There are many things people trade based on. They can trade based on a company’s fundamentals or macro economic trends. People can place trades based on their own beliefs, projections, predictions or personal opinions. Also psychological errors like the fear of missing out on a move, greed, or ego can lead to trading decisions.
There is another way to trade.
A price action strategy lets the current price make the decisions for them.
- Higher highs and higher lows define the market is in an uptrend. Lower highs and lower lows define the market is in a downtrend. Trading inside a defined price range is considered a sideways market. Defining what type of market you are in helps you go in the direction of least resistance.
- Where price is in relation to the moving average in its time frame can show the current trend.
- An entry is placed due to price reaching a predetermined level that creates a signal. A trading signal must have an edge, it must be based on a historical pattern that creates bigger wins than losses.
- A stop loss is a price level that should not be reached if the trade is going to work out in your favor. This is the price level where you admit you are wrong and take a small loss before it becomes a big loss and the odds of success shift against you. A stop loss along with your position sizing sets the risk on the trade.
- A profit target is the best case scenario of where price could trend until the odds of further profits shift against you. Your profit target sets the reward in your trade.
- The MACD can quantify if the market is showing momentum in one direction based on the direction of the signal line crossover.
- The RSI can signal if a market has moved too far too fast in either direction. Long positions risk/reward ratio can be diminished at the 70 RSI and a short position can be close to reversing back higher at a 30 RSI.
- When the price range expands by twice as much as it has been trading at that is a sign of volatility and increased risk in both directions. It is usually a good signal to trade smaller.
- A breakout of a previous trading range usually signals the odds of price continuing in that direction.
- A market usually continues to move in the direction of a price gap.
Current price action is the truth everything else is pretending to know something.
Chart courtesy of TrendSpider.com