Price action trading and strategies

What is price action trading?

Price action is the idea of trading a “naked” chart with very little or no indicators and simply focusing on price and structure. Before we go deeper into price action trading, it’s important to remember that price is the only truly leading indicator, and learning to read it could give you an advantage when trading. 

Trading without indicators does not mean that you will have more success but could be a preference for those who prefer cleaner and less cluttered charts as well as a more minimalistic approach.

Indicators vs. no indicators

There’s a sharp contrast between trading charts with indicators and clean charts. Here’s a chart with indicators on it in Figure 1, and not too that many.

Figure 1

Figure 2 is a naked chart with candlesticks only.

Figure 2

Aside from candlesticks, traders can use bars that are displayed differently than candlesticks but show the same information, as seen in Figure 3. 

Figure 3

Now some people can use indicators successfully and make money or apply their strategy properly but using clean charts will not only give the average trader clarity but can also improve their understanding of market structure by focusing purely on price. 

Indicators are not displaying any special information beyond mimicking price with minor differences. In other words, they are showing you what you are already seeing with price and nothing new. 

Nonetheless, some traders may be able to see patterns among indicators that are not so visible on price itself but that’s mostly a preference in terms of what works better visually and is not factual in real life.

Identifying market structure

The market is either trending or ranging, and most of the time, it’s doing the latter. You may find trends within ranges or ranges within trends but ultimately, the best odds are found trading corrections in already established trends.

Let’s start by looking at the price. Is it making higher highs? What about the lows, are they also moving up? If you answered yes to both those questions, you have an uptrend in place. You only need to look at the price to determine if that’s the structure. The opposite applies to downtrends.

Now let’s say the market is moving up, as seen in Figure 4, forming higher highs but also correcting sharply after every rise to form lower lows. In this case, the market is not trending and is mostly ranging or whipsawing with no clear direction.

Figure 4

Other times you may see a clearer range with price failing to make new highs and consistently reversing from the same area while finding support near the same, and already established lows.

Let’s look at some examples. The first one, Figure 5, is a clear uptrend. You can see how the price is moving up, correcting occasionally but eventually continuing higher.

Figure 5

Now let’s look at what a ranging market looks like, Figure 6. You can see how trades may be fooled by price moving higher and breaking the previous high before reversing or simply reversing before reaching the latest high. Ranging conditions are easy to trade in hindsight but put you at a disadvantage by not knowing when the market could break support or resistance.

Figure 6

Candlestick patterns and other price action triggers, especially when found near major support and resistance zones could be precursors for new trends. For example, a hammer after extended downside could trigger a large enough up move that it would be seen as a new uptrend especially if price breaks the structure and starts showing higher highs and higher lows.

Trading with price action

One way to explain trading with price action is finding significant support and resistance areas and trading candlestick patterns near them. Trends and price movements repeat themselves given that the same players are always behind the action.

Let’s look at some steps on trading with price action properly.

Remove all indicators and focus purely on price. Begin by watching what the price is doing over a decent period. See how it reacts around news time or important support and resistance. Look at the candles and try to analyze what happened with a specific candle and what could happen next.

At this point, you should be familiar with candlestick patterns, support and resistance zones, and Fibonacci retracements and confluence areas, among other fairly used and relatively clean tools that can be used. Now the real trading begins. 

Start by identifying the trend. Is the market bullish? Bearish? Ranging? Whatever the market is currently doing, you need to adjust your strategy, setups, and risk parameters to suit what is happening right now or simply sit on the sideline until more favorable conditions present themselves.

Let’s assume an uptrend with shallow corrections. In this case, price action is telling us momentum is strong and not that many traders are taking profit which is leading to shallow corrections. Here, candlestick patterns and Fibonacci may not be ideal so traders should focus on large bullish candles or bearish ones if the trend is down. In other words, traders should look for a breakout and continuation of the original trend.

Now, what if we have a trend with deeper corrections? Here, we need to see how deep the correction is. Fibonacci retracements will be a great tool in this case and combining them with candlestick patterns should give good results. Is the correction stopping at 50%? It’s still healthy even down to 61.8%. Beyond this point, the entire move and trend are prone to failure with a reversal possibly setting up.

What if the price is parabolic and simply not correcting noticeably? In this case, we switch to a smaller timeframe to have a better view of price action and attempt to follow the idea behind shallow corrections.

Now, let’s assume the price is consolidating in a well-defined range, seen in Figure 7. Do we trade the range or wait for a breakout? Ideally, it’s both. You continue to look for signs of weakness near the top and signs of strength near the bottom and the more aggressive traders would enter as the price approaches those extremities. The key here is to watch for a potential break and make sure it's a real one. 

Figure 7

Figure 7

How can we tell the range is ending and the breakout is real? There’s no easy way to do this. We need to watch for a close above or below the range then see how the price is holding and whether it’s reversing lower or showing healthy consistency. After the break, we define the near-term support and resistance and watch for another break away from the range. At this point, and if this break happens, then we would know the odds are in our favor that a new trend is forming.

Let’s look at some hypothetical scenarios:

Example 1

The trend is up with higher highs and higher lows. On the latest swing, we have price consolidating near the 50% Fibonacci, seen in Figure 8, retracement and forming a hammer candlestick. At this point, aggressive traders have a trade on their hands and could go in towards the long side. Prudent and risk-averse traders will wait for the next candlestick to be bullish before they get in.

Figure 8

Example 2

A downtrend is in place with clear lower lows and lower highs. A Fibonacci is placed on the latest swing to see where the price might end its correction. We see some stalling around the 38.2% and bearish engulfing candlestick forms. Ideally, if the trend has been showing shallow pullbacks, then the odds on this trade would be good but before pulling the trigger, we should see how price action has been behaving in general, seen in Figure 9. 

Figure 9

If the correction seems too shallow compared to previous ones, the candlestick, while bearish, could be a trap done by large-scale buyers tricking sellers into thinking the market is about to continue lower. It’s a way for institutional traders, especially buyers in this case to take the short-side liquidity from those traders and initiate their long positions.

Example 3

An uptrend has been in place for some time with a clear structure but approaching a major resistance zone. We identify the correction and draw the Fibonacci retracements with price stalling just below the 61.8% Fibonacci and forming a bullish candlestick pattern. Corrections are increasingly deeper with every swing, a potential sign that sellers are coming in heavier each new leg higher. While the signal is valid and could be considered a good setup, it’s a bit risky as we know the upside is limited.

In this scenario, a break below the trigger candlestick could quickly see price action dipping near the low of the correction and possibly breaking lower which could lead to a break of structure and some consolidation ahead of renewed upside or a potentially new downtrend.

Conclusion

Price action trading will not turn a trader into a successful one, but it can help you look at price in a completely different manner while relying on what matters the most and that is the price. 

Clean charts are easier to look at and understand and at the end of the day, you are looking at the price in its truest form and making decisions based on the flow on that stock market. It’s all about context, and understanding what price is doing will tell you what your odds are when you find your next setup.