Price Action

What Is Price Action?

Price action refers to the changes in a security's price displayed over time. It serves as the foundation for all technical analyses of stock, commodity, or other asset charts.

Numerous short-term traders depend solely on price action, along with the patterns and trends derived from it, to make trading decisions. Technical analysis, as a method, originates from price action, as it uses historical prices in calculations to guide trading choices.

KEY TAKEAWAYS

• Price action typically denotes the variations in a security's price over time.

• Various chart representations can highlight price action trends more clearly for traders, especially when examining data across diverse time frames.

• Price action forms the basis for technical analysis formations and chart patterns.

• Technical analysis instruments, such as moving averages, are calculated using price action and extended into the future to guide trades.

• While price action is often employed to predict future prices, past price action does not ensure future outcomes.

What Does Price Action Tell You?

Price action can be observed and analyzed using charts that plot prices over time. Traders employ various chart configurations to enhance their ability to identify and interpret trends, breakouts, and reversals. Many traders prefer candlestick charts as they offer better visualization of price movements by displaying open, high, low, and close values in up or down sessions.

Candlestick patterns like the harami cross, engulfing pattern, and three white soldiers are examples of visually interpreted price action. Numerous other candlestick formations are derived from price action to create expectations for future movements. These formations can also apply to other chart types, such as point and figure charts, box charts, and box plots.

Besides visual formations on charts, many technical analysts use price action data when computing technical indicators. The aim is to find structure in the seemingly random price movements. For instance, an ascending triangle pattern formed by applying trendlines to a price action chart may be used to predict a potential breakout, as the price action indicates that bulls have attempted a breakout several times, gaining momentum with each attempt.

How to Use Price Action

Price action is not typically considered a trading tool like an indicator, but rather the data source from which all tools are developed. Swing traders and trend traders often work closely with price action, opting to focus exclusively on support and resistance levels to predict breakouts and consolidation, instead of using fundamental analysis.

However, even these traders must consider additional factors beyond the current price, as trading volume and the periods used to establish levels all influence the accuracy of their interpretations. Many institutions have started using algorithms to analyze past price action and execute trades under specific conditions. In a 2020 report to Congress, the Securities and Exchange Commission (SEC) stated that the "use of algorithms in trading is pervasive." These automated systems receive price action data and can infer outcomes and predict potential future price movements.

Limitations of Price Action

Interpreting price action can be highly subjective. It's not unusual for two traders to reach different conclusions when analyzing the same price action. One trader may perceive a bearish downtrend, while another might think the price action indicates a potential short-term reversal. The time period being used also greatly affects what traders observe, as a stock can experience multiple intraday downtrends while maintaining an overall month-over-month uptrend.

It's crucial to remember that trading predictions based on price action at any time scale are speculative. The more tools you can use to confirm your trading predictions, the better.

Ultimately, a security's past price action does not guarantee its future performance. High probability trades remain speculative, which means traders assume risks in pursuit of potential rewards. Price action does not explicitly account for macroeconomic factors or non-financial issues that may impact a security.

How Can I Use Price Action in Trading?

Price action is employed to examine trends and pinpoint entry and exit points for trading. Numerous traders utilize candlestick charts to depict previous price action and identify potential breakout and reversal patterns. While past price action doesn't assure future outcomes, traders frequently analyze a security's historical patterns to gain insight into its possible future price movements.

How Do I Read Price Action?

Price action is commonly represented visually using bar charts or line charts. Two main aspects to consider when analyzing price action include determining the direction of the price and identifying the direction of the volume.

If a security's price is rising accompanied by increasing volume, it signifies strong market conviction as numerous investors are purchasing at the higher price. Conversely, if the volume is low, the price action may be less persuasive since fewer investors are opting to invest at the current price levels.

What Is Bullish Price Action?

Bullish price action is a sign suggesting positive expectations for a security's future price increases. For instance, a bullish trend can be characterized by "higher highs" and "higher lows," forming an ascending triangle pattern. This indicates that the security's price action recently reached a higher peak while maintaining a level above a recent low price.

Is Price Action Good for Swing Trading?

Swing traders depend on price fluctuations; if a security's price remains stagnant, it becomes challenging to find profitable opportunities. Generally, price action benefits swing traders as they can recognize the upward and downward oscillations and make trades accordingly.