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Price Action Trading: Learning the Strategy

Jason BondJason Bond ·

There are as many specific ways to trade stocks as there are traders on the market. Everyone is different, even between two people using the same general trading strategy or theory. However, out of the different ways to buy, hold, and sell securities, similar tactics fall into general labels. There is one common trading method you may have heard of before. Beginners often use it and some advanced investors and even firms do as well.

Its name is price action trading, but what is it, and should you try it? How do you make this method work for your investing goals, your quirks as a trader, and the current market? Let’s find out.

Breakdown:

  • Price action trading is done primarily by analyzing price changes.
  • Price action offers limited information but can still be researched well.
  • There are many more specific strategies for how to make price action trading work.

What Is Price Action Trading?

Price action trading is a style of trading where decisions are made based on how prices are moving while minimizing other factors. If a trader’s priority is finding stocks or other securities that have made specific movements in price, such as suddenly dropping, that person is price action trading.

Price action is only one metric by which to analyze the market and make decisions. Other traders might prioritize specific indicators, how a company is doing in the news, the volume of available shares, statistics, seasonal factors, or some combination of these and other variables. Compared to tracking all of that, price action can be liberating in its simplicity. If a stock’s price movements look promising to you, you watch that stock and/or take action on it.

Without a doubt, price action trading is one of the simplest and purest ways of making investing decisions. However, don’t take that to mean that the method is less effective. Like any common trading strategy, it can work beautifully or fail spectacularly based on how you use it day by day.

With the right strategies and follow-through on your plans, you can commit to price action trading and turn a substantial profit. With the wrong strategies, it’s just as easy to lose money as it is with any poorly implemented trading method. If you’re a complete novice to investing, however, price action trading is an excellent place to begin. You can start making transactions and grow comfortable and confident that investing works for you, without diving too deep into the other variables and getting overwhelmed.

The advantages of price action trading are:

  • The strategies are all fairly simple and don’t demand very much research.
  • The limited variables in play can make it easier to investigate more of the market.
  • Price information, unlike most indicators, is real-time.

The disadvantages of price action trading are:

  • There often isn’t enough information to automate the trading process.
  • The limited information may create an incomplete picture of an asset’s potential.

Price Action Trading Example

Suppose a trader purchased shares of a stock at $25 one month ago and is now looking for the optimal time to sell. For the past weeks, the stock has remained stable, but suddenly, within the past day, it climbed to $31 per share.

The buyer might judge that such a sudden jump likely won’t immediately fall back down, and that as soon as the rise starts to wilt, that is the peak that the stock will reach and the optimal time to sell. The trader waits another day, which sees the stock rise from $31 to $34. Over the day after that, it goes only from $34 to $34.50. At that point, the trader sells. This turns out to be wise, as in the following days the price quickly drops back toward $25. The decisions were solely based on price movement.

Price Action Trading Strategies

The basic premise of this method is simple enough: when analyzing assets, price action gets top priority. If a stock goes up, people are buying. If it goes down, people are selling. The key is to look a little closer and try to judge the likely future of an asset.

Historical price data and recent, real-time price data will be your best friends with this trading method. For instance, you may find a stock that is currently dropped to a price of only $3. But what did it drop from? If the historical price of a stock hovers between $10 and $12, and it usually spends most of each year at that price, you know that buying it at $3 is likely a good move.

Other important factors you’ll want to slowly introduce into your price action trading include:

  • Bid price, with a higher price indicating higher demand among buyers.
  • Velocity, meaning how rapidly a stock changes in price.
  • Magnitude, the ultimate difference in lowest price and highest price.

With these elements, a price action trader hunts for stocks that either have an optimal entry point for buying or may have one soon after. The goal is to buy at as low of a price as possible on the likelihood of that price rising back up, as soon and dramatically as possible.

There are a few commonly known price action strategies, such as:

  • Breakout: this strategy entails studying assets to find patterns, and then capitalize on a pattern that has suddenly broken. One example could be a stock that suddenly started to rise compared to its recent, stable price history. A disrupted pattern can indicate a new potential opportunity. It might continue to climb or suddenly drop. There is a lot to learn in breakout trading, but if you like to be active in the market and jump on potential trades at the best possible time, it may be a good fit for you.
  • Engulfing Candle: this is a strategy that requires studying candlestick price charts. Candlesticks show the price action of an asset and how quickly each bullish or bearish move happened. Be sure to learn about candlestick price charts first if you aren’t familiar with them. Suffice it to say, though, that an engulfing candle is when one candle direction’s real body completely covers the progress of the previous candle in the opposite direction. For example, many traders wait for when a down candle engulfs the progress of an up candle as a sign of new price trends for that stock.
  • Finding Double Tops: this strategy refers to double tops, which are when an asset price rises significantly two times in close proximity, with only a short and minor price drop in between. Such behavior could indicate a major reversal in the stock’s direction soon afterward. The same theory applies to finding double bottoms, with the hope of buying in at the nadir of the second bottom and then selling at a restored, high price later.

By and large, markets have reliable momentum. That means that stocks in motion tend to stay in motion. If a market doesn’t appear to be making any substantial changes, however, and assets are just moving sideways, it’s best not to speculate too much and keep searching.

Day Trading Strategies Using Price Action Patterns

Much of the time with price action trading, the goal is to identify price support and resistance points. This simply means price amounts where the asset in question is less likely to keep going in the direction it was taking and start to reverse. You could use this repeatedly-tested information on prices to make smart day trades.

For example, if you look through the long-term history of a stock, you might see that it generally hovers at $14. Every few months, however, it jumps up to around $18 and then promptly tapers out and drops back down over a few days.

If it looks like this rise will happen again within the day, you could buy shares early on and sell them at the end of the market day to capitalize on that peak. Since that price support and resistance point of $18 has repeatedly occurred, you can make that day trade if the time is right, confident that you won’t lose money or miss out on greater potential gains.

How to Learn Price Action Strategy

The most important aspect of a price action trading strategy is to pick a method and stick to it, without getting mired in the “why” of how a stock’s price is changing. While other strategies emphasize statistical analysis and researching industry news, these elements can overcomplicate a price action trader’s thoughts and invite decision paralysis.

If you commit to trying price action trades, resist the urge to look up more information on a stock that seems promising, because once you get that information, it becomes much easier to second guess your initial impressions and miss out on a great opportunity.

Ultimately, all trade strategies are going to have challenges and occasional defeats. What matters most is to take setbacks in stride, stick to a strategy long enough to get good at it, and keep maximizing your wins. For critical secrets on the potential of shifting prices, be sure to check out the upcoming webinar.

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