A price action trading strategy must have three components: why, how, and what. The 'why' is why you want to trade a given market. Price action patterns are useful in this situation. Price action analysis will help you predict whether the market will rise or fall next.
The mechanics of your craft are the 'how.' It is, in essence, how you will trade. This analysis requires you to know your entry, stop-loss, and target price levels. After all, trading is all about probability. Therefore, you must protect yourself and limit losses if the market goes against you.
The outcome of the exchange is the 'what.' Is this a short-term or long-term trade? This boils down to managing the trade to profitability and managing yourself if the outcome is not as desired.
Here are a few major price action strategies that are used in either one form or another in different markets:
Supply and demand price action
Supply zones are evident where sellers enter the market aggressively, causing the price to fall and not recover. Traders keep an eye out for these because sellers may still be around and ready to sell when the price rebounds, causing the price to fall again.
Demand zones are where buyers have actively joined the market. The price rose and has not since returned. If the price returns to that level, traders will monitor to see if buying resumes, causing the price to rise again.
Price action trading patterns
Price action trading patterns are patterns that result either in the trend continuation or reversal.
- Trend continuation
Continuation patterns appear throughout a trend. Assume that the trend is upward and that a triangle forms. Because the trend is up, the price has a slightly larger possibility of breaking out of a triangle to the upside. When a pattern appears during a decline, the same logic applies. The technique here is to wait for a trend to build, then for a pattern to form, and then to trade only if the price breaks out of the pattern in the trending direction.
- Trend reversal
When the rules of an uptrend or downtrend are broken, price action reversals occur.
Consider an uptrend with greater swing highs and lows. This is an indicator when it makes a lower swing low. If the price then reaches a lower swing high, it indicates that a reversal is in progress. This is not to say that things cannot reverse, allowing the upswing to restart. The data simply suggests that a reversal is likely.
Candlestick patterns in price action
Candlesticks are graphical representations of an asset's price trend, open, close, high, and low on a chart. Traders use candlesticks in various ways, both individually and in combinations. Certain candlestick patterns cause a certain reaction with some probability on specific instruments. It also depends on the timeframe you are using.
Price action for scalping
Scalping is a trading method in which gains and losses are taken swiftly, as deals are often completed in a few minutes or less. In forex scalping, this may entail employing a stop loss of 3 to 5 pips and a goal of 5 to 10 pips. In the stock market, it may imply putting a few cents per share at risk in order to make a few cents. Scalping entails fast entering and closing a position in order to profit on minor price changes, for whatever that asset's definition of a small price move is. Many scalpers like to trade on one or five-minute charts.
A scalping technique seeks to trade in the direction of the trend and enter during a pullback when the price begins to move back in the trending direction. To do so, traders seek engulfing patterns, such as when a candle in the trending direction envelops a candle in the retreat direction, to signify an entry. During a retreat, this happens.
Price action for swing trading
Any of the above-mentioned price action strategies can be employed as part of a swing trading strategy. Swing traders often look for trade setups on hourly, 4-hour, and daily charts, while they may employ 15-minute or 5-minute charts to fine-tune their market entrance.
Consider a supply and demand scenario combined with trend trading.
If you allowed the price to reach the supply zone, it would frequently exceed the previous high. If you want to short the market, you might do it when there is a bearish engulfing pattern or when the price consolidates and then breaks down to the downside. And vice versa. The main goal in swing trading is to enter trending markets (on higher swing lows in an uptrend and on lower swing highs in a downtrend)
Stop losses and profit targets for price action trading
The risk may be managed by putting a stop-loss order on each trade. A stop loss is placed below the most recent swing low when purchasing and entering a long position. You can position an asset above the most recent swing high when shorting it. In both cases, this mitigates the danger of the price falling too low or climbing too high. You might quit Renko charts when the bricks reverse orientation and change colour.
Price action traders should also lock in profits in order to close the position on the anticipated move. This can be accomplished in a variety of ways. A risk-reward ratio is one of the simplest approaches. For example, if you risk $5 per share on a scalp transaction, you should profit $10. That is a risk-reward ratio of 2:1. Scalping ratios of 1.5:1 or 2:1 are frequent. A risk-reward ratio of 3:1 or greater is usual for swing trading, and trend traders typically employ a higher risk-reward ratio.
Other exit strategies include exploiting price action. If you enter a trade because a downtrend has begun, keep it open until the trend reverses. Price action advises when to exit by indicating when the price is turning. Consider departing at demand if you enter at supply. Consider departing near supply if you enter near a demand location.