action. You can generate several insights by plotting the price movements of an asset. Different patterns emerge after plotting the price movements, which helps understand the market trends.
For instance, you can get bullish candlestick patterns like a hammer, piercing line, morning star, ascending triangle, or three white soldiers. You might also get bearish candlestick patterns like a shooting star, dark cloud cover, evening star, descending triangle, or three black crows. You can predict future scenarios by understanding the meaning of a particular candlestick pattern.
Price action can help you understand price movements, market conditions, volatility, investors’ sentiment, and more. Let us delve deeper and understand what price action is in the stock market.
What is Price Action in the Share Market?
Price action depicts the price movement of a share/stock. Price action trading does not refer to the price movement charts. It is a technique that involves studying price movement charts and finding insights. Price action analysis involves studying the data points on the plot closely to generate insights. It is essential in the share market, where prices change rapidly due to different factors. Investors can know whether the share prices are expected to rise or fall in the future based on the available data for price action analysis. When share prices are expected to rise, you might stay invested for the long term. On the other hand, investors might make an exit when share prices are expected to fall.
Price action analysis forms the base for technical analysis in the stock market. You can predict the future price movements of a particular stock based on the given plot. As discussed above, different bullish and bearish candlestick patterns are also studied via price action analysis. Price action trading focuses solely on the price of the asset over a given period. Technical tools are usually not used for price action analysis, as the focus is solely on price movements. It can provide relevant information regarding a stock, which can help in decision-making. While price action trading is common among stock investors, it is also applicable to other assets, like derivatives, commodities, and currencies.
Price Action Trading Benefits
Price action trading improves the informed decision-making power. You can make better investment choices after considering the historical price movements of the asset. Not to forget, price action analysis requires less time as compared to other investment analysis techniques. Traders do not have to use complex mathematical formulas or technical indicators in price action analysis. The idea is to observe the pattern formed by the price swings of the asset and make decisions accordingly. However, one must understand different trading patterns and their meaning to take advantage of price action analysis.
As discussed above, price action trading involves studying the price charts of an asset for a given time frame. Since the price chart will generate some patterns or insights, trading strategies are developed accordingly. Here are common price action trading strategies used by investors:
Pin Bar Strategy
Pin bar patterns are usually small but have a long tail. A sharp reversal or rejection of the current price level is observed when such a pattern forms. It is assumed that the price of a particular asset will move in the opposite direction when a pin bar pattern is formed. For the same rationale, investors trade in the direction of the long tail of the pin bar. The long tail represents the reversal of price in the opposite direction in a pin bar.
Breakout Trading Strategy
Stock investors might witness consolidation price patterns like rectangles and triangles. A breakout represents the market movement outside the support or resistance levels. Investors usually place buy orders above the resistance levels and sell orders beneath the support levels to make a profit. Investors are interested in taking long positions when the price crosses the highest resistance level. On the other hand, investors might take short positions when the stock price goes below the support level.
Inside Bar Trading
A candle’s high and low might appear within the high and low of the previous candle. In such a case, an inside bar is formed. The inside bar’s size and position determine the stock price movement. Usually, investors trade in the direction of the breakout of the inside bar to make a profit.
Reversal candlestick patterns can help stock investors predict the flow of the market. Hammer, shooting star, doji, and other candlestick patterns indicate the reversal of the current trend. Stock investors also make trades in the direction of the trend reversal.
Scalping through Price Action
Price action also includes analysing price charts for shorter durations, like a day or a few hours. Some intraday traders might even rely on 5-minute and 15-minute charts to understand the short-term price swings. You can place multiple stock market orders throughout the day to take advantage of short-term price movements.
Price action with confluence, multiple time frame analysis, head and shoulders patterns, range trading, pennant and flag patterns, counter-trend trading, and volume analysis with price action are a few other strategies for stock market investors.
Limitations of Price Action Trading
As with most investment analysis techniques, price action trading also has some limitations. For the same rationale, entities and institutional investors indulge in extensive technical analysis, which considers price action, technical indicators, and other techniques. Here are some limitations of price action trading for investors:
Investors might overlook certain patterns in price charts. As a result, investors might fail to understand the market movement or trend. Also, interpretations of a price chart might change from one trader to another.
Based on Historical Data
Price action analysis is entirely based on historical price movements. It might not predict the future price of the asset exactly. However, it can give insights into the possible scenarios related to the price of a particular asset.
Lack of Fundamental Factors
Price action analysis does not include company events, financial earnings, and other fundamental factors. Investors preferring fundamental analysis might not use price action analysis alone for decision-making.
Does Not Work in Whipsaw Markets
Whipsaw markets experience erratic price movements and sudden reversals. Investors might fail to find known patterns in the price charts of assets in whipsaw markets.
Difference Between Price Action and Technical Analysis?
As discussed above, price action forms the base for technical analysis. However, it cannot be considered the same as technical analysis in the stock market. Let us understand the difference between price action and technical analysis in detail:
Price action is a subset of technical analysis focusing only on price movements. It involves studying the price movement charts and predicting future prices. Mathematical formulas or technical indicators are not used, as you are studying only the given chart in price action analysis. Investors try to find patterns that might indicate future price movements. If you can identify a
you might predict the stock’s future price.
Price action focuses solely on historical price movements or price changes within a given time frame. Patterns, trends, support levels, and resistance levels are identified with the help of price action analysis. It is a simplistic approach to stock analysis, as it does not involve external factors or technical indicators. Even though it is a simplistic approach, it can help understand a particular stock’s supply and demand dynamics.
The difference between price action and technical analysis is based on their scope. On the other hand, technical analysis is a broader field that involves different techniques for analysing the stock market, including price action. You can say that technical analysis is the superset of price action analysis. Technical analysis involves studying the price charts, using technical indicators, and implementing mathematical formulas. Technical tools are also used to generate insights in technical analysis.
Price movements in charts
Broader stock analysis
Use of indicators
Study of price changes
Pin Bar, Breakout, Inside Bar, Reversal, Scalping, and more
Various strategies involving indicators
Limited to price movement
Includes price, volume, open interest, and more
Beginners in the stock market might also not know about the technical indicators. They are mathematical calculations applied to the available data for generating insights. The available
data can be related to the stock price, volume, or open interest. MA (Moving Average), RSI (Relative Strength Index), stochastic oscillator, ATR (Average True Range), OBV (On-Balance Volume), and Ichimoku cloud are a few technical indicators used by analysts.
Investors must make a habit of studying and analysing price charts. It can help understand different patterns and market trends. Price action analysis is a simple trading technique for stock market investors. You don’t have to indulge in technical analysis or complex calculations. However, you must know the different patterns observed in price charts and their meaning. Implement price action trading and earn returns!