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What is price action?
Price action is the movement of a security’s price plotted over time. Price action forms the basis for all technical analysis of a stock, commodity or other asset chart.
Many short-term traders rely solely on price action and the formations and trends extrapolated from it to make trading decisions. Technical analysis as a practice is a derivative of price action as it uses past prices in calculations that can then be used to inform trading decisions.
Key takeaways
Price action usually refers to the changes in a security’s price over time. Different looks can be applied to a chart to make trends in price action clearer to traders. This is especially true when analyzing data covering different time periods. Technical analysis formations and chart patterns are derived from price action. Technical analysis tools such as moving averages are also calculated from price action and projected into the future to inform trades. Although many use price action to predict future prices, past price action does not guarantee future results.
What does price action tell you?
Price action can be seen and interpreted using charts that plot prices over time. Traders use different chart compositions to improve their ability to spot and interpret trends, breakouts, and reversals. Many traders use candlestick charts as they help better visualize price movements by displaying the open, high, low and close values in the context of up or down sessions.
Candlestick patterns such as the Harami cross, engulfing pattern and three white soldiers are all examples of visually interpreted price action. There are many more candlestick formations generated from price action to set an expectation of what will come next. These same formations can apply to other types of charts, including point and figure charts, box charts, box plots, and so on.
In addition to the visual formations on the chart, many technical analysts use price action data when calculating technical indicators. The goal is to find order in the sometimes seemingly random movement of a price. For example, an ascending triangle pattern formed by applying trend lines to a price action chart can be used to predict a potential breakout as the price action indicates that bulls have attempted a breakout on multiple occasions and gained momentum each time.
How to use price action
Price action is not generally seen as a trading tool like an indicator, but rather the data source from which all the tools are built. Swing traders and trend traders tend to work most closely with price action, eschewing any fundamental analysis in favor of focusing solely on support and resistance levels to predict breakouts and consolidation.
Even these traders must pay attention to additional factors beyond the current price, as the volume traded and the time periods used to set levels all have an impact on the likelihood that their interpretations are accurate.
Many institutions have started using algorithms to analyze past price action and execute trades in certain circumstances. In a 2020 report to Congress, the Securities and Exchange Commission (SEC) noted that the “use of algorithms in trading is pervasive.” These automated systems are fed price action data and can infer outcomes and determine potential future price action.
Limitations of Price Action
The interpretation of price action is very subjective. It is common for two traders to come to different conclusions when analyzing the same price action. One trader may see a bearish downtrend and another may believe that the price action is showing a potential near-term reversal. Of course, the time period used also greatly affects what traders see as a stock can have many intraday downtrends while maintaining a month-to-month uptrend.
The important thing to remember is that trading predictions made using price action on any time scale are speculative. The more tools you can apply to your trading forecast to confirm it, the better.
However, in the end, the past price action of a security is no guarantee of future price action. High probability trades are still speculative trades, meaning traders take the risks to access the potential rewards. Price action does not expressly include macroeconomic or non-financial matters affecting a security.
How can I use price action in trading?
Price action is used to analyze trends and identify entry and exit points when trading. Many traders use candlestick charts to chart past price action, then chart potential breakout and reversal patterns. Although past price action does not guarantee future results, traders often analyze a security’s historical patterns to better understand where the price may move next.
How do I read price action?
Price action is often depicted graphically in the form of a bar chart or line chart. There are two general factors to consider when analyzing price action. The first is to identify the direction of the price, and the second is to identify the direction of the volume.
Should a security’s price move upwards while volume increases, it means that there is strong conviction in the market as many investors are buying at the rising price. Alternatively, had there been low volume, the price action may not be as compelling as not many investors choose to invest at current price levels.
What is Bullish Price Action?
Bullish price action is an indicator that gives positive signals that a security’s price is due for future increases. To be precise, one bullish trend is often defined by “higher highs” and “higher lows” forming an ascending triangle pattern. This means that the price action of a security recently exceeded a high price but remained higher than a recent low price.
Is price action good for swing trading?
Swing traders rely on price movement; if a security’s price remains unchanged, it is more difficult to look for opportunities to make a profit. In general, price action is good for swing traders because traders can identify the up and down oscillations and trade accordingly.
Disclaimer for Uncirculars, with a Touch of Personality:
While we love diving into the exciting world of crypto here at Uncirculars, remember that this post, and all our content, is purely for your information and exploration. Think of it as your crypto compass, pointing you in the right direction to do your own research and make informed decisions.
No legal, tax, investment, or financial advice should be inferred from these pixels. We’re not fortune tellers or stockbrokers, just passionate crypto enthusiasts sharing our knowledge.
And just like that rollercoaster ride in your favorite DeFi protocol, past performance isn’t a guarantee of future thrills. The value of crypto assets can be as unpredictable as a moon landing, so buckle up and do your due diligence before taking the plunge.
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