In this post, I will discuss and explain the various elements of the Price Action Trading Strategy. It will include market structure, multiple time frame analysis, and entry and exit strategies. Once you read this post till the end, you should gain excellent clarity on Price Action Trading Strategy.
What is a Price Action Trading Strategy?
The concept of Price Action Trading Strategy was founded by Richard Wyckoff in 1907. The strategy involved an in-depth analysis of price movement and volume. Hence, it would not be wrong to say that the Price Action Trading Strategy deals with the movement of price and change in volume. Everything in the market is based on price and volume, which is why there is a famous quote among Gujarati investors and traders – “Bhav Bhagwan Che.” It means the price is God in the stock market.
Over the years many new elements and terms have evolved in Price Action Trading Strategies like Demand and Supply, Consolidation, Momentum, and Overbought and Oversold. Besides, many traders trade using indicators like MACD, EMA, and Supertrend. However, what's important to understand is that indicators are derived from price and volume. Besides, most indicators are lagging, and this is where pure price-action traders have an edge over traders who rely on indicators.
How Does the Price Action Trading Strategy Work?
There's a famous saying among traders: “Trend is your Friend.” It's always wise to identify the trend correctly and trade in the direction of the trend. Price Action Trading Strategy works equally well for all forms of trading and financial instruments. Besides, it works equally well on line charts and candlestick charts. The strategy starts with Trend Analysis. The trend goes like this: Uptrend, Distribution, Downtrend, and Accumulation. An uptrend is when the institutional buyers in the market take the price constantly higher.
Distribution is the phase wherein the institutional buyers decide to square off all their positions or book profits.
When Distribution happens, it eventually leads to a Downtrend, which means the price keeps falling. However, at one point price will stop falling, and that happens at a strong Support or a Demand zone.
At such as point, you will see the price consolidating. A consolidation means neither buyers nor sellers can move the price in their desired direction, and the price is stuck within a range, or in other words, the price is range-bound. Another way of seeing it is through the concept of Accumulation, which means, that institutional buyers accumulate more volume of a financial instrument gradually when they are convinced that the price is already at its low. It will eventually lead to an Uptrend again.
Price Action Trading Strategy: Trendlines
Now that you understand the concept of trend, it's time that you learn how to plot trendlines on the chart. If you are a day trader, you start your trend analysis on the 1D timeframe. It will give you a clear picture of where the price is heading.
You can join the highs of two last swings to get a down trendline and on the contrary, you can join the lows of the last swings to get an up trendline. Besides, you can analyze the trend in a 15m timeframe, to get your trendline more accurate.
Price Action Trading Strategy: Support & Resistance
Next, it's important to understand the concept of Support and Resistance. Support is a level where a good number of buyers have created their positions. Hence, the price will have difficulty in breaking this level. If the Support level is strong, the price will start rising after hitting this level. However, if the Support level is not strong, the price may be able to break it and fall further.
Resistance, on the other hand, is a level where a good number of sellers have created their positions. Hence, after reaching this level, the price may start falling if the Resistance level is strong. The price may break the level if it's not that strong.
You can plot Support and Resistance using a 1D or 15m timeframe by connecting the highs of swings using horizontal lines. Another way of finding Support and Resistance is to look for the levels where prices met some rejections in the recent past.
Price Action Trading Strategy: Demand & Supply Zone
Demand and Supply Zone is one of the most commonly used concepts of Price Action Trading Strategy. While a Demand Zone is an area on the chart where big buying started, a Supply Zone is an area on the chart where big selling started.
After the price reaches these levels, it's expected to reverse in most cases (Trend Reversal). If the price in an Uptrend hits a Supply zone, and after a rejection breaks a Swing low, it may indicate the start of a Downtrend. On the contrary, if the price in a Downtrend hits a Demand zone, and breaks a Swing high, it may indicate the start of an Uptrend.
Price Action Trading Strategy: Overbought & Oversold
Now, this is an interesting concept and will provide you with more accuracy in trading once you master it. Once you have a trendline plotted on your chart, you ideally enter your positions whenever the price touches the trendline to be with the trend but what if the trend is uptrend and the price opens way higher than the trendline?
In such a scenario, it's always wise to abstain from trading with the trend since the price is already Overbought meaning buyers have already taken the price way higher and it may not possibly go up any further. Hence, if you still want to trade, you must look for a good Supply zone from where the price may fall all the way down to the trendline. Once you fund the level, you will need to Short sell instead of buying and your target will be the trendline. The moment the price gets close to the trendline, you must exit.
On the contrary, you may encounter a scenario where the price gets oversold in a Downtrend. It means you must not consider Selling and instead look for a good Demand zone or a strong Support level to start buying with the trendline as the target level.
