The price of a financial asset, such as a share, currency pair or commodity, is essential to trading, as ultimately, it is the shift in price that produces profit or loss.
Traders who choose to focus solely on price charts will need to develop a price action strategy that will involve analyzing trending waves in order to ascertain when to enter or exit a position.
Understanding the mechanics of price action and developing a highly effective price action trading strategy has the potential to be highly profitable. In this article, we explore the techniques and indicators that will help in building this strategy.
How to read price action
Trading on price action involves analyzing trending waves and pullback waves, also known as impulse and corrective waves.
Traders monitor “swing highs” and “swing lows”, or the length of the trending and pullback waves, to identify the direction of the trend.
During an uptrend, the rules are that the price makes higher swing highs in price, and higher swing lows. The reverse is true during a downtrend.
How to trade supply and demand with price action
Supply areas are seen where sellers have entered the market aggressively and caused the price to drop, and it has not returned. Traders watch out for these because, when the price returns, sellers may still be present and ready to sell again, pushing the price back down.
Demand areas occur where buyers have entered the market aggressively. The price rallied and has not returned. If the price returns to that level, traders will be watching to see if the buying picks up again, pushing the price back up.
Price action trading patterns
Price action continuation patterns
Continuation patterns occur during a trend. Assume the trend is up, and a triangle forms. Because of the uptrend, the price has a slightly higher chance of breaking out to the upside because the trend is up. The same concept applies during a downtrend when a pattern forms.
The strategy here is to wait for a trend to form, and then wait for a pattern, and then only trade if the price breaks out of the pattern in the trending direction.