This is a guest post by Casey Stubs, he is a trader, investor, entrepreneur, author and marketer. He is active online every day and you can learn more about Casey by visiting https://caseystubbs.com or by following him on Twitter at https://twitter.com/caseystubbs
If you have been interested in stock trading for even just a little bit of time, you have surely heard the phrase “buy low, sell high” by now. At its face, this phrase is an excellent starting point for someone who is hoping to develop an effective trading strategy—after all, it makes perfect sense that you would want to purchase a stock before the price is about to increase and sell that stock while it has some value. However, though this is indeed a fundamentally sound mantra, if you hope to develop a comprehensive trading strategy, you should eventually incorporate a more nuanced approach.
Price Action Trading is a stock trading strategy that focuses primarily on using trend lines to justify the “buy low, sell high” approach mentioned above. In other words, price action traders don’t focus on identifying the intrinsic value of a stock, rather, they primarily focus on instances of resistance and support to determine when it is a good time to open or close a position.
Generally speaking, because price action trading does not focus on intrinsic values, this strategy is most effectively utilized by traders operating within a short-term time frame. In this brief guide, we will discuss the fundamentals of price action trading and how this simple—yet effective—strategy can be adequately employed to increase your daily return on investment.
What is price action trading?
Regardless of what the “true” value of a stock is, the price of this stock will inevitably fluctuate upwards and downwards throughout the day. Contrary to a momentum trading strategy—which typically involves opening a position at the very first sign of movement—price action trading waits until the price of a given stock has broken out of the “dead zone” and has demonstrated at least some deviance from its normal, “noisy” range of price fluctuation.
Suppose that, after looking at a chart of a stock’s historical price data, it becomes apparent that the price of the (typically $10) stock has consistently moved between $9 and $11. If, throughout the course of the day, the stock’s price decreases to $8.50, you may have reason to believe that the stock has broken out of the “dead zone” and is about to engage in a specific price action. This specific situation is referred to as a price action opportunity. Though it is certainly possible that the stock could decrease in price even further, the historical data will tell you that the most likely movement will be back to a state of normalcy (the price will increase to be between $9 and $11). In response, a price action trader will likely open a position for a short amount of time.
Identifying Resistance and Support
When analyzing price charts—which typically include the open, close, high, and low values from recent trading days—the most important things for price action traders to be looking for are areas of resistance and support. When a stock is experiencing a state of resistance, the price is high enough that there is adequate pressure to eventually push the price lower (using the example given above, $12 would likely be considered a state of resistance). Conversely, when the stock is experiencing a state of support, then that means the price is low and there is adequate pressure to push the price up (using the same example, this would likely occur around $8).
Naturally, there are no guarantees when it comes to trading stocks. If a trend line that was once supportive continues to fall, even once it has entered and exited the limited price action range, then the once supportive trend may eventually become resistive. This may be an indicator that the daily movement in price was more than just ordinary noise (i.e. related to news stories, mergers, etc.).
Following Market Trends and Ranges
Price action traders have a duty to carefully monitor whether the price of a stock has effectively broken out of its ordinary range. Remember, if the stock has “historically”—a phrase that may be applied to only a few days of movement—maintained a specific range, you should wait until the price has deviated from the trend line before investing. Furthermore, it is also important to try to identify patterns of impulsive and corrective movements and invest accordingly. Impulsive movements are gradual and take place over time; corrective movements occur much more quickly. If you are interested in learning a specific day trading Price Action Strategy there is one in detail at the link.
To know which trend lines to follow—and to know the range of historic data that’s relevant—it is important to identify the phase that the stock is actually in. Accumulation, advancing, distribution, and declining stages typically occur sequentially. If you hope to be an effective price action trader, you should only act when a stage is clearly in motion—using this strategy during the “breakout” period will expose you to increased risks.
Effectively Implementing a Price Action Trading Strategy
Price action traders seek to utilize the “sweet spot” of a price movement and invest right before a price increase or decrease is most likely to occur. However, these investments are not without risks. Fortunately, there are several things you can do to help protect your wealth.
Using stop trades and stop losses can effectively shield you from either losing too much during market abnormalities or failing to cash out a position. Furthermore, simultaneously holding long and short positions of the same stock helps increase your buying and selling flexibility.
When developing a price action trading strategy, it is important to remember that opportunities for these actions are not guaranteed to occur with each stock every day. The best price action traders are the ones who can be patient, understand the significance of historical trend lines, and have the intuition necessary to time their entry into the market.