Price Action Trading
Price Action Trading
Price Action Trading
Credibility
There is no evidence that these explanations are correct even if the price action trader who makes such statements is
profitable and appears to be correct. Since the disappearance of most pit-based financial exchanges, the financial
markets have become anonymous, buyers do not meet sellers, and so the feasibility of verifying any proposed
explanation for the other market participants' actions during the occurrence of a particular price action pattern is tiny.
Hence the explanations should only be viewed as subjective rationalisations and may quite possibly be wrong, but at
any point in time they offer the only available logical analysis with which the price action trader can work.
The implementation of price action analysis is difficult, requiring the gaining of experience under live market
conditions. There is every reason to assume that the percentage of price action speculators who fail, give up or lose
their trading capital will be similar to the percentage failure rate across all fields of speculation. According to
widespread folklore / urban myth, this is 90%, although analysis of data from US forex brokers' regulatory
disclosures since 2010 puts the figure for failed accounts at around 75% and suggests this is typical.[10]
Some sceptical authors[11] dismiss the financial success of individuals using technical analysis such as price action
and state that the occurrence of individuals who appear to be able to profit in the markets can be attributed solely to
the Survivorship bias.
Analytical Process
A price action trader's analysis may start with classical technical analysis, e.g. Edwards and Magee patterns
including trend lines, break-outs, and pull-backs,[12] which are broken down further and supplemented with extra
bar-by-bar analysis, sometimes including volume. This observed price action gives the trader clues about the current
and likely future behaviour of other market participants. The trader can explain why a particular pattern is predictive,
in terms of bulls (buyers in the market), bears (sellers), the crowd mentality of other traders, change in volume and
other factors. A good knowledge of the market's make-up is required. The resulting picture that a trader builds up
will not only seek to predict market direction, but also speed of movement, duration and intensity, all of which is
based on the trader's assessment and prediction of the actions and reactions of other market participants.
Price action patterns occur with every bar and the trader watches for multiple patterns to coincide or occur in a
particular order, creating a 'set-up'/'setup' which results in a signal to buy or sell. Individual traders can have widely
varying preferences for the type of setup that they concentrate on in their trading.
This annotated chart shows the typical frequency, syntax and
terminology for price action patterns implemented by a trader.
One published price action trader[8] is capable of giving a name and a
rational explanation for the observed market movement for every
single bar on a bar chart, regularly publishing such charts with
descriptions and explanations covering 50 or 100 bars. This trader
freely admits that his explanations may be wrong, however the
An candlestick chart of the Euro against the USD,
explanations serve a purpose, allowing the trader to build a mental
marked up by a price action trader.
scenario around the current 'price action' as it unfolds, and for
experienced traders, this is often attributed as the reason for their profitable trading.
Implementation of trades
The price action trader will use setups to determine entries and exits for positions. Each setup has its optimal entry
point. Some traders also use price action signals to exit, simply entering at one setup and then exiting the whole
position on the appearance of a negative setup. Alternatively, the trader might simply exit instead at a profit target of
a specific cash amount or at a predetermined level of loss. A more experienced trader will have their own
well-defined entry and exit criteria, built from experience.[8]
An experienced price action trader will be well trained at spotting multiple bars, patterns, formations and setups
during real-time market observation. The trader will have a subjective opinion on the strength of each of these and
how strong a setup they can build them into. A simple setup on its own is rarely enough to signal a trade. There
should be several favourable bars, patterns, formations and setups in combination, along with a clear absence of
opposing signals.
At that point when the trader is satisfied that the price action signals are strong enough, the trader will still wait for
the appropriate entry point or exit point at which the signal is considered 'triggered'. During real-time trading, signals
can be observed frequently while still building, and they are not considered triggered until the bar on the chart closes
at the end of the chart's given period.
Entering a trade based on signals that have not triggered is known as entering early and is considered to be higher
risk since the possibility still exists that the market will not behave as predicted and will act so as to not trigger any
signal.
