Contents:
- Is price action trading the best strategy?
- What does price action mean in trading?
- Indicators vs. a Chart-Only Approach
- How to apply a price action strategy
- Why do price action traders fail?
- Does price action trading really work?
Is price action trading the best strategy?
Think of it like this: whenever you place an order to buy or sell, you do it primarily because of a security’s price. Price movements alone dictate whether traders make a profit or loss. If a trader’s technical analysis emphasises price action, they are focusing their attention on the exact same thing that determines trading success or failure.
If, for example, your price action strategy urges you to buy EUR/USD at 1.20, cut your losses with a stop loss at 1.1950 (50 pips lower), and take profit at 1.21 (100 pips higher), your entries, exits and money management were all determined using nothing but the price.
What does price action mean in trading?
Price action is the way the price itself is moving. Price action traders focus solely on price to inform their strategy. They look for patterns and structure, mostly ignoring popular indicators.
Of course, there is more than one way to display price – you can look at a bare-bones ticker tape, scrutinise level 2 market depth (i.e. aggregate bid and ask offers), or perhaps peruse a line chart. All of these have their advantages, but price action traders most commonly rely on bar charts and candlestick charts.
When talking about price action trading, we are talking about the action in the price from minute to minute, day to day, and so forth. The kinds of charts used reflect this fact. You can think of price action trading as happening exclusively in the upper half of the chart, excluding all underlay charts.
Is following price action better than looking at indicators?
There is nothing wrong with technical indicators – they can certainly be used effectively. However, they can end up confusing as well as informing, and many uninformed or inexperienced traders run into problems by misusing them. Just below, you’ll see an example of what not to do:
I think you will agree that the above chart is almost impossible to read. With all those technical indicators showing different things – how can a trader know when to buy or sell? There are too many conflicting trading signals to offer the trader a good trade idea. At best, you’re likely to be mired in “analysis paralysis”; at worst, you’ll start seeing things that aren’t really there.
If you want to be a consistent trader with a good track record, anything resembling the above chart must be avoided at all costs.
From a technical analysis standpoint, indicator trading strategies are the opposite of price action trading strategies. However, there is no need to take an extreme position as to whether price action is better than technical indicator trading. There is a place for both, and it is even possible to combine the two.
In this article, we’ll make the argument that price action should be the focus of technical analysis…however, there is no reason not to turn to indicators when you want to confirm price movements. After all, technical indicators are just price action, distilled through a little mathematical wizardry. It makes logical sense that a security’s price, in as raw a form as possible, should always be the first consideration, though other techniques can also be employed.
How to apply a price action strategy
A reliable trading strategy is based on doing three things, and all three can be accomplished using price action techniques.
- Determine the trend.
- Find trade entries and exits.
- Manage risk.
Let’s review these three crucial tasks through the lens of price action.
Finding the Trend Without Indicators
What can you tell from this chart? Do you need a technical indicator to understand that the price is moving from the bottom left to the top right, or in other words increasing steadily?
In this case, the chart is clearly indicating that an uptrend is in effect. So, merely by glancing at a security’s recent history, we can determine the general momentum of the market. What comes next is to settle on a price action trading strategy that can be expected to work in an uptrend, most likely one that involves going long rather than shorting the market.
Leveraging price action to assess trade entry and exits
One feature of using a price action strategy is that analysing charts is always somewhat subjective and intuitive. With that in mind, let your eyes scan around the chart above before scrolling down. Can you spot any potential trade entry points in this general uptrend? Is a technical indicator really necessary to tell you about any of these trade entries?
Entry 1 is a breakout trade.
Entry 2 is another breakout trade.
Entry 3 is firstly a breakout trade, but then also a pullback trade.
Entry 4 is a breakout.
Entry 5 is a breakout.
Refining risk management with price action
What about if the trend is sideways? Are there any reliable ways to spot low-risk entry and exit prices inside this price range, without using technical indicators?
In this example, using price action alone, a price action trader can clearly see that the price is moving sideways within a 100 pip price range. Buying in the bottom 20 pips of the range and selling in the top 20 pips would, therefore, result in a 4:1 risk-to-reward ratio.
Common Mistakes That Lead to Losses
It is possible to trade profitably with a price action trading strategy. However, monitoring the price alone, or indeed spending all your energy on whatever kind of technical analysis, will not guarantee profits. A sound risk management system, as well as monitoring fundamental data via an economic calendar, and perhaps complementing the price action techniques with technical indicators, all increase the probability of successful trading.
Does price action trading really work?
Ultimately, the price action traders who turn out to be successful do so for the same reasons traders following any strategy make money. Here are 5 tips to become a consistently profitable trader:
- Don’t reinvent the wheel. There are many tried-and-tested price action trading strategies that you can emulate. Spend a little time on trading books, courses, or free internet resources.
- Backtest your price action strategy. Don’t take our word on whether price action works; instead, use your trading platform to scroll back through historical charts and see for yourself whether this has worked in the past
- Forward test your strategy using a live trading account. A demo account is a good way to get familiar with the platform’s interface, but it does not provide a true reflection of how you will trade when using real money.
- Maintain a trading journal to record the success of the price action trading strategies you are trying out.
- Give the strategy time. One of the most common newbie trader mistakes is to jump from one strategy to the next without giving it a chance to work. This is one example of a skill you learn by doing, so keep practising and discovering.
