Trading Stocks Based on Price Action

Trading Stocks Based on Price Action

Trading Stocks Based on Price Action


Price action trading is a form of technical analysis that focuses primarily on the price movements of an asset, such as stocks or bonds. Unlike other forms of trading, such as quantitative trading or technical indicator trading, price action trading is interested in the movement of price over time. Price action traders use price charts over different intervals and make trading decisions based on pattern analysis.

Price action trading is a simple, straightforward, and low-cost way to begin a trading career.

Basic Components

Below is the main component of price action trading: the candlestick chart. This is Apple’s intraday price movements in a candlestick chart format.

The candlestick represents price movement over a period of time. Each candlestick shows the high, open, close, and low price for each time segment. Candlesticks can be bullish, bearish, or flat, and together form over 40 different candlestick patterns.

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Price Action Trading Primer

Now that we have a rough understanding of charts and candlesticks, we’ll want to look at some introductory charts. These charts will help you develop an idea of the positions and patterns. As you grow familiar with the patterns, keep a folder of screenshots with common trading patterns. Eventually, you’ll need to spot these patterns developing while trading live.

For this first chart, we’re back to Apple’s stock, this time over a six-day period. The three primary price movement trends are highlighted: uptrend, flat, and downtrend. Also included is a broader continuation of the downtrend.

Here we are looking at the three main ways prices move. Prices can continue up in an uptrend, can stay level in a flat trend, and can continue down in a downtrend. Let’s try a short interpretation of this chart.

One way to think of the flat trend is to imagine a struggle between bulls and bears, between the price rising and the price falling. In the first uptrend, the bulls pushed the price high. This was met with resistance at about $324. This established the flat trend, which was eventually broken by a short bear breakout, or the first downtrend. This bear downtrend was met with a much stronger and more sustained bear downtrend. This chart tells the story of a bull-bear struggle that resulted in a significant loss, a retrace, of the bull position established in the uptrend.

Price Action Trading Setups

As a price action trader, your job will be to choose a time period and trade the price movements of your favorite stocks or bonds. You’ll want to identify price movement patterns and buy or short stocks or bonds based on where you think the price is going. Read here for more on chart patterns.

Now we’re going to look at a few setups.

#1. Spring at Support

This setup occurs when a stock tests a low range, only to spring back into a new trend. Unfortunately in this example, the spring led to a false setup, suggesting a price climb only to fall down after limited gains.

#2. Bullish Reversal

Here we are looking for pairs of candles where the first is a small bearish move and the second is a strong bullish move that kicks off a trend. Also called a bullish engulf, this happens when bulls overcome a previous bear trend. This signals a new trend, which in the below chart is reinforced 20 minutes later in a second bullish engulf.

#3. Bearish Reversal

This is the exact opposite of a bullish outside reversal. Again look at the two candles where the bulls are overwhelmed by the bears’ reversal. Here the second candle is a strong bearish move, solidified by the following candles that grow in intensity as the trend increases downwards.

These are just a few of the many setups price action traders use to generate returns. Remember, price action trading is a simplified way to get into the markets without relying on complicated technical indicators. For those new to trading, make sure to practice identifying patterns and setups using a stock simulator.