Price Action Trading

Key Takeaways

1. Price Action: Trading Based on Pure Price Movements

'Price Action Trading' is a trading concept in which a trader reads the chart, and makes subjective trading decisions based on the price movements, rather than relying on technical indicators or any other factors.

Defining Price Action. Price action trading is a methodology where traders make decisions based on the actual price movements on a chart, rather than relying on lagging indicators. This approach focuses on understanding the story the price is telling, using only price and volume data to identify potential trading opportunities. It's a direct and uncluttered way to analyze the market, cutting through the noise of complex indicators.

Essential Components. The core of price action trading revolves around three key elements: price, time, and volume. Price reveals opportunities, time regulates them, and volume measures their success. Volume is particularly important because it reflects the participation of major players, who account for a significant portion of trading activity. By mastering these components, traders can develop a keen sense of market dynamics.

How to Use It. To effectively use price action trading, traders must first identify key price levels using tools like trend lines, pivot points, or supply and demand zones. Then, they look for confirmation signals, such as candlestick patterns, at these levels to plan their entries and exits. This method requires patience and a deep understanding of market behavior, but it can provide a significant edge in trading.

2. Support and Resistance: Identifying Key Price Levels

Many traders consider support and resistance concepts as basic trading concepts, and hence they look for some complicated analysis.

Defining Support and Resistance. Support and resistance levels are crucial price points where the market tends to find buying or selling interest. Support is a price level where demand is strong enough to prevent further price declines, while resistance is a level where selling pressure prevents prices from rising further. These levels are not always precise lines but can often be zones or areas on a chart.

Drawing Trendlines. Trendlines are straight lines drawn on a chart connecting two or more price peaks or troughs, revealing the script's trend, support & resistance points, and allowing one to spot any excellent trade opportunities. To draw valid trendlines, connect at least two peaks, ensure the slope is less than 45 degrees, and confirm that the price respects the line. Invalid trendlines are those that the price doesn't respect or have slopes exceeding 45 degrees.

Avoiding Fatal Mistakes. Many traders fail to profit from support and resistance because they assume these levels will always hold. However, these levels can break, leading to significant moves in the opposite direction. Understanding when a level is likely to break or hold is key to successful price action trading. This involves analyzing the strength of the price action and volume at these levels.

3. Candlestick Patterns: Confirming Price Action Signals

Two things are crucial in price action trading – 1) Identifying key price levels, and 2) Confirmation or Rejection of the price, to look for any profitable trade opportunities.

Candlestick Confirmation. Candlestick patterns provide visual confirmation of potential price movements at key support and resistance levels. These patterns, formed by the open, high, low, and close prices of a security over a specific period, can signal potential reversals or continuations of trends. However, it's crucial to use these patterns in conjunction with key price levels, not as standalone signals.

Powerful Patterns. Among the numerous candlestick patterns, some are more impactful and frequently occurring than others. These include:

• Engulfing Patterns: Bullish engulfing signals a potential uptrend reversal, while bearish engulfing indicates a downtrend reversal.
• Hammer/Hanging Man: The hammer at support suggests a bullish reversal, while the hanging man at resistance signals a bearish reversal.
• Harami Patterns: Bullish harami indicates the selling is over, and bearish harami indicates the buying is over.
• Star Patterns: Morning star signals the beginning of an uptrend, and evening star signals the beginning of a downtrend.
• Doji Pattern: Indicates indecision in the market.
• Pin Bar Patterns: Represents a strong reversal and rejection of the price.

Using Patterns Effectively. To use candlestick patterns effectively, traders should wait for the pattern to fully form at a key price level before taking a trade. For example, if a bullish engulfing pattern appears at a support level, it can be a strong signal to enter a long position. However, it's essential to wait for the candle to close before acting on the signal.

4. Swing and Trend Trading: Applying Price Action Strategies

If I stop at this point, traders will take trades in all possible trading styles and lose money.

Swing Trading. Swing trading is a strategy that aims to capture short-term price swings in the market. Traders identify range-bound stocks or indices and look for bullish or bearish candlestick patterns at support or resistance levels to enter trades. The goal is to exit the trade before the market reverses, capturing the full swing.

Trend Following. Trend following involves identifying stocks or indices in a clear uptrend or downtrend and taking trades in the direction of the trend. For long trades, traders look for healthy pullbacks to support levels and bullish candlestick patterns. For short trades, they look for bounces to resistance levels and bearish candlestick patterns. Trailing stop-loss is the most critical aspect of the trend following system.

Rules for Long/Short Trades:

• Long Trades: Uptrend, healthy pullback, bullish pattern at support, risk-reward minimum 1:1.5.
• Short Trades: Downtrend, healthy bounce, bearish pattern at resistance, risk-reward minimum 1:1.5.

