What is price action?

A price action definition?

There is no widely accepted definition of price action, but I think a broad one is
most helpful for traders. I like the one that I use in the first video in the course,
and I am basing this article on that video. Price action is any representation of
price movement of any financial instrument, on any type of chart and on any
timeframe. Here are some examples:

One of these is a daily chart, another is a 5 minute chart, and the third is a 1
minute chart. Also, one is a stock during the