Technical analysis is a trading tool that uses trading activity statistics, specifically price movement and volume, to try and predict future movement in the market. When a technical trader talks about price action, he is referring to the day-to-day fluctuation in the price of a particular stock.
Traders gauge a stock’s price action by monitoring patterns and indicators to help find order in the seemingly random movement of price. Generally, a trader uses candlestick charts to better visualize and contextualize price movement. It’s a subjective art; two traders might study the same price action and arrive at completely different conclusions about what the pattern represents. This is one reason that price action is best considered just one part of the overall trading strategy.
Price action trading is a trading strategy in which trades are executed strictly on the basis of an asset’s price action. It’s a tactic most often employed by institutional and retail traders. Generally, these traders use leverage to place large trades on the basis of small underlying price movement. The short-term nature of these trades makes other strategies, such as technical or fundamental analysis, less effective.
Predicting Price Actions
Hundreds of indicators have been designed to help predict an asset’s future direction. These include the relative strength index (RSI), the moving average convergence divergence (MACD) and the money flow index (MFI). They use historical trading data to analyze and predict price movement.
Short-term traders plot this information with charts, such as the candlestick chart. Common chart patterns include the ascending triangle, the head and shoulders pattern and the symmetrical triangle. Patterns are an integral part of price action trading, along with volume and other raw market data. It’s a difficult strategy, part art and part science, that even experienced traders struggle with.
Ultimately, in trading, no two people will analyze every bit of price action in the same way. As a result, many traders find the concept of price action to be elusive. Like other areas of active trading, gauging the price action of a stock is completely subjective and price action should be just one of many factors under consideration before entering into a trade. (See also: Basics of Technical Analysis.)