Talking Points:
- Price Action is a form of technical analysis devoid of indicators
- Traders can trade price action in isolation, or in addition to existing indicators and strategies
- We look at three of the most important aspects of Price Action Analysis
As traders, our job is not easy.
By opening a trade with the anticipation of profit, we are essentially trying to predict the future. And human beings can’t predict the future, so the very nature of our goal is somewhat of a conundrum.
This is where technical analysis can come into play. By observing the way that prices have moved in the past, we may be able to get an idea for the way that prices may move in the future.
Price action can be a valuable tool for the trader. The benefits of price action are numerous.
In this article, we’re going to discuss three of the most pertinent themes of the study of price action.
Tenet #1 Old support can become new resistance, and old resistance can become new support
One of the greatest aspects of price action is that its logical. Trends rarely develop in a straight line… usually an up-trend is a series of higher-highs, and higher-lows; while down-trends are often series of lower-lows, and lower-highs.
More interesting is the fact that in an up-trend, as prices are making higher-highs and higher-lows; the resistance from the previous ‘higher-high,’ can, in many cases, become a similar price level for the next ‘higher-low.’
In essence, previous resistance has become new support when prices are trending higher. Let’s take a look at the recent down-trend in the Aussie-dollar as an example:
Created with Marketscope/Trading Station II
Tenet #2 The past cannot predict the future, but it can help work with probabilities
One of the inherent difficulties of technical analysis is that the past is not always going to be indicative of the future.
Things change…trends reverse… and new information finds its way into the market at a break-neck pace.
One of the allures of price action is that it’s one of the cleanest ways to perform technical analysis. Price action doesn’t purport to tell us anything other than the cleanest interpretation of what has happened in the past (and I call this the cleanest because there is no mathematical function introducing lag into our technical analysis).
So, we can look to buy up-trends cheaply, or to sell down-trends expensively in the effort to get the probabilities on our side as much as possible.
If we see that the Aussie is trending lower or that the Sterling is trending higher – it’s not enough to simply buy or sell and ‘hope’ that profit produces itself. We need to be tactical in an effort to avoid The Number One Mistake that Forex Traders Make (looking for advantageous risk-reward ratios).
We outlined this approach from the perspective of a swing-trader in the article The Four-Hour Trader, a Full Trading Plan.
Traders can use price action to look
to buy up-trends cheaply, or sell down-trends expensively
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