Although there are lots of trading strategy classifications, one of the root classifications answers the question whether the trading system uses technical analysis or not. You may ask how it’s possible to make trading decisions without looking into charts and indicators?
Price Action implies trading based solely on price changes and totally excludes any use of indicators. Based on Price Action, trading performs only on price patterns.
Price Action advantages
Let’s consider some pros and cons of trading based on Price Action.
No one would argue the fact of price primacy. Therefore, everything else is secondary, including technical indicators. One of foundation theorems of technical analysis is “Price Discounts Everything”. It means that the current price fully reflects all possible information. Adepts of Price Action theory add the following: “Price itself shows future movements” and it’s not necessary to use any other tools for it.
Why don’t Price Action traders have attachment to technical indicators? They would argue that all indicators defer and, therefore, mislead. Personally I don’t agree with this because I successfully combine classical technical analysis with Price Action patterns. I find the idea of refusing additional benefits and features absurd. For example it’s possible to drive a car focusing on personal feelings but it’s more safe and comfortable to use car gauges.
After scrutinizing Price Action patterns it’s possible to define the basic ones. Essentially it doesn’t matter what chart style to use. I prefer bars style, but what is really important is ability to detect patterns and to trade them.
Pin Bar pattern
The most common Price Action pattern is a “Pin Bar”. It derived its name from fairy woody boy Pinocchio. Pinocchio has a distinctive feature of having a short nose that becomes longer when he is under stress, especially while telling a lie. The same occurs in a market when the price shows it is cheating with its long tail. Let’s look at the following example:
On the first bar price drops down the support line but rolls back fast. So bears are not controlling the market and bulls get revenge. Long tail indicates that price is cheating and it is not going to fall, so we can open a long position. A similar situation happens with the second bar. The price rises steadily but we have a ping with this bar. As the price lies, it will not rise more and therefore bulls are not controlling the situation. It’s crucial that pin bar’s open and close values should be inside previous bar’s range.
There are several methods of trading pin bars. The aggressive one means opening a new trade immediately after closing signal bar. The conservative denotes waiting for price breaking through opposite signal bar’s max/min level (if the bar has bottom tail then it will be max level and vice versa). The most conservative method implies waiting for 50% price rollback in direction of tail.
Inside Bar pattern
The second Price Action pattern is “Inside Bar”. It occurs when one bar absorbs another one or several bars, drawing a figure that looks like unfinished triangle. Breaking of inside bar’s range serves as a signal to trade. In my opinion this pattern should be traded only during well-formed trends. Let’s look at the example:
What is invisible on this chart is price up-trending, then having some rest and consolidating before it continued to rise. It’s a good moment to enter the market during uptrend.
In the second case price goes against the trend. It’s also possible to trade this signal but it’s too risky.
This is the most common Price Action patters, all others are their mere variations.
Price action is the study of the movement of price across a certain period of time in a raw, indicator-free price chart. This strategy of trading the markets is one of the oldest, if not the oldest existing trading strategy, as it has been used since the 1700s when rice traders in Japan first employed the analysis of simple price action candlestick patterns to predict the course of price movement in rice. Obviously, the price action trading has evolved and progressed since this time and new traders have added their own “tweaks” and perspectives to this time-tested trading strategy.