In stock trading, there are several buying and selling strategies to choose from. Price action trading is one of them. Rather than relying on technical analysis or fundamental analysis, price action trading simplifies tracking and acting on stock trends. If you think it could help build your portfolio, here’s what you need to know.
A financial advisor can help you create a financial plan for your investing needs and goals.
Price Action Trading Defined
In short, price action trading makes real-time trade decisions based on a stock’s price movement. Rather than studying historical performance, investors examine the most recent price changes. Further, they use it as a guide to which stocks to buy and sell and when to execute trades.
The idea is fairly simple. If you’re studying a stock and its price increases, that’s a signal that people are buying it. However, if the price goes down, that suggests that people are selling or that it’s losing momentum.
When a stock you’re watching rises in price, you’d then decide how likely that trend is to continue. The goal is to choose an entry and exit point for a stock that would allow you to maximize profits when buying and selling.
This is different from technical analysis, which relies on a specific rules for making trading decisions. With technical analysis, you’re monitoring not only price movements but other factors. Those include trading volumes and past market activity.
Price action traders zero in on price but they’re not rule-bound. A trader to decides if a stock can sustain rising prices. As a result, they determine whether to buy or sell.
Price Action Trading Strategies
There are specific tactics investors can use to fuel returns. They involve identifying pricing trends, then taking action on those trends trend.
For example, there are three main trends an investor may look for:
- Bullish stock price movements, meaning the price is increasing.
- Bearish stock price movements, meaning the price is going down.
- Stock prices that remain flat.
Investors can also use what’s known as a candlestick chart to gauge pricing. This reflects a stocks price movements over time in a way that can be easier to read than a bar or line graph. It shows investors the difference between a stock’s open and close price on a given day, as well as any movements above or below the closing and opening prices. This type of charting can make it easier to spot patterns in pricing over a set period of time.
Price Action Trading in Action
An investor might be looking for a breakout movement that brings stock prices above a certain range. If the breakout is accompanied by an uptick in trading volume, it may suggest a sustainable stock price. An investor could then decide whether to go long in the stock or cover short positions. Breakouts can also move the opposite way, with prices dipping below a certain range. In that case, an investor might take a short position to see which way the stock will move.
Price action traders can also study swings in price movements to make trading decisions. For example, if a stock appears to be swinging up or down, you might study the most recent pricing swings to determine if there’s a pattern. If there is, you could use that to decide when to buy or sell to capitalize on which direction the swing is headed.
Upside of Price Action Trading
Arguably the biggest advantage price action trading is minimal research. Traditional technical analysis and fundamental analysis require you to do some digging when making investment decisions. Each analysis has rules for screening stocks and choosing entry or exit points.
Price action trading isn’t like that. You’re just focusing on price movement. Also, you have more flexibility in deciding whether or not to buy or sell. Since trading decisions happen in real time, you don’t wait for a trailing indicator to update a stock’s price. This might appeal to investors who want a streamlined trading system, but don’t want to guess about trades.
Downside of Price Action Trading
Price action trading requires you to be more hands-on than other trading strategies. A buy-and-hold investor, for example, could purchase 1,000 shares of a stock and let them sit. Their goal is to accumulate value over the long-term. With price action trading, however, returns are delivered on a short- to medium-term basis. So you have to stay involved and connected with your portfolio.
That can make it more difficult to automate trades since you need to monitor price movements. Also, price action trading is not a perfect science. Since much of investor decision-making is subjective, returns aren’t always predictable.
For example, you might have two investors adopting a price action trading strategy with the same stock. But if one uses a different price range to identify a breakout, then their return potential could end up being very different. And it’s always possible that a breakout will end up being smaller than anticipated. As a result, it could lead to lower returns or, in the case of a failed breakout, a loss.
Bottom Line
Price action trading is an investing technique that even beginners can use to their advantage. The best approach may be to study the various ways to use price action trading. Then you can focus on mastering one specific strategy at a time. Like any other investment strategy, it’s important to understand both the rewards and risks of price action trading to ensure that it’s a good fit for your overall investing goals.
Investment Tips
- Consider talking to your financial advisor about using price action trading strategies in your portfolio. A good advisor should be able to help you compare the advantages and disadvantages. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- When trading stocks, your choice of online brokerage matters. Ideally, you should be using a broker that offers commission-free or low-cost stock trades, along with research and educational tools you can use to grow your investing knowledge.
- It’s important to be aware of common investing biases that could skew your decision-making if you’re pursuing price action trading strategies. Recency bias, for example, is the idea that what’s happened recently with a stock or investment will continue to happen. Avoiding these biases as much as possible can help when it comes to making trades with a level head.
Photo credit: ©iStock.com/Chainarong Prasertthai, ©iStock.com/primeimages, ©iStock.com/FlamingoImages