Why Price Action Trading is “so” fundamental to your success…

...a look into what makes this method so good at delivering results.

6 minute read

Following on from the discussion on the possible advantages of using stock charts without indicators, the obvious subject to move straight into is that of price action trading. This is a method of trading whereby a trader uses a number of chart formations and candlestick patterns, usually referencing only very recent price activity, with which to base their entry and exit points. These formations might include bull or bear flags, descending wedges (pennants), chart pattern breakouts, or indeed trading false chart pattern breakouts, fakeouts. Moreover, trading price action can involve analyzing individual bars specifically, which might take the form of a pin bar, entry bar, or reversal bar.

Price Action Trading
You'll need a fairly good memory to be able to trade using price action techniques as there are a plethora of different candlestick patterns and chart movements to be aware of. However, learn this trading strategy and it can serve as a potent weapon in your trading tool kit.

Since the formation of stock charts, price action has been omnipresent, and even since the adage of algorithmic trading, and millions more participants trading via their smart phones, price action has in principal, remained relatively consistent in its nature. There are possibly a few more flash crash type movements in today’s markets, which happen mostly when trading algos latch onto a trending news story whilst scanning Online, and though these are on a relatively small scale (in terms of the size of the spike), it is nevertheless a new phenomenon which traders need to be aware of.

 

Price action dictates that you wait for the close price until you make a decision, and as many will be aware; what looks like a large pin bar 5 minutes before it closes, luring traders into what looks could potentially be a reversal in price direction, can easily turn into a strong continuation bar during this very short time period. Trading price action relies on acting on what the price is actually telling you in the present moment, as opposed to using technical indicators in an effort to attempt to predict what the price will do in the future. For that reason alone, it makes this a very sound and convincing method of going about your business in the markets. A huge number of the most successful (both past and current) traders, trade price action exclusively (I certainly do!).

 

Some traders can get easily drawn in to placing too much emphasis on historical chart patterns. For instance, analyzing a weekly chart and noticing that the current price is approaching a double top, whereby the first top formed 7 years ago, and then giving it greater emphasis because it is on a weekly chart, is unlikely to form a solid method for trading the markets. Chart formations such as in this example should be given less relevance the further away they are from today’s current price point. Trading price action means being in the moment whilst at work, not in the past, and this is why I actually strongly believe mindfulness has an important role to play for traders who want to be really successful.

"Trading price action involves both understanding, and getting familiar with market rhythm, and whilst this sounds simple enough in theory, it often takes traders an incredible amount of time before they get in-tune with the market and are able to trade stock movements 'as and when' they are taking place."

Markets have individual nuances and characteristics which can in some cases can take a person years to become accustomed with. It is for this reason that traders who are struggling with their current techniques should remain hopeful, because as cliche as it sounds, things can suddenly click into place and you could quite suddenly have a realization moment where you are able to see the market with new perspective, and in greater depth. Your trading abilities can quite literally transform over night, which backs up the epiphany style events which take place in some of the popular trading literature you might have read.

 

Price action isn’t confined to using candlestick charting exclusively, and an individual could trade this method with equal competence using a line chart, the main principal is that the trader is making decisions based on current price movements as opposed to making predictions. As an aside, if you have never traded using a line chart for any amount of time then it is well worth trialling this out. It is widely accepted that trading involves much trial and error in order to determine what works, and suits you best as an individual; some people are able to see the market more clearly using a more straightforward line chart and this therefore improves their trading performance.

 

How quickly a person is able to learn the art of price action trading is largely down to their own academia, and as with any educational vocation, how interested they are in the subject is to them to start with. Reading Al Brooks’ 3 part price action book series is probably not a bad place to start (I hope you are quicker at reading than me though, or this could take you at least a year to get through, and even longer to fully digest especially if you are taking detailed notes during the read). This will undoubtedly provide a comprehensive introduction to the topic with which you can develop by watching live charts; 5 minute charts come in particularly useful for this exercise since they display the same price action and market rhythm with which you’d expect to find across any time frame.

 

Learning how to trade price action will give you a much more solid understanding of the way in which markets move and there are most certainly underlying patterns which have a high probability of re-occurrence under the right precursors. The fact that markets will form a two or three leg down pattern before reversing is advantageous to have an understanding of, and the likelihood that markets will reach a new high, pull back and then go on to reach a final climax can help better-time your entry; gaining a knowledge of price action is to gain insights into common market behavior and patterns which will stop you making basic mistakes.

 

The problem with using chart patterns such as double tops, head and shoulders, or trend lines with which to enter the market is that quite simply, if trading were this simple every trader would be a millionaire already. Despite this, a huge proportion of market participants continue to trade using such methods, and failing miserably in the process. By taking the time to study and implement an advanced trading technique which focuses on the price as it is in the present will provide you with a far greater opportunity overall. Price action trading should be a long term, underlying development goal, which once at the stage where it can be implemented, can have a hugely positive impact your results.

 

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