Behavioural observation
A price action trader generally sets great store in human fallibility and the tendency for traders in the market to
behave as a crowd.[1] For instance, a trader who is bullish about a certain stock might observe that this stock is
moving in a range from $20 to $30, but the traders expects the stock to rise to at least $50. Many traders would
simply buy the stock, but then every time that it fell to the low of its trading range, would become disheartened and
lose faith in their prediction and sell. A price action trader would wait until the stock hit $31.
That is a simple example from Livermore from the 1920s.[1] In a modern day market, the price action trader would
first be alerted to the stock once is broke out to $31, but knowing the counter-intuitiveness of the market and having
picked up other signals from the price action, would expect the stock to pull-back from there and would only buy
when the pull-back finished and the stock moved up again.[13]
Trapped traders
"Trapped traders" is a common price action term referring to traders who have entered the market on weak signals,
or before signals were triggered, or without waiting for confirmation and who find themselves in losing positions
because the market turns against them. Any price action pattern that the traders used for a signal to enter the market
is considered 'failed' and that failure becomes a signal in itself to price action traders, e.g. failed breakout, failed
trend line break, failed reversal. It is assumed that the trapped traders will be forced to exit the market and if in
sufficient numbers, this will cause the market to accelerate away from them, thus providing an opportunity for the
more patient traders to benefit from their duress.[14]
Since many traders place protective stop orders to exit from positions that go wrong, all the stop orders placed by
trapped traders will provide the orders that boost the market in the direction that the more patient traders bet on. The
phrase "the stops were run" refers to the execution of these stop orders.
Open: first price of a bar (which covers the period of time of the
chosen time frame)
Close: the last price of the bar
Range bar
A range bar is a bar with no body, i.e. the open and the close are at the same price and therefore there has been no net
change over the time period. This is also known in Japanese Candlestick terminology as a Doji. Japanese
Candlesticks show demand more precision and only a Doji is a Doji, whereas a price action trader might consider a
bar with a small body to be a range bar. It is termed 'range bar' because the price during the period of the bar moved
between a floor (the low) and a ceiling (the high) and ended more or less where it began. If one expanded the time
frame and looked at the price movement during that bar, it would appear as a range.
Trend bar
There are bull trend bars and bear trend bars - bars with bodies - where the market has actually ended the bar with a
net change from the beginning of the bar.
With-trend bar
A trend bar with movement in the same direction as the chart's trend is known as 'with trend', i.e. a bull trend bar in a
bull market is a "with trend bull" bar. In a downwards market, a bear trend bar is a "with trend bear" bar.[14]
Countertrend bar
A trend bar in the opposite direction to the prevailing trend is a "countertrend" bull or bear bar.
BAB
There are also what are known as BAB - big a**** bars - which are bars that are more than two standard deviations
larger than the average.
Shaved bar
A shaved bar is a trend bar that is all body and has no tails. A partially shaved bar has a shaved top (no upper tail) or
a shaved bottom (no lower tail).
Inside bar
An "inside bar" is a bar which is smaller and within the high to low range of the prior bar, i.e. the high is lower than
the previous bar's high, and the low is higher than the previous bar's low. Its relative position can be at the top, the
middle or the bottom of the prior bar.
There is no universal definition imposing a rule that the highs of the inside bar and the prior bar cannot be the same,
equally for the lows. If both the highs and the lows are the same, it is harder to define it as an inside bar, yet reasons
exist why it might be interpreted so.[14] This imprecision is typical when trying to describe the ever-fluctuating
character of market prices.
Outside bar
An outside bar is larger than the prior bar and totally overlaps it. Its high is higher than the previous high, and its low
is lower than the previous low. The same imprecision in its definition as for inside bars (above) is often seen in
interpretations of this type of bar.
An outside bar's interpretation is based on the concept that market participants were undecided or inactive on the
prior bar but subsequently during the course of the outside bar demonstrated new commitment, driving the price up
or down as seen. Again the explanation may seem simple but in combination with other price action, it builds up into
a story that gives experienced traders an 'edge' (a better than even chance of correctly predicting market direction).
The context in which they appear is all-important in their interpretation.[14]
If the outside bar's close is close to the centre, this makes it similar to a trading range bar, because neither the bulls
nor the bears despite their aggression were able to dominate.
Primarily price action traders will avoid or ignore outside bars,
especially in the middle of trading ranges in which position they are
considered meaningless.