Price Action Trading Strategy: Retest
It's time to talk about Entry strategies in Price Action Trading Strategy. Some of the popular entry setups are Range Breakout/Breakdown Retest, Double Top or Botton Neckline Retest, and Trendline Breakout/Breakdown Retest. Now, when it comes to planning your entry, you have to monitor the chart in a 5m timeframe and plan an entry in 1m. The conventional way to enter a trade is to wait for a pullback after a breakout or breakdown.
Next, wait for a candle in your desired direction and another candle of the same color to break its high to enter the trade. For example, after a Trendline Breakout, you must wait for the price to take a pullback to the Trendline again, and when it does, you wait for one Green candle to form. Your entry will be right when another Green candle breaks the high of the previous Green candle.
However, there is another type of entry called the “Ambush” entry wherein you enter the trade just as the price retests a Breakout/Breakdown level. It is a little risky entry but can be very advantageous if executed properly.
Price Action Trading Strategy: Stop Loss
Trading without a Stop Loss is never wise as it may cost you big losses. Hence, you must always place a Stop Loss when entering a position. However, like you plan your entry, you must plan your Stop Losses too. You must always try to place a Stop Loss behind a technical barrier, which can be a Support or Resistance depending on the direction of your trade. Besides, it's always wise to keep your Stop Losses small.
Price Action Trading Strategy: Exit Strategy
A right exit is equally crucial as a right entry. While entering a trade, you must be clear about your target. You need to have one target based on your Money Management, and another based on strong Support or Resistance. For example, if you take a trade on the buying side, you must plan to exit at a strong Resistance. On the contrary, if you take a trade on the selling side, you must plan to exit at strong Support.
Another way to do this is by trailing your Stop Loss wisely. That way, you give the price space to move without squaring off your positions right away and at the same time locking some profit. Trailing Stop Loss can be a wise thing to do if you are already at some profits.
Does Price Action Trading Strategy Work with 100% Accuracy
It's important to understand that no trading strategy works with 100% accuracy and neither does Price Action Trading Strategy because there are many other factors that may impact the market. For example there can be a sudden good or bad news with a big impact on the market. However, Price Action Trading Strategy provides excellent clarity about the market. Just like every other strategy, Price Action Trading Strategy may also fail sometimes, which is why you need to have a good money management plan alongside a trading strategy. On days when your trading strategy fails, your money management will save you from big losses.
I have walked you through all the essential basics of Price Action in this post. If you are looking forward to sustaining as a trader or investor in the stock market, you must learn the Price Action Trading Strategy really well. Even though you can start using indicators but indicators are lagging while you can get early entries with Price Action. Price Action Trading Strategy works like magic if you execute it properly.
Price Action Trading Strategy FAQs
What is the foundation of the Price Action Trading Strategy?
Price Action Trading Strategy was introduced by Richard Wyckoff in 1907, emphasizing the analysis of price movements and volume. It revolves around understanding price changes and volume fluctuations, considering them as primary market influencers.
How does the Price Action Trading Strategy identify trends?
The strategy begins with trend analysis, recognizing phases like Uptrend, Distribution, Downtrend, and Accumulation. These phases depict institutional buyer behavior, guiding traders to identify entry and exit points.
What role do Support and Resistance play in this strategy?
Support represents buying interest levels, while Resistance marks selling interest levels. Traders plot these levels by connecting swing highs and lows, aiding in understanding potential price reversals.
What are Demand and Supply Zones in Price Action Trading?
Demand Zones denote areas where significant buying began, while Supply Zones mark areas where substantial selling originated. These zones often signal potential trend reversals.
How does the strategy deal with Overbought and Oversold conditions?
When a price is deemed Overbought (in an uptrend) or Oversold (in a downtrend), traders look for reversals or corrections. Overbought conditions suggest caution for further buying, while oversold conditions hint at potential buying opportunities.
What are some common entry strategies in Price Action Trading?
Entry strategies include Range Breakout/Breakdown Retest, Double Top or Bottom Neckline Retest, and Trendline Breakout/Breakdown Retest. Traders aim to enter trades after confirming the validity of a breakout or breakdown.
Why is setting a Stop Loss crucial in this strategy?
Placing a Stop Loss is essential to limit potential losses. It's recommended to position Stop Losses behind technical barriers, such as Support or Resistance, based on the trade direction, and keep them relatively small.
How should one plan an exit strategy using Price Action Trading?
An effective exit strategy involves setting profit targets based on Money Management principles or identifying strong Support/Resistance levels. Trailing Stop Losses can also be employed to secure profits while allowing room for price movement.
Can this strategy be combined with indicators?
While some traders use indicators alongside Price Action, this strategy is primarily based on price and volume analysis. Indicators, although derived from price data, are considered lagging in comparison.
Is the Price Action Trading Strategy suitable for all financial instruments?
Yes, this strategy is versatile and can be applied to various trading instruments across different timeframes, making it adaptable to different market conditions and assets.