A Practical Guide To Price Action Trading
A Practical Guide To Price Action Trading
A Practical Guide To Price Action Trading
ACTION TRADING
Price action trading is often touted as an elusive magic bullet for traders. But the
truth is that it is neither elusive nor magical.
It is not elusive. In fact, you can grasp the essential concepts of price action
trading with ease.
But it is not magical as well. Price action trading is a just one of the many trading
approaches. It does not magically produce profits.
The good news here is that you do not need a magical trading method.
Want to learn how to trade with price action without all the complicated
jargon?
If you answered yes to the questions above, this is the guide you need.
GUIDE OVERVIEW
Definition Of Price Action Trading
Price Bars
Price Patterns
Confluence
Price-Only Charts
Entry Strategy
Trade Execution
Stop Losses
Profit Targets
But this is not the best way to define price action trading.
But remember to use it with price action as an anchor. Price action must remain the
cornerstone of your trading strategy.
You can do this easily with OHLC price charts. OHLC means Open-High-Low-Close.
This means that the price chart must show the open, high, low, and close price of
each trading period. (E.g., 5-minute, 1 hour, 1 day)
Both traditional Western bar charts and Japanese candlestick charts fit the bill here.
In this guide, we’ll use price bars and candlesticks interchangeably.
3. Understand the different types of price action setups suitable for each
market context.
PRICE BARS
Learning how to read price charts bar-by-bar is a critical skill.
Hence, I’ve written a separate article – Beginner’s Guide To Reading Price Action.
I highly recommend that you read the article above to learn the basics of reading
price action. It will bring you through a bottom-up approach to understanding
price action.
After completing the Beginner’s Guide To Reading Price Action, the chart below will
make sense to you.
The rest of this practical guide is not going anywhere. You can return here after
picking up the basics.
Each turning point is a swing pivot. When a rising market turns down, a swing high
is formed. When a falling market turns up, a swing low is formed.
To make sense of the market, you just need to observe the swing highs and swing
lows.
Markets often consolidate before reversing its trend direction. This period is known
as accumulation or distribution depending on the trend that follows.
In fact, the chart below shows the consolidation that took place before the bear
trend shown in the previous chart.
IMPORTANT NOTE ON DRAWING PRICE SWINGS
For price swing analysis to be helpful, you must employ a consistent method of
identifying swings. You must not mark out the swings subjectively.
You need to use an objective framework for marking out swings. The swings drawn
in the charts above are the tested and valid pivots taught in my course.
1. Retracement
2. Reversal
3. Range-Bound
4. Break-Out
The first two, retracement and reversal, are setups you look for in a trending
market.
The other two, range-bound and break-out, are setups you find in a
ranging/consolidating market.
When analyzing a trend, it’s useful to know the difference between an impulse
swing and a corrective swing.
However, as the market is trapped in a range, the profit potential is limited. Hence,
it’s important to pay close attention to your reward-to-risk ratio.
#4: BREAK-OUT TRADING SETUP
A break-out trade is challenging because of the possibilities of many false break-
outs.
However, if you spot the right signals, you are likely to enjoy a swift trade with an
excellent risk-to-reward ratio.
In this section, you’ve learned how to read price action and judge the market
context using price bars and swings.
And in the next section, you’ll learn three vital tools to help you pinpoint these
turning points.
Trend Lines
Price Patterns
A support zone is a price area that rejects falling prices. In other words, it is a price
zone that supports the market from falling.
A resistance zone is a price area that rejects rising prices. It is a price zone
that resists the market from ascending.
Standard methods used to determine S/R:
Psychological Numbers
Moving Averages
Fibonacci Levels
Pivot Points
Trend Lines
When using S/R in your trading, take note of the phenomenon of S/R flipping.
If a support zone fails, it turns into a resistance zone. Likewise, if a resistance zone
fails, it becomes a support level.
The existence of S/R zones, together with market inertia, form a major part of
a price action trader’s edge.
TREND LINES
As covered earlier, you can derive great insights simply by observing price
swings. Trend lines allow you to amplify those acumens.
A bear trend line slopes downwards. Connect a pair of falling swing highs to get a
bear trend line.
As shown in the examples above, trend lines act as a support or resistance.
Hence, you can use trend lines to help you time your market entry.
On top of that, broken trend lines hint at a market reversal, making them a
prime tool for tracking trends.
PRICE PATTERNS
Specific sequences of price movement can be useful. They tell us what the market is
doing now, and offer clues to what it might do in the future.
These sequences are called price patterns. They are helpful for pointing out entry
points and potential stop-loss levels.
Hence, price patterns form an integral part of a price action trading strategy.
Short-term price patterns include bar patterns and candlestick patterns. The
diagram below shows a typical bar pattern known as Pin Bar.
