Price action is a study of technical analysis that can bring quite a bit of benefit to the trader. By focusing on price and price alone, investigating previous movements and how markets have reacted – traders can look to get the cleanest technical picture of a given market that might be available.
While future price movements are always going to be unpredictable, regardless of the technical method used –Price Action can highlight potential areas of interest in which traders might be able to look to risk a little bit to make more (if they’re right). This brings up the concept of risk-reward, which can be a major undoing for many traders, especially new ones.
Price Action can be that tool that helps traders look for advantageous risk-reward ratios. If you’re not familiar with price action and would like to establish a foundation of this type of analysis
In this article, we’re going to look at three of the basic rules that traders can look to build their approaches and strategies around.
The trend is your friend – but the trend is also a relative!
Most traders know they should look to trade in the direction of the trend. And the reason for this goes right back to the unpredictable quality of markets: As in, I may not be able to predict what will happen next, but if the bias I’ve seen here (trend) can continue, then I can find myself in a pretty good spot by trading in that direction.
Sometimes trends continue, sometimes they don’t… and that’s where risk management comes in: So that when trends don’t continue, the trader can look to mitigate the loss but if the trend does continue, they can look to make more than they had to risk to get in the trade
Candlestick shadows highlight reactions – and reactions can be opportunities
One of the greatest parts about trading with candlestick charts are the potential ‘tells’ that might be offered. As in, if resistance is coming in a market we’ll generally see sellers coming in to offset buying interest. And this can show up on a chart before the actual move or swing materializes as that buying pressure (of those attempting to chase the previous up-trend) and selling pressure roughly offset.
When sellers come into a market to take advantage of new higher prices, a wick on the top-side of price action can show up… or on the other side, if buyers are coming in to a market to take advantage of new, lower prices wicks can show up on the bottom-side of price action.
This can be valuable because it’s the earliest sign of a potential reversal or swing in the market. Buyers taking control mean higher prices, and that wick highlights a potential area of support.
Risk Management comes along with Price Action
The last rule is, in my opinion, the best one. And that’s the fact that the aforementioned basic price action rules offer a rather simple way of looking to manage risk.
If a trader sees an up-trend on the longer-term chart, and wants to buy – what business does that trader have of staying in the long position should the market go on to make lower-lows and lower-highs?
After all, this is indicative of a down-trend; and if the trader is in a buy position when a down-trend starts or picks up, why would they want to sit in the trade and watch equity evaporate from their account?
They shouldn’t – this is exactly how traders fall prey to that Number One Mistake Traders Make.
Things change, markets are dynamic, and prices are unpredictable: You’ll never be able to build a strategy with a 100% success rate because perfection in trading is, unfortunately, impossible.
While price action may not be a Holy grail, But it does offer traders a clean way of analyzing technical setups on the chart so that they can look for strong risk-reward ratios.
Traders can use trends on longer-term charts to expose biases in the markets. And if looking to buy, traders can wait for a ‘higher-low’ to be made, and then can investigate entry on the shorter-term chart. As the shorter-term chart begins to show ‘higher-highs’ and ‘higher-lows’ as evidenced with wicks on the bottom-side of price action; the trader can enter under the presumption that the trend may be coming back.
There is no need to predict, nor should traders expect the powers of prediction to bring them much long-term benefit in the field of trading.
If the trend doesn’t come back, then bail for the smallest loss possible by using that support (and wicks) for stop placement…. And if the trend does come back, the trader gets to manage a winning position.