When an outside bar appears in a retrace of a strong trend, rather than
acting as a range bar, it does show strong trending tendencies. For
instance, a bear outside bar in the retrace of a bull trend is a good signal
that the retrace will continue further. This is explained by the way the
outside bar forms, since it begins building in real time as a potential
bull bar that is extending above the previous bar, which would
encourage many traders to enter a bullish trade to profit from a
continuation of the old bull trend. When the market reverses and the
potential for a bull bar disappears, it leaves the bullish traders trapped
in a bad trade.
If the price action traders have other reasons to be bearish in addition to
this action, they will be waiting for this situation and will take the
opportunity to make money going short where the trapped bulls have
their protective stops positioned. If the reversal in the outside bar was
quick, then many bearish traders will be as surprised as the bulls and
the result will provide extra impetus to the market as they all seek to
sell after the outside bar has closed. The same sort of situation also
holds true in reverse for retracements of bear trends.[14]
The outside bar after the maximum price
(marked with an arrow) is a failure to restart the
trend and a signal for a sizable retrace.
ioi pattern
Small bar
As with all price action formations, small bars must be viewed in context. A quiet trading period, e.g. on a US
holiday, may have many small bars appearing but they will be meaningless, however small bars that build after a
period of large bars are much more open to interpretation. In general, small bars are a display of the lack of
enthusiasm from either side of the market. A small bar can also just represent a pause in buying or selling activity as
either side waits to see if the opposing market forces come back into play. Alternatively small bars may represent a
lack of conviction on the part of those driving the market in one direction, therefore signalling a reversal.
As such, small bars can be interpreted to mean opposite things to opposing traders, but small bars are taken less as
signals on their own, rather as a part of a larger setup involving any number of other price action observations. For
instance in some situations a small bar can be interpreted as a pause, an opportunity to enter with the market
direction, and in other situations a pause can be seen as a sign of weakness and so a clue that a reversal is likely.
One instance where small bars are taken as signals is in a trend where they appear in a pull-back. They signal the end
of the pull-back and hence an opportunity to enter a trade with the trend.[14]
Trend
Classically a trend is defined visually by plotting a trend line on the
opposite side of the market from the trend's direction, or by a pair of
trend channel lines - a trend line plus a parallel return line on the other
side - on the chart.[15] These sloping lines reflect the direction of the
trend and connect the highest highs or the lowest lows of the trend. In
An iii formation - 3 consecutive inside bars.
its idealised form, a trend will consist of trending higher highs or lower
lows and in a rally, the higher highs alternate with higher lows as the
market moves up, and in a sell-off the sequence of lower highs (forming the trendline) alternating with lower lows
forms as the market falls. A swing in a rally is a period of gain ending at a higher high (aka swing high), followed by
a pull-back ending at a higher low (higher than the start of the swing). The opposite applies in sell-offs, each swing
having a swing low at the lowest point.
Trend Channel
A trend or price channel can be created by plotting a pair of trend channel lines on either side of the market - the first
trend channel line is the trend line, plus a parallel return line on the other side.[15] Edwards and Magee's return line is
also known as the trend channel line (singular), confusingly, when only one is mentioned.[17][18]
Trend channels are traded by waiting for break-out failures, i.e. banking on the trend channel continuing, in which
case at that bar's close, the entry stop is placed one tick away towards the centre of the channel above/below the
break-out bar. Trading with the break-out only has a good probability of profit when the break-out bar is above
average size, and an entry is taken only on confirmation of the break-out. The confirmation would be given when a
pull-back from the break-out is over without the pull-back having retraced to the return line, so invalidating the
plotted channel lines.[18]
Microtrend line
If a trend line is plotted on the lower lows or the higher highs of a trend over a longer trend, a microtrend line is
plotted when all or almost all of the highs or lows line up in a short multi-bar period. Just as break-outs from a
normal trend are prone to fail as noted above, microtrend lines drawn on a chart are frequently broken by subsequent
price action and these break-outs frequently fail too.[18] Such a failure is traded by placing an entry stop order 1 tick
above or below the previous bar, which would result in a with-trend position if hit, providing a low risk scalp with a
target on the opposite side of the trend channel.
