Price Action Analysis in Trading

In this article, I am going to discuss Price Action Analysis in Trading. Please read our previous article, where we discussed Candlestick Analysis in Trading. As part of this article, we are going to discuss the following pointers in detail, which are related to Price Action Analysis in Trading.

1. What is Price Action Analysis?
2. Understanding the advanced features of CANDLESTICK

The ultimate guide you will ever need to understand CANDLESTICK and its characteristics. Once you complete this article, then you will not need to recognize any CANDLESTICK patterns.

What is Price Action Analysis?

The Price Action Analysis is the movement of price in the chart. The candlestick format shows clear price action. I mean what buyers and sellers are doing in that period. Their activity clearly shows in CANDLESTICK. So, to learn price action, we have to learn all the basic and advanced features of candlestick

5 steps to candlestick analysis

Step1: The size of the body (high to low)

BODY:

1. Narrow
2. Average
3. Wide

Find the body of your timeframe. The candle’s body shows a lot of information, such as

• A long body is showing strength
• A narrow body shows weakness
• When consecutive bodies become larger and larger, it shows an increase in momentum
• When consecutive bodies become smaller and smaller, it shows slowing momentum
• If an up or down move with greater than average body candle, it shows volatility high

How to compare?

1. current candlestick with respect to the previous candle
2. current candlestick with respect to the same swing
3. current candlestick with respect to the previous swing

Step2: The length of the wick

• Larger wicks show that the price has moved a lot during the duration of the candle, but it got rejected, which shows the presence of supply or demand.
• At major support and resistance levels. Candlewick becomes larger, which indicates volatility. This generally happens after long trending phases before a reversal happens from the support and resistance level.
• One more thing: the longer the shadow, the more likely prices will move in the opposite direction of the shadow
• Long-wick candles do not always signal a reversal. If a subsequent move engulfs the wick of the rejection candle, it fails; it is called reverse rejection.
• If it appears between the trend, it shows trend cont. ( as a small pullback in a smaller time frame)
• While a single long wick indicates possible prices moving in the opposite direction of the wick, a cluster of multiple wicks indicates that prices are likely to move in the same direction of the wick created, and if the body closes the direction of the trend

    

Step3: The ratio between wicks and bodies

Understanding the relationship between the open and close when compared to the high and the low of the present bar

• Open price tells us where the balance between buyers and sellers at the opening of that period.
• Close price tells us where the balance point was at the end of the period

Etep4: Volume contains

WYCKOFF BASIC LAW

1. THE LAW OF SUPPLY AND DEMAND: When demand is greater than supply, then the price will rise to meet this demand, and conversely when supply is greater than demand, then the price will fall
2. THE LAW OF CAUSE AND EFFECT: The effect will be indirectly proportional to the cause. In other words, a small amount of volume action will only result in a small amount of price action. If the cause is large then the effect will be large vice Versa
3. THE LAW OF EFFORT VS RESULT: Similar to Newton’s third law. Every action must have an equal and opposite reaction. In other words, the price action on the chart must reflect the volume action below. Effort (volume) is seen as the result (price), were validated and anomaly comes into consider

Wide spared candle

Price action –

Strong BULLISH market sentiment. The price has risen sharply and closed at or near the high of an up candle.

Volume Action–

• The associated volume should, therefore, reflect this strong sentiment with a ‘strong’ volume. As we can see in the above example, if the volume is above average(effort vs result), then this is what we should expect to see as it validates the price. Smart money is joining the move higher, and everything is as it should be.
• This is a warning signal if the volume is below average or low. The price is being marked higher but with little effort. The move is not genuine. If we are in a position, we look to exit. If we are not in a position, we stay out and wait for the next signal to see when and where the smart money is now taking this market.

Narrow Spread Candles

Price action – weak market sentiment

Volume Action–

• A narrow spread candle should have low volume – again, effort vs result.
• NARROW SPREAD CANDLE WITH HIGH VOLUME. If the volume had represented buying, how could the spread be narrow? Only two possible explanations exist for a narrow spread-up candle on a very high volume.

1. Either the professional money is selling into the buying [see the end of a rising market]
2. There is a trading range to the left, and the professional money is prepared to absorb the selling from traders locked into this old trading range.

