Gone are the days when traders use indicators plotted on the chart to follow the market and predict any possible move. Price action is the new fascinating term that most traders are claiming to be using in their trading lifestyle. Price action trading started mainly from the forex market, but especially in the Indian context, it has gained popularity in the last 6-7 years.
As a beginner, we are always in doubt about what is price action. A beginner always gets confused with the term price action, and you need to understand certain concepts before understanding what we call price action.
“This comprehensive guide is a must read for those who wants to trade price action and wanted to gain understanding of the true uses of price action trading”
In today’s blog of StockTrone, we are going to learn:
- What is price action and what do we need to see?
- What is a market structure, and how to identify it?
- How to identify the start of a new trend in early-stage with high accuracy?
- Finally, a simple price action trading strategy without any indicator
And I bet that you will not see the chart the same way again at end of the article.
What is Price Action?
Basically, as the name suggests, price action is the manner in which the price moves from candle to candle. But how to read it correctly? To read the price action, we must know that any price trend constitutes two major moves, i.e., an Impulse and a correction. Logically, due to new buying/increased demand, the price makes a new high. Those who bought at the lower levels exit their trade and turn into sellers, which causes the selling pressure and correction in a stock resulting in the price moving lower.
A similar movement happens when some new traders start a short-selling trade that increases selling pressure which results in stock prices diving lower. After a significant fall, the seller exits their trade and turns into a buyer. This buying pressure causes a bounce in the stock price.
When a stock moves in an uptrend, an up move is an impulse and a correction is a down move. But in a downtrend, the down move is an impulse and a bounce is a correction.
You can understand what I mean by Impulse and correction using the following figure.
What is Market Structure?
To understand the Market Structure, one must know the simple but very important term, i.e., trend. In laymen’s terms, a trend is a direction where the market is heading. So, either market can go up or it can go down. But here is a catch, the market can have another trend, i.e., no trend, which means the market does not move in either direction significantly and it is termed as consolidation in trading. A trend is decided on the basis of market structure. Probably you are wondering what is market structure?
Market forms various impulse and corrective moves as explained earlier. This movement can be studied using market structure, i.e., step-by-step movement of the market. So, before explaining anything about market structure, let’s discuss the important components of market structure.
- Higher High: A fresh high price on the chart, which is higher than the previous peak.
- Higher Low: A new low which is higher than the previous bottom on the chart.
- Lower High: On a chart, the stock forms the new high, which is lower in value than the previous high.
- Lower Low: Similarly the market creates a lower low when it slips below the previously traded value.
Basically, the market structure is different combinations of higher highs and lower lows. On the basis of different market structures, a price action trader identifies the trend of the market. So, now you might have some idea of what the market structure actually is.
Identifying the trend in just 10 seconds
Uptrend market
When a market is in an uptrend, it starts forming higher highs, but the obvious question is how many higher highs? So, at any particular moment, if the stock forms two higher highs then the uptrend will be confirmed.
Remember market can never move in a single direction continuously, it has to retrace. But to remain in an uptrend the next high should be higher than the previous one and similarly, the next low should be higher than the current low.
Downtrend market:
In a downtrend, the market moves by making lower lows and lower highs. It means the next move creates a new bottom that is lower than the previous bottom and the trend continues till the structure breaks higher.
The third phase in a No trending zone
From the legendary book of “the disciplined traders”, markets can never be trending all the time. In fact, stock prices keep consolidating 60% of the time or higher. So, understanding the consolidation is important. In this zone, the market is consolidating in a range and no clear structure can be seen.
You can understand the consolidation from the chart below.
How to identify the start of a new trend in early-stage with high accuracy?
The market behaves like a spring, after correction, there is a high probability that it will move in either direction. So when a price exits from a rage-bound market and forms 2 higher highs then a new uptrend starts. The same thing happens in the case of a downtrend when a stock leaves a consolidation and forms two new lower lows. You might be thinking about why a range isn’t invalidated when it makes a new higher high/lower low. Because it can quickly go back to its range and become a false breakout and become a new “high” of the range.
Now, I will share with you a price action trading strategy framework that works by using everything you’ve learned so far
Price Action Strategy Framework
So, a strategy is a set of rules that guide you on when to enter and where to exit into a trade. Because in trading, we work on probabilities and any setup can fail so we also need to know when we will exit when we are right and when we will exit when we are wrong!
So this strategy uses a 4 step guide to identify when one should enter into it and exit it
- Trend
- Area of value
- Entries
- Exits
For me, the first foremost criterion is to know the trend of the market, obviously because the trend is your friend. To enter into any trade we must know the trend of the market and to buy stock in any particular time frame, we need at least 2 higher highs to confirm the uptrend.
Even if the trend is up, we cannot directly jump on to the stock because as a trader, we want to risk as small as possible in case of our trade does not go well.
So the next course of action is to find the area of value, as I explained earlier that even in an uptrend, price retrace and forms a higher low, this higher low is formed due to a new buyer’s entry, and that area is called the area of value. Basically, it is an area where bulls think that stock is corrected enough and it will again continue its up move.
Identification of an area of value guides us to prepare with our setup to enter a bullish trade. But there can be different entry strategies based on candle stick patterns like a bullish hammer, bullish engulfing pattern, etc.
The final part of this strategy is to find where to exit the trade. So if everything goes well then we consider exiting the trade when the stock price reaches its previous high. Otherwise, in case of a losing trade, a trader must exit the trade when the price slips below the previous swing low.
Conclusion
Price moves in swings and these swings form specific structures. On the basis of a particular structure, a price action trader defines the trend of the market, and enters after a correction around the “area of value”. Price action helps eliminate the sophisticated indicators and allows the trader to trade naked price and volume charts. Further, it gives an edge over the indicator because of the fact that all the indicators are mathematically derived from the price and volume.
Let us know what you think about Price Action Trading and what are your strategies for it. Subscribe to our trading page on Instagram and Telegram for daily insights about trading moves.