Price Action or the movement of a security's price plotted over time, is the discipline of making all of your trading decisions from a stripped down or “naked” price chart. It's about understanding the imbalance between buying and selling pressure so you can better time your entries and exits. As "price is king", it gives you the most objective view of markets. Experience shows me that is the most reliable framework for entering a trade, both for the long-term and short-term.
With Price Action Analysis you can determine the directional bias of an underlying: trending or no-trending (consolidating), just checking the presence of its structure, that is higher-highs and higher-lows for an uptrend, or lower highs and lower-lows for downtrends. The absence of them means the stock price is ranging, usually between support and resistance levels.
Price Action Analysis improves your ability to spot and interpret trends, candlesticks, breakouts, and reversals. And teach us an important lesson: never use only signals of any technical indicators for an entry trade. Only use them to support what we already established by its analysis.
Consider these four principles for a correct Price Action Analysis, developed each below.
1. Select the proper timeframes for your specific strategy, for finding the better key level to trade there.
2. Find accurate support/resistance (S/R) levels (lines or "zones") in the chart of the stock.
3. "Read" single candlesticks at a glance, and also the patterns it forms, mainly when price approaches an S/R level. Do always in conjunction with volume. This point merits a later full post.
2. Find accurate support/resistance (S/R) levels (lines or "zones") in the chart of the stock.
3. "Read" single candlesticks at a glance, and also the patterns it forms, mainly when price approaches an S/R level. Do always in conjunction with volume. This point merits a later full post.
4. Maintain clean your chart: use only one trend indicator (moving averages) and an oscillator (the RSI). Less is more.
Timeframes
Once you decide, the ideal is to use a minimum of three timeframes: major, intermediate, and lower. reviewing them from top to bottom, since the most reliables levels (support, resistance, trendlines, and patterns) are obtained from the highest timeframes, and the lowest timeframes are used for the tactical or entry decision.
Major Timeframe:
- Identify here the market phase or trend (bull, bear, sideways) through its structure (swing-highs-lows pattern).
- Prefer indicators: simple moving averages SMA50 and SMA200 (this one helps to identify the overall trend).
- Drawings: obvious horizontal levels (quality S/R, Fibonacci and psychological levels), up/down trendlines, and price patterns (channels/flags, triangles/wedges, head&shoulder, cup&handle, double top/bottom, structure trend-change).
- Action: decide here if do a trade or not.
- Drawings: obvious horizontal levels (quality S/R, Fibonacci and psychological levels), up/down trendlines, and price patterns (channels/flags, triangles/wedges, head&shoulder, cup&handle, double top/bottom, structure trend-change).
- Action: decide here if do a trade or not.
Intermediate Timeframe:
- For looking inside the candlestick or price pattern found in the higher timeframe, to confirm the trend through a more accurate structure.
- Prefer indicators: exponential moving averages EMA50 and EMA100, which are quicker than SMA.
- Drawings: recent horizontal S/R levels (or zones) and immediate up/down trendlines.
- Drawings: recent horizontal S/R levels (or zones) and immediate up/down trendlines.
- Action: define here, if exists, a key level in the intersection of major and intermediate timeframe drawings.
Minor timeframe:
- Is the operative timeframe. Wait patiently, until the price approaches the key level for a trade decision.
- Prefer indicator: the RSI, and add the VWAP and Volume Profile for day trading and scalping.
- Drawings: although this timeframe is for analyzing price action and candlesticks, sometimes you could need more immediate (so, accurate) trendlines to confirm the entry.
- Action: when price touches a key level, look for a price reaction (rejection, indecision, confirmation, reversal) through the respective candlestick pattern (pin-bar long-wick, inside-bar harami, momentum no-wick, hammer/shooting star/engulfing) or other pattern combinations (bigger candles, multiple-rejections, shrinking candles, color-change candles). All detail in the next post.
Preferred Timeframes:
- Drawings: although this timeframe is for analyzing price action and candlesticks, sometimes you could need more immediate (so, accurate) trendlines to confirm the entry.
- Action: when price touches a key level, look for a price reaction (rejection, indecision, confirmation, reversal) through the respective candlestick pattern (pin-bar long-wick, inside-bar harami, momentum no-wick, hammer/shooting star/engulfing) or other pattern combinations (bigger candles, multiple-rejections, shrinking candles, color-change candles). All detail in the next post.
