|What is price action?|
Most traders believe that prices rise because of large number of buyers in the market. But that isn’t the case. Imagine that there are 100 buyers that each of them want to buy a single share of Google Inc. At the same time, there is a seller who wants to sell a million of these shares.
Now what do you think that will happen to the price? Will it increase or decrease? It will definitively decrease, because the sell pressure is higher than the buy pressure. So the price is under the influence of volume of transactions rather than the number of sellers and buyers.
This is the same concept, which price action method relies on. Therefore, understanding the pressure on each side, helps you to be able to adjust your entry and exit points accordingly.
Price action advantages
Replacing fundamental analysis
If you are a technical trader and only rely on the price chart, you can easily exclude fundamental analysis from your trading plan. You may ask yourself that “how can I exclude fundamentals if they are the main motive of the market?”. Let’s start with another question. Have you ever payed attention to the trend of the market, when an important news or report is published?
For example, AMD shares were at a downtrend in 2014, 2015 and 2016, but the price of this exact share grew 700% in only 12 months. If you were a fundamental trader and only traded based on news, you would have probably missed this opportunity. Now what would have happened if you were a technical trader?
Media is always looking to create a trend and prepares different news for each market. Therefore, positive news are always published when the market is in an uptrend, whereas in a bearish market, news are always focused on negative aspects. So there is always two sets of news ready to be published according to the current trend of the market. In fact, the fundamentals aren’t the main actuators of the market.
Providing comprehensive view over the market
Most technical indicators are constructed via a formulation. For example, the 200 day moving average calculates the closing price over the recent 200 days. Using indicators is only helpful when you use them correctly, otherwise they will cause deception.
For example, The “Relative Strength Indicator” or RSI shows overbought and oversold regions in a specified time span. RSI calculates the amount of loss and profit in different time spans and if you change the time span, you would see different results on the chart. So there could be different conclusions when studying a technical indicator such as RSI.
On the other hand, price action only provides you with raw data about how price has moved over time. The only conclusion you can make on this data, is closely related with the movement of price itself. What you should have in mind is that markets with less amount of liquidity are more likely to be manipulated by those with financial dominance.
Being able to improve your entry and exit
As you may already know, indicators are essentially a number of mathematical formulas. Therefore, they will always move behind the market. This means that if you see a price action signal on the chart today, it might not be reflected on a certain technical indicator until tomorrow. This is a very good reason to use price action instead of technical indicators. Because this method allows you to act instantly. But always have in mind that indicators are still a very reliable set of tools to analyze the market, despite their latency.
Applicable to all financial markets
Imagine that you want to build a house. Would you just randomly build any part of the house that you feel like it? Of course not. At first, you should have a robust plan for yourself to follow. In this plan, several foundational aspects shall be discussed. The same case applies when you are trying to trade in financial markets.
You should have a comprehensive trading plan. You can never trade randomly without any clear trading plans, and expect to get good results. In fact, you should have a framework including where and when to enter a trade and when to close it.
Therefore, price action comes into play, because price action helps you to analyze the market in a deep level and adopt the most suitable strategy according to the current condition of the market. This way, your trading strategy always changes as the overall condition of the market does.
Price action disadvantages
Now according to what has been mentioned about price action, you may consider it as a savior for you failed trading career. But always have in mind that like any other methods, price action has its downsides too.
- Price action doesn’t allow backtests
- Validating price action strategies takes a lot of time
- Price action is under the influence of an individual’s perception from the market
Price action allows you to understand the reasons behind the movements of the market. Price charts are the most important analysis tool which price action traders use. Price action is not a strategy itself, it rather helps traders to understand the market and allows them to adjust their trading strategies accordingly. As mentioned before, price action is not a seamless analysis method and has some downsides that make this method useless for some traders.
In Aron Groups Broker, all type of traders can benefit from the wide spectrum of financial services around the world. This forex broker facilitates trading by providing MetaTrader 5 to its clients. MetaTrader 5 offers numerous analysis tools which could help both fundamental and technical traders to follow their trading strategies. Using MetaTrader5, traders are allowed to trade several financial instruments such as Stock, Energy, Commodity, Cryptocurrency and Currency pairs.
Written by: Mohsen Mohseni (Aron Groups).