Step5: RELATIVE OR 2 CANDLE PRICE ACTION

DIRECTION OF CANDLE

The relationship of each bar’s high/low relative to the previous bar

1. An upbar starts an upswing and confirms the end of a downswing
2. A downbar starts a downswing and confirms the end of an upswing
3. The inside bar does not break the previous high low; they do not affect the direction of the current swing
4. The outside bar breaks both the previous high and low, introducing uncertainty in the market structure. The outside bar in the upswing cont the upswing, and the outside bar in the downswing cont the downswing. Typically, an outside bar does not end or start a price swing without a down bar or a break below the swing low; an upswing will cont

DIRECTION OF TREND WITH RESPECT TO CANDLE POSITION

  

Context or Background

CANDLESTICK should not be analyzed in a vacuum. A candlestick must always be analyzed in the context of what has happened in the past.

Context is what the current candlestick shows with respect to the previous candlestick.

• Is the current candlestick larger or smaller than the previous ones? Which shows momentum increases or decreases
• Is the size changing meaningfully or not? Buying or selling pressure
• Is volatility increase or decreases
• Is the change happening during an active trading period or not? For example, candlesticks in mid-period are generally dead or inactive.

  

TESTING PRICE LEVELS

Testing refers to the market moving towards a price level to “test” if the price level will accept or reject the market’s advances. The high and low of each price bar are natural support and resistance levels, and the wick generally acts as a supply and demand zone. The test of these levels or zones shows the undercurrents of the market and is critical for reading price action.

 

THREE PRICE BARS/expectation

With a clear read of 2 BAR PRICE ACTION (DIRECTION, CONTEXT, TESTING), we can form an expectation of the market in the third candle. We expect the market to move in a certain way in the third bar with our read of 2 bar price action. The confirmation or failure of our expectations of the third bar reveals more about the market and adds to our price action analysis.

To form expectations, we need to make a very simple assumption about how the market should behave and should not behave. Essentially, the market has momentum and inertia. bearishness should follow bearishness, and bullishness should follow bullishness. When it does not obey this assumption, we have to be cautious, Maybe a possible change in market direction.

Some more examples

Price Action Analysis in Trading Summary:

Price action analysis in trading refers to studying historical price movements to identify patterns and make trading decisions. Unlike technical analysis, which includes indicators and oscillators, price action analysis focuses solely on price movements and chart patterns. Here’s how to perform price action analysis:

1. Understand the Basics of Price Action

• Recognize Key Levels: Identify significant support and resistance levels where the price has historically reacted.
• Trend Identification: Understand the direction of the market trend by observing higher highs and higher lows in an uptrend or lower highs and lower lows in a downtrend.

2. Chart Preparation

• Clean Charts: Use a simple chart with minimal indicators to clearly see the price movement.
• Time Frame Selection: Choose multiple time frames to analyze the price action. For example, use daily charts for the general trend and lower time frames like 1-hour charts for entry points.

3. Identify Chart Patterns

• Look for common price action patterns such as triangles, channels, flags, pennants, double tops, and double bottoms.
• Recognize candlestick patterns like pin bars, engulfing patterns, and inside bars, which can give insight into market sentiment.

4. Analyze Price Swings

• Study the length and duration of price swings to gauge volatility and momentum.
• Pay attention to swing points for potential reversals or continuation of trends.

5. Look for Breakouts and Breakdowns

• Observe price levels where breakouts or breakdowns occur to enter or exit trades.
• Validate breakouts with volume to ensure they aren’t false breakouts.

6. Use Price Action Signals

• A strong move in price away from a level indicates continuation, while a weak move indicates a potential reversal.
• A quick rejection of price at key levels can be seen as a strong signal for reversal.

7. Apply Confluence

• Combine multiple price action signals for stronger confirmation. For instance, a pin bar at a key support level during an uptrend provides a more robust signal.

8. Integrate Volume

• While price action focuses on price, volume is an important factor that can confirm the strength of a price movement.

9. Monitor Price and Time Correlation

• Observe how price behaves at certain times of the day or during specific market sessions. For example, prices may be more volatile during market openings and closings.

10. Consider Market Context

• Stay informed about economic news and events, as they can cause significant price movements that override patterns identified in price action analysis.

11. Practice Patience and Discipline

• Price action trading requires patience to wait for the right patterns and signals and discipline to stick to your trading plan.

12. Backtesting and Paper Trading

• Before applying price action analysis in live trading, backtest your understanding of price patterns and practice with paper trading.

13. Record Keeping

• Keep a detailed log of your trades and observations to refine your price action analysis over time.

14. Continuous Learning

• The market evolves, and so should your analysis. Regularly review your price action strategies and adapt as necessary.

Price action analysis is a skill honed over time and with experience. It’s subjective and can vary from trader to trader. It’s important to remember that price action does not provide certainties but probabilities that must be managed with a solid risk and money management strategy.