Price Action Trading: What Is It and 7 Trading Strategies to Apply

Price action refers to studying a security’s price movement over time without relying on any technical indicators.

This approach focuses on analyzing raw price data to make informed trading decisions based on the belief that the price contains all essential market information.

This article further explains this trading technique and presents seven price action trading strategies to adopt.

Key Takeaways 

• Price action involves analyzing raw price movements without relying on indicators.

• Strategies like pin bars and trend following enhance your ability to trade based on price action.

• Price action trading offers clarity, real-time insights, and improved risk management.

• Despite its benefits, price action requires experience and may produce subjective interpretations.

What Is Price Action?

At its core, price action refers to the movement of a security's price plotted over time.

It's a method traders use to analyze and make decisions based solely on price movements without relying on indicators or other technical tools.

This approach is based on the belief that all necessary information about a market is reflected in its price.

Why Eliminate or Minimize Indicators?

Most traders encourage using indicators, so why does the price action method argue against them?

While technical indicators can provide valuable insights, they often lag behind actual price movements and can sometimes offer conflicting signals.

Here’s why some traders might prefer the price action indicator-free trading:

• Trading is clearer and simpler without the clutter of multiple indicators.

• Price action offers real-time insights, allowing quick reactions to market changes.

• Works across various markets, including forex, stocks, and day trading.

• Focusing on price movements enhances understanding of market psychology and dynamics.

P.A Chart vs. Indicator Chart

As you can see in the image below, the difference in clarity between a pure price action (P.A.) chart (left) and one cluttered with popular trading indicators (right) is very noticeable.

A P.A. chart presents the market's movements in their rawest form, free from distractions, allowing traders to focus solely on price movements.

However, a chart loaded with indicators like MACD, Stochastics, and Bollinger Bands can quickly become overwhelming.

While popular, these indicators take up valuable space on the chart and divert attention from the natural price action, which should be the primary focus.

The cluttered chart reduces the screen area available for viewing the actual price action. It shifts the trader's focus to the indicators, which are ultimately derived from the same price data.

This adds unnecessary complexity and variables to the trading process without offering new insights beyond what is already visible in the raw price movements.

How to Use Price Action

Using price action involves analyzing historical price data to predict future movements.

Here's how you can use price action techniques in your trading:

• Identify Key Levels: Look for support and resistance levels where the price has historically reacted. These levels can serve as potential entry and exit points.

• Observe Candlestick Patterns: Recognize common patterns like pin bars, inside bars, and engulfing bars, which can signal potential reversals or continuations.

• Analyze Trends: Determine whether the market is trending upwards, downwards, or sideways. This helps you align your trades with the prevailing price action market trends.

Top 7 Trading Strategies with Price Action Signals

Now that you know the basics of the price action techniques, here are the top 7 trading strategies with price action signals.

1. Price Action Trend Trading

Price action trend trading focuses on spotting and following market trends.

By observing how prices move, traders can make trades that align with the current trend, improving their chances of success.

To trend trade using price action, first, look for a clear trend direction (uptrend or downtrend).

• In an uptrend, wait for the price to pull back to a support level.

• In a downtrend, wait for the price to pull back to a resistance level.

Then, look for a price action signal (like a pin bar or inside bar) at the support or resistance level to confirm the continuation of the trend.

• Enter a buy position after the pullback in an uptrend

• Enter a sell position after the pullback in a downtrend.

Place a stop loss just below the support level in an uptrend or just above the resistance level in a downtrend.

Lastly, set a profit target at the next key level of resistance in an uptrend or the next support level in a downtrend.

2. The Sequence of Highs and Lows

Price action trading is fundamentally about understanding highs and lows. The sequence of highs and lows strategy helps traders map out trends.

For example, a series of higher highs and higher lows indicates an uptrend, while lower highs and lower lows suggest a downtrend.

Traders use this sequence to identify entry points at the lower end of an upward trend and set stop losses just below the previous higher low to manage risk effectively.

1. In an uptrend, look for a sequence of higher highs and higher lows. In a downtrend, look for lower highs and lower lows.

2. A break in this sequence may indicate a trend reversal.

3. Enter trades in the direction of the trend continuation after pullbacks that respect the sequence.

4. Place stop losses beyond recent swing points and set profit targets based on previous price levels.

3. Trend Following Retracement Entry

In this straightforward strategy, traders simply follow the existing trend by noticing the retractments.

A retracement refers to a temporary reversal in the direction of a stock, commodity, or other asset's price that goes against the prevailing trend.

It's a short-term movement where the price pulls back or "retraces" before continuing toward the main trend.

How to Trade:

1. Recognize a strong trend and wait for a retracement towards a key level or moving average.

2. Look for price action signals like bullish or bearish engulfing patterns indicating the end of the retracement.

3. Enter the trade in the direction of the main trend once confirmation occurs.

4. Set stop losses below or above the retracement low or high and aim for profit targets in line with the trend's strength.

4. Trend Following Breakout Entry

The trend-following breakout entry strategy focuses on significant market movements. A breakout occurs when a price breaks through a key support or resistance level.