5. Price Acceptance and Rejection: Gauging Market Sentiment

Irrespective of your reputation, experience, and educational qualifications, only two things decide the fate of your trade – 1) Entry and 2) Exit.

Price Rejection. Price rejection occurs when the market tests a key level, such as support or resistance, and then sharply reverses, indicating that the level is holding. This can be seen when the price breaks a support box, but smart money steps in to buy, rejecting the breakdown. Traders can use this signal to enter trades in the direction of the rejection.

Price Acceptance. Price acceptance, on the other hand, occurs when the market breaks through a key level and continues to move in that direction, indicating that the level is no longer holding. This can be seen when the price breaks above a resistance trendline with strong buying pressure. Traders can use this signal to enter trades in the direction of the breakout.

Case Studies. The book provides several case studies illustrating how to use price acceptance and rejection to make trading decisions. These examples cover various instruments and timeframes, demonstrating the versatility of these concepts. By analyzing the price action and volume at key levels, traders can gain valuable insights into market sentiment and potential trading opportunities.

6. Volume Analysis: Understanding Market Participation

Traders should use ‘Volume’ as a confirmation tool and should never use it independently to initiate a trade (ignoring the ‘Price’).

Volume as Confirmation. Volume, the total number of shares or contracts traded over a period, is a crucial tool for confirming price action signals. It reflects the level of participation and conviction behind a price move. Traders should use volume as a confirmation tool and should never use it independently to initiate a trade (ignoring the ‘Price’).

Price-Volume Correlation. Generally, an increase in price accompanied by an increase in volume is considered bullish, while a decrease in price with increasing volume is bearish. However, the book challenges this traditional view, arguing that price can move up or down with varying levels of volume. The key is to analyze the context of the volume and the price action.

Advanced Volume Analysis. The book introduces an advanced approach to volume analysis that focuses on analyzing significant volume spikes at key levels. By examining the buying and selling wicks in the corresponding price candles, traders can determine whether the volume is bullish or bearish. This involves assessing the presence of buyers or sellers within the volume spike.

7. Four Pillars: Technicals, Money Management, Psychology, Execution

Even a poor trading system could make money with good money management” – Jack D. Schwager.

Technical Analysis. Technical analysis involves studying price charts, indicators, and volume to predict future price movements. It's a crucial skill for any trader, but it's only one piece of the puzzle. The book emphasizes that technical analysis alone is not enough for success.

Money Management. Money management is a set of rules to allocate the required position size to reduce the risk while aiming for good returns in trading. It involves managing risk and position size to protect capital and maximize profits. The book recommends allocating 10% of capital per trade for positional traders and risking only 2% per trade for intraday traders.

Psychology. Trading psychology refers to the mental and emotional factors that influence trading decisions. Emotions like greed, fear, regret, and hope can lead to poor decision-making. The book provides strategies for managing these emotions and developing a disciplined mindset.

Execution. Execution is the real Holy Grail in Trading. It involves implementing the trading plan consistently in all market conditions. This requires discipline, patience, and the ability to stick to the plan even when faced with losses.

8. Trading as a Career: Prerequisites and Considerations

Trading for a Living is like a fierce fight between you vs. Mike Tyson, Muhammad Ali, Rocky Marciano, Manny Pacquiao, etc. altogether simultaneously.

Passive Income. Before considering trading as a full-time career, it's essential to have multiple sources of passive income. This provides financial stability and reduces the pressure to generate income solely from trading. The book suggests various passive income ideas, such as photography, eBook cover design, video editing, and online courses.

Zero Debts. Having debts can add extra pressure to a trading career, as it creates a monthly financial obligation. It's better to clear all pending loans before transitioning to full-time trading.

Savings. One should save enough money to run the family for at least one year. This provides a financial cushion and reduces the emotional stress of trading.

Trading Results. Before quitting a job, it's crucial to have a proven track record of consistent profitability. The book suggests considering oneself a successful trader when making at least six months of current salary from trading profits and making profits for three consecutive months.

9. Trading with a Job: Balancing Work and Market

Ask any established trader what their most important tip for the people who are aiming at full-time trading is, and every one of them suggests, " Not to quit the current job immediately. "

Right Trading System. Pick the Right Trading System. It is essential to have the right trading system with a suitable timeframe that compliments your personality and schedule.

Right Trading Instrument. Select the Right Trading Instrument. We have below 3 trading instruments in the stock market: 1. Equity 2. Futures 3. Options. So, a trader should know how these trading instruments work.

Time Management. Time management is crucial for balancing a 9-to-5 job with trading. This involves setting aside specific times for trading, analyzing charts, and reviewing trades. It's also important to avoid distractions and stay focused during trading hours.

Automation. Automation can help reduce the time required for trading. This involves using tools like alert mechanisms, SL-M trigger orders, or partial/full algo trading to automate certain aspects of the trading process.

Last updated: February 4, 2025

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