Microtrend lines are often used on retraces in the main trend or pull-backs and provide an obvious signal point where
the market can break through to signal the end of the microtrend. The bar that breaks out of a bearish microtrend line
in a main bull trend for example is the signal bar and the entry buy stop order should be placed 1 tick above the bar.
If the market works its way above that break-out bar, it is a good sign that the break-out of the microtrend line has
not failed and that the main bull trend has resumed.
Continuing this example, a more aggressive bullish trader would place a buy stop entry above the high of the current
bar in the microtrend line and move it down to the high of each consecutive new bar, in the assumption that any
microtrend line break-out will not fail.
Pull-back
A pull-back is a move where the market interrupts the prevailing trend,[19] or retraces from a breakout, but does not
retrace beyond the start of the trend or the beginning of the breakout. A pull-back which does carry on further to the
beginning of the trend or the breakout would instead become a reversal[13] or a breakout failure.
In a long trend, a pull-back oftens last for long enough to form legs like a normal trend and to behave in other ways
like a trend too. Like a normal trend, a long pull-back often has 2 legs.[13] Price action traders expect the market to
adhere to the two attempts rule and will be waiting for the market to try to make a second swing in the pull-back,
with the hope that it fails and therefore turns around to try the opposite - i.e. the trend resumes.
One price action technique for following a pull-back with the aim of entering with-trend at the end of the pull-back is
to count the new higher highs in the pull-back of a bull trend, or the new lower lows in the pull-back of a bear, i.e. in
a bull trend, the pull-back will be composed of bars where the highs are successively lower and lower until the
pattern is broken by a bar that puts in a high higher than the previous bar's high, termed an H1 (High 1). L1s (Low 1)
are the mirror image in bear trend pull-backs.
If the H1 doesn't result in the end of the pull-back and a resumption of the bull trend, then the market creates a
further sequence of bars going lower, with lower highs each time until another bar occurs with a high that's higher
than the previous high. This is the H2. And so on until the trend resumes, or until the pull-back has become a
reversal or trading range.
H1s and L1s are considered reliable entry signals when the pull-back is a microtrend line break, and the H1 or L1
represents the break-out's failure.
Otherwise if the market adheres to the two attempts rule, then the safest entry back into the trend will be the H2 or
L2. The two-legged pull-back has formed and that is the most common pull-back, at least in the stock market
indices.[13]
In a sideways market trading range, both highs and lows can be counted but this is reported to be an error-prone
approach except for the most practiced traders.
On the other hand, in a strong trend, the pull-backs are liable to be weak and consequently the count of Hs and Ls
will be difficult. In a bull trend pull-back, two swings down may appear but the H1s and H2s cannot be identified.
The price action trader looks instead for a bear trend bar to form in the trend, and when followed by a bar with a
lower high but a bullish close, takes this as the first leg of a pull-back and is thus already looking for the appearance
of the H2 signal bar. The fact that it is technically neither an H1 nor an H2 is ignored in the light of the trend
strength. This price action reflects what is occurring in the shorter time-frame and is sub-optimal but pragmatic when
entry signals into the strong trend are otherwise not appearing. The same in reverse applies in bear trends.
Counting the Hs and Ls is straightforward price action trading of pull-backs, relying for further signs of strength or
weakness from the occurrence of all or any price action signals, e.g. the action around the moving average, double
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Breakout
A breakout is a bar in which the market moves beyond a predefined significant price - predefined by the price action
trader, either physically or only mentally, according to their own price action methodology, e.g. if the trader believes
a bull trend exists, then a line connecting the lowest lows of the bars on the chart during this trend would be the line
that the trader watches, waiting to see if the market breaks out beyond it.[15]
The real plot or the mental line on the chart is generally comes from one of the classic chart patterns. A breakout
often leads to a setup and a resulting trade signal.
The breakout is supposed to herald the end of the preceding chart pattern, e.g. a bull breakout in a bear trend could
signal the end of the bear trend.
Breakout pull-back
After a breakout extends further in the breakout direction for a bar or two or three, the market will often retrace in
the opposite direction in a pull-back, i.e. the market pulls back against the direction of the breakout.