Both bar and candlestick patterns are based on pure price action. Hence,
unsurprisingly, they overlap a great deal. Many bar patterns have a similar
candlestick counterpart.
To make the most out of your price pattern study, I encourage you to review these
price patterns in the pairs listed below.
Bar Pattern
Pin Bar
Inside Bar
NR7
Outside Bar
————-
————-
————-
————-
————-
Candlestick Pattern
Hammer
Harami
Doji
Engulfing
Price patterns that tend to form over a longer period are known as chart patterns.
The example below shows the Head and Shoulders pattern, a striking reversal
pattern.
Many traders focus on finding price patterns because they signal an entry. But price
patterns should not be the cornerstone of your trading strategy.
This is because price patterns work best in the correct market context. Hence, your
evaluation of the market bias is crucial.
But if you want to refine your price action tactics, take a close look at the following
concepts.
Confluence
In the chart below, you’ll see that the market made two attempts (two upswings) to
move against the trend. Both attempts failed, and the market fell to new
lows.
EXAMPLE #2: DOUBLE BOTTOM PATTERN
In the chart below, the market made two attempts to push lower before reversing
up. This formation is the well-established Double Bottom reversal pattern.
Many compelling price patterns are the result of multiple failed attempts.
Hence, this is a principle you can rely on when interpreting price action. It is also the
basis for the re-entry equivalent setup.
CONFLUENCE
Confluence refers to confirmation from different trading tools.
The chart below from Template For A Simple Day Trading Strategy shows an
example of confluence working in our favor.
A bearish Pin Bar formed as price met the resistance of the bear trend line. An
excellent short setup.
Don’t be intimidated. “Multiple” usually means just two or three time frames.
For instance,
1. A higher time frame to analyze the market context
When using only two time frames, the trading time frame is used to determine
setups, time entries, and limit risk.
The example below used the weekly chart to determine a bullish trend. Then, a
break of the resistance on the daily time frame triggered the long trade.
Multiple time frames offer a glimpse into the fractal nature of financial markets.
For a specialized reading on trading with multiple time frames, check out this book
– Technical Analysis Using Multiple Timeframes.
In this section, you will learn about three tools favored by price action traders of all
stripes:
Moving Average
Volume
It is a simple line plotted alongside price action. Hence, it offers depth to your
analysis without obscuring price action.
The chart below uses a 3-period simple moving average (SMA) of the median price
to track price swings. Median price refers to the mid-price of the bar range.
A medium-term moving average acts as dynamic support and resistance.
For active traders, this setup works well for timing trade entries.
A long-term moving average shows the market trend.
Use moving averages as a tool, not a crutch.
As the examples above show, moving averages add value to price analysis.
However, always remember that you are not trading the moving averages. You are
trading price action.
One of the most reliable and easy-to-spot volume signals is climatic volume.
Climatic volume points to significant support and resistance levels and
might precede a trend reversal.
The chart above shows how a high volume bar set the stage for a major support
zone.
Intrigued?
The best way to study the relationship between price and volume is
through Volume Spread Analysis (VSA).
Price-only charts remove the time element from the chart. In other words, these
charts represent real market movement.
Many traders do well with conventional charts. But most price action traders will be
intrigued by the option of a price-only chart.
The example below shows a type of price-only chart, Renko, which means brick.
A Renko chart forms a new brick only when the market moves beyond the previous
brick by a preset price range. When the market stagnates, the Renko chart
stays still.
Renko
Be careful. Due to their unique construction, these exotic chart types may defy the
usual price action analysis. Observe them with an open mind and tread carefully.
We’ve covered an array of price action trading concepts. It’s time to create your
own price action trading framework.
Entry Strategy
Trade Execution
Stop Losses
Profit Targets
I’m not going to lie. It takes hard work to put together a functional trading plan.
But the concepts you’ve learned so far and the resources in this section will be of
great help.
The following sections contain examples, advice, and resources to assist you with
each aspect of your trading plan.
ENTRY STRATEGY
The most efficient way to learn is by examples.
I’ve selected three of my favorite simple price action strategies to get you started.
TRADE EXECUTION
The moment you enter the market is critical. But how exactly should you enter into a
position?
You have a choice between entering at the market, with a stop order, or with
a limit order.
Make sure you understand the implications of your selected order type – How To
Enter The Market As A Price Action Trader.
STOP LOSSES
You must always limit your risk. A stop loss order is one of the best ways to do so.
Having a profit target will ensure consistent performance and remove emotions from
your exit plan.
TradingView – one of the best online charting platform that works with just
your browser
Day Trading With Price Action Course – The swings and trend lines in this
guide are drawn according to the method taught in this course.