Traders can use this breakout to take action—entering a long position if the price breaks above resistance or a short position if it falls below support.

Here’s how to trade based on the trend following breakout strategy:

1. Spot consolidation near a key level within a trending market.

2. Wait for a strong breakout candle closing beyond the level.

3. Enter the trade immediately after the breakout.

4. Place stop losses just below or above the breakout level and set profit targets based on the trend's potential continuation.

5. Pin Bar

The pin bar strategy often called the candlestick strategy, is characterized by a candle with a long wick and a small body.

This pattern signals a sharp reversal and rejection of a specific price level. The long wick, or "tail," represents the rejected price range.

Traders use this information to anticipate that the price will move in the opposite direction of the tail.

For example, a long lower tail suggests that lower prices have been rejected, indicating a potential upward movement.

Here’s how to trade a pin bar using the price action technique:

1. Spot a pin bar forming at a key support or resistance level.

2. Ensure the long wick rejects a price level and points against the desired trade direction.

3. Place a trade in the direction opposite to the wick after the pin bar closes.

4. Set a stop loss beyond the pin bar's wick and a profit target based on nearby support or resistance.

6. Inside Bar

The inside bar is a two-bar pattern where the inner bar is smaller and falls within the range of the preceding bar, known as the mother bar.

This pattern often forms during market consolidation but can also indicate a potential turning point.

Traders can quickly assess whether the inside bar suggests a continuation of the current trend or a reversal.

The position and size of the inside bar relative to the mother bar can help predict the price's next move.

Here’s how to trade an inside bar:

1. Look for an inside bar forming during a strong trend.

2. Wait for a breakout above or below the inside bar's range.

3. Enter the trade in the direction of the breakout.

4. Place a stop loss on the opposite side of the inside bar and set profit targets based on recent price swings.

7. Head and Shoulders Reversal Trade

The head and shoulders pattern is a well-known reversal formation that looks like a head flanked by two shoulders.

This pattern suggests a potential reversal from an uptrend to a downtrend, or vice versa in the inverse head and shoulders pattern.

Here’s how to trade the head and shoulders pattern:

1. Recognize the formation of three peaks, with the middle peak (head) higher than the two sides (shoulders).

2. Wait for the price to break below the neckline, connecting the lows between the peaks.

3. Enter a short trade after the neckline break.

4. Set stop losses above the right shoulder and set profit targets equal to the distance between the head and the neckline.

How to Set Stop Losses and Profit Targets for Price Action Trading

Setting stop losses and profit targets depends on your strategy. Here's how to set stop losses and profit targets using price action, in general:

Stop Losses:

• Place stop losses beyond significant support or resistance levels to avoid premature exits.

• Use recent swing highs or lows as reference points for setting stops.

• Adjust stop losses based on volatility; wider stops in volatile markets and tighter stops in stable markets.

Profit Targets:

• Identify previous key levels where the price is likely to react.

• Use the height of chart patterns (like head and shoulders) to estimate potential price moves.

• Implement multiple profit targets to scale out of positions and secure profits progressively.

Advantages of Price Action

Using price action trading comes with several benefits:

• Clarity: Provides a clear and straightforward view of the market without the clutter of multiple indicators.

• Versatility: Applicable across different markets and timeframes, from price action day trading to long-term investing.

• Real-time Insights: Offers immediate feedback, allowing traders to adapt quickly to market changes.

• Improved Risk Management: Enables precise entry and exit points, enhancing overall price action risk management.

Limitations of Price Action

Despite its advantages, price action isn't without limitations:

• Subjectivity: Interpretations of patterns and signals can vary between traders.

• Requires Experience: Mastering price action analysis takes time and practice.

• No Guarantees: Like all trading methods, it doesn't guarantee success and can produce false signals.

• Market Noise: In volatile markets, price movements can be all over the palce, making analysis challenging.

Understanding these limitations is crucial for setting realistic expectations and continuously improving your trading approach.

Conclusion

Price action trading simplifies the trading process by focusing on price movements rather than indicators, offering a clearer market view.

If adopted correctly, this method is helpful to both beginners and advanced traders. Join XS for further tips and guidance on your trading journey.

FAQs

What Is an Example of a Price Action Strategy?

A common price action strategy is the pin bar. Traders look for a candlestick with a long wick, signaling a sharp price reversal. After identifying it near key levels, they enter trades opposite the wick’s direction.

How to Calculate Price Action?

Price action isn’t calculated; it’s analyzed by observing price movements on a chart. Traders study patterns, trends, and key levels like support and resistance to make decisions based on how the price is behaving.

How Do You Start a Price Action?

To start with price action trading, learn the basics of chart analysis, study common price patterns, and practice identifying trends. Begin by analyzing historical charts and then apply your knowledge in real time with small trades.

How Profitable is Price Action?

Price action can be profitable if applied correctly with discipline and solid risk management. Success depends on the trader’s ability to read market conditions and react promptly and accurately, but like any strategy, it carries risks.

Is Price Action Trading Good for Beginners?

Yes, price action trading is suitable for beginners because it simplifies the trading process by focusing on price movements without relying on complex indicators. This makes it easier to learn and understand market behavior.