Breakout failure
A breakout might not lead to the end of the preceding market behaviour, and what starts as a pull-back can develop
into a breakout failure, i.e. the market could return back into its old pattern.
Brooks[14] observes that a breakout is likely to fail on quiet range days on the very next bar, when the breakout bar is
unusually big.
"Five tick failed breakouts" are a phenomenon that is a great example of price action trading. Five tick failed
breakouts are characteristic of the stock index futures markets. Many speculators trade for a profit of just four ticks, a
trade which requires the market to move 6 ticks in the trader's direction for the entry and exit orders to be filled.
These traders will place protective stop orders to exit on failure at the opposite end of the breakout bar. So if the
market breaks out by five ticks and does not hit their profit targets, then the price action trader will see this as a five
tick failed breakout and will enter in the opposite direction at the opposite end of the breakout bar to take advantage
of the stop orders from the losing traders' exit orders.[20]
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Reversal bar
A reversal bar signals a reversal of the current trend. On seeing a signal
bar, a trader would take it as a sign that the market direction is about to
turn.
An ideal bullish reversal bar should close considerably above its open,
with a relatively large lower tail (30% to 50% of the bar height) and a
small or absent upper tail, and having only average or below average
overlap with the prior bar, and having a lower low than the prior bars
in the trend.
A bearish reversal bar would be the opposite.
Reversals are considered to be stronger signals if their extreme point is
even further up or down than the current trend would have achieved if
it continued as before, e.g. a bullish reversal would have a low that is
below the approximate line formed by the lows of the preceding bear
trend. This is an 'overshoot'. See the section #Trend channel line
overshoot.
Reversal bars as a signal are also considered to be stronger when they
occur at the same price level as previous trend reversals.
The price action interpretation of a bull reversal bar is so: it indicates
that the selling pressure in the market has passed its climax and that
A bear trend reverses at a bull reversal bar.
now the buyers have come into the market strongly and taken over,
dictating price which rises up steeply from the low as the sudden
relative paucity of sellers causes the buyers' bids to spring upwards. This movement is exacerbated by the short term
traders / scalpers who sold at the bottom and now have to buy back if they want to cover their losses.
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Wedge
A wedge pattern is like a trend, but the trend channel lines that the
trader plots are converging and predict a breakout.[23] A wedge pattern
after a trend is commonly considered to be a good reversal signal.
Trading range
An Up-Down Pattern.
Once a trader has identified a trading range, i.e. the lack of a trend and
a ceiling to the market's upward movement and a floor to any
downward move,[24] then the trader will use the ceiling and floor levels
as barriers that the market can break through, with the expectation that
the break-outs will fail and the market will reverse.
Broadening top
Flag and pennant patterns
Gap
Island reversal
Price channels
Support and resistance
Triangle
Triple top and triple bottom
Notes
[1]
[2]
[3]
[4]
[5]
[6]
[7]
References
Brooks, Al (2009). Reading Price Charts Bar by Bar: the Technical Analysis of Price Action for the Serious
Trader. Hoboken, New Jersey, USA: John Wiley & Sons, Inc.. pp.402. ISBN978-0-470-44395-8.
Chicago Board of Trade (1997). Commodity trading manual (9th ed. ed.). London: Fitzroy Dearborn Publishers.
ISBN978-1-57958-002-5.
Duddella, Suri (2008). Trade chart patterns like the pros : specific trading techniques. [S.l.]: Surinotes.com.
ISBN978-1-60402-721-1.
Eykyn, Bill (2003). Price Action Trading: Day-trading the T-Bonds off PAT. UK: Harriman House Publishing.
pp.164. ISBN978-1-897597-34-7.
Livermore, Jesse Lauriston (1940). How to trade in stocks. New York, USA: Duel, Sloan & Pearce. pp.133.
Mackay, Charles (1869). Extraordinary popular delusions and the madness of crowds. London, New York: G.
Routledge. pp.322.
Mandelbrot, Benoit (2008). The (mis)Behaviour of Markets: a fractal view of risk, ruin and reward. London, UK:
Profile Books Ltd. pp.328. ISBN978-1-84668-262-9.
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