What is price action trading?
Price action trading is a byword
Price action trading is a byword to describe trading based on observation of naked price i.e. in other words trading without employing trading indicators. There are probably different applications of price action trading according to how each trader interprets it. Therefore price action trading is more of trading approach or philosophy rather than a specific trading strategy.
Original price action trading
Technical analysis deals with price and volume coming in from the market. Original technical analysts and traders like Homma Munehisa (came up with the classical candlesticks more than 300 years ago) and Ralph Nelson Elliott (credited with the Elliott Wave Theory) looked at price phenomenon. For example, Munehisa’s original application with classical candlesticks was to look at each day’s price in terms of Open High Low Close (printed into candlesticks). From these, he interpreted the strength of buying and selling to gauge the enthusiasm of players (and the balance of power between them) in the market. He went on to develop and finalise a price action trading treatise that also interpreted 2-candlesticks and 3-candlesticks patterns for market direction.
Ralph Nelson Elliott also looked at price action trading but from a birds-eye. His work with the Elliott Wave Theory attempted to explain what the big picture is conveying in terms of wave structures. Wave structures and ratios aside, the Elliott Wave Theory looks at how markets will behave following previous movement.
Development of trading indicators
A group of traders and analysts took the development of technical analysis further by developing trading indicators based on mathematical formulas to process price and volume information. It is thought that indicators can produce superior buy or sell signals by cutting out noise. The simple moving average is the best example. The indicators are often based on price, volume or a hybrid that processes both. Some worked very well and some worked only under specific market conditions. Many were probably misunderstood or misused so the outcome was charts became very cluttered and produced more noise. A cluttered chart did not guarantee trading performance either.
Concepts at foundation of price action trading
Individuals who adopt price action trading comes full circle by dropping the use of trading indicators and coming back to price. However we are lucky now ‘to stand on shoulders of giants’ because the price action is better documented and understood than ever before. Below are all technical analysis concepts that deal with price action and sentiment of the market:
- Candlesticks patterns
- Point and figure
- Chart patterns
- Simple resistance, support and trendlines
- Elliott Wave structures, fibonacci expansions and fibonacci retracements
- Documented phenomenon like breakouts and stop hunting
All these concepts contribute to price action trading but as mentioned earlier, there is no single price action trading strategy. Anyone who is using a single or combination of concept(s) here IS doing price action trading. But however the trading may be, it is very important to meld these concepts into a personalised rule-based trading approach.