Preferred Timeframes:
My triple screen involves the most common timeframes used by the average trader:
- Day trade: 5min - 15min - 1 (or 4) hour
- Swing trade: 15min - 1 (or 4) hour - 1 day
- Position trade: 1 (or 4) hour - 1day - 1week
- Scalping: 5min.
- Swing trade: 15min - 1 (or 4) hour - 1 day
- Position trade: 1 (or 4) hour - 1day - 1week
- Scalping: 5min.
Choose accurate Support and Resistance (S/R) levels
As all traders know, support is the horizontal line or zone on your charts where potential buying pressure could come in and push the price higher. And resistance is the horizontal line or zone on your charts where selling pressure could come in and push the price lower. Both levels are the key to Price Action Analysis.
Of course, there are better levels than others. Some factors determine the quality of an S/R level: clear swing highs and swing lows, more rejections of the level, a strong reverse move there, or a newer level that usually weights more.
Also important is identifying the strength of a level. Consider that price forming higher lows into a resistance zone is a sign of bullish strength (ascending triangle pattern). And price forming lower highs into a support zone is a sign of bearish strength (descending triangle pattern).
Then, for drawing S/R levels, are better lines or zones?
Consider the following details in its drawing:
- Draw the zones in the higher timeframe, when the price approaches it, analyze the price action on a lower timeframe.
- Draw the zones in the higher timeframe, when the price approaches it, analyze the price action on a lower timeframe.
- Forget that price action only works "inside the zone".
- When using a single line for its borders, make sure all reversal points are touched. And better use the candle close/open, not the wicks.
Finally, does not matter what you use, lines or zones, both represent areas of value, not a line or a solid number.
The RSI as an oscillator gives different and important information than the moving averages (trend indicators). Then, is the only one you need to include in your chart, especially in the operative timeframe. It qualifies the situation of the stock as overbought or oversold on a 0-100 scale (above 70 and below 30, respectively). The crossovers are used by traders as a probable reversal.
- When using a single line for its borders, make sure all reversal points are touched. And better use the candle close/open, not the wicks.
As can be deduced every time I have described an S/R "key level", I was referring to horizontal lines or zones, indistinctly. To the obvious question, which is better? the answer is also: none more than another, it all depends on the way of trading and the risk to be assumed. Conservative traders wait for trade at clear S/R lines. Risky traders trade zones.
Finally, does not matter what you use, lines or zones, both represent areas of value, not a line or a solid number.
Some words for the Relative Strength Index (RSI)
For my way of trading, it's enough this indicator to complement my Price Action Analysis. I use it only as a reference to how the buyer/seller sentiment is coming from the traders.
I never take its signal as an indication of action (with any indicator it should be done!), because the main weakness of the RSI is that it can be a very long time as overbought while the stock continues trending, due to greedy traders still in their positions trailing their stop-loss. RSI oversold usually gives more clean information: the time it stays below 30 is more punctual, due to traders' natural fear.
And finally, its best feature: its accurate bullish or bearish divergences with the price. There are more powerful when happening in wide (much better than tight) swings of price AND the divergence line is drawn at (or inside) the overbought or oversold area. But take note that not all divergences work: they need a further trend-change or structure confirmation, that came from any form of Price Action, that's a candlestick or price pattern.
And finally, its best feature: its accurate bullish or bearish divergences with the price. There are more powerful when happening in wide (much better than tight) swings of price AND the divergence line is drawn at (or inside) the overbought or oversold area. But take note that not all divergences work: they need a further trend-change or structure confirmation, that came from any form of Price Action, that's a candlestick or price pattern.
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An example of a neat daily chart, in which candlesticks are clear, with a trend indicator (moving averages) and an oscillator (RSI), enough for looking in this case for a swing trade. This $NVDA daily chart shows its main supports: the zone in yellow at $220 and the 8-month line near $200. As the price is now touching a key level, a cautious trader just waits for the next candles for a resolution using Price Action Analysis. Price could overcome its simple moving averages (DMA200, in wide light blue, and DMA50 the skinny one), or simply continue its bearish trend towards its other support line near $200. Only the next price action would tell it. Being patient is key for a successful trader. |
As the title says, this is just the basics of the Price Action Analysis. In successive posts I will detail aspects of this, such as candlesticks, the soul of this framework, as well as its application in the three types of trading that I use, that is, Trend, Breakout and Reversal trading.
Good trading,
@BravoTrader
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