Price Action Trading – The Basics
Price action trading. It may seem simplistic, and in theory, it is as there are really only two major principles any market has that you need to know to create consistent profits from your trading or active investing. And these principles hold true for most liquid markets throughout the world. Those being:
If there are more buyers than sellers, the price will go up.
If there are more sellers than buyers, the price will go down.
We can see evidence of this in so many markets around us, and understanding price action trading and general price movement will allow you to easily identify these. The Australian property boom of 2003 had buyers scrambling to get into real estate, with massive price increases as a result. The record sell off on global stock markets as a result of the events of 9/11. Even something as simple as the price of prawns at Christmas – when there are more people buying, the price goes up!
So the basic principle behind price movement is quite simple, but the ART of making money from trading is learning to read the market to determine if there are more buyers, or more sellers, or the market is in equilibrium. A key skill in reading the market is also learning to assess when the market control is changing between these three states.
In our opinion, there are 3 major areas that need to be addressed when getting a good read on the market. This article will cover the first of these:
Part 1: Understanding General Price Action Trading
Part 3: Understanding Trend Trading
What to Consider When Assessing General Price Action Trading
There is only one way that we read the market and that is to look to the general movement in price. We’re not so concerned with why a price has moved, only where the price is now and where it is most likely to move to next.
So when assessing the general movement in price, our primary considerations are:
- Where are the closest major support and resistance levels?
- Where is the current price in relation to these support and resistance levels?
When we have those answers, we then have a feel for where price is most likely to move to.
For example, if current price is close to a resistance level, especially after a strong push up, then a move down off the resistance level is more likely. Likewise, if price is close to a support level after a strong push down, then a move up off the support level is most likely.
Remember, at this point, we are looking at general price movement. In the next article we’ll look at building on our market read and likely price movement by looking at more specific, short term price action.
A Note on Indicators
The number and use of indicators that are available to assist traders with their trading decisions is enormous, ever increasing and often overwhelming. However, all indicators are simply derivatives of price and/or volume and all of them require some subjective input and/or interpretation.
Our preference is to use price as the primary analysis tool as it is current, factual and unquestionable. We only utilise a very small number of indicators as support for trading decisions, never as the sole basis for trading decisions.
Predicting vs What is Actually Happening
Our aim in analysing the price action is to determine what is occurring in the market. We then make trading decisions based on this analysis and our assessment of what the next most likely movement in price will be.
We need to make an important distinction here; In our trading we are taking a position on the MOST LIKELY next movement in price based on the current market conditions. We’re not trying to PREDICT future prices.
When our current price analysis indicates that market conditions have changed, then we review our position. Instead of thinking in terms of what price is ‘going to do’, think in terms of, ‘if price does this then I’ll do that’. This then covers you for price going either with your read or against it. It also helps to take the emotion out of your trade.
Trying to predict the future price is dangerous because it clouds your assessment of what is actually happening. Predicting causes many traders to ignore their stops and incur large losses as they are inherently saying that they’re right and the market is wrong.
Be ready for price to go either way and stay away from thoughts of what you think price should be doing.
General Price Action Trading: The Bottom Line
Key Message: When getting a read on general price movement, always let the market tell you what is happening. Use support and resistance levels, and where current price is in relation to these as your major considerations for general price movement. Avoid making predictions about the future direction of the market. Learn to change your view of the market based on the current price action.
To further your understanding in reading the markets, we recommend reading our 2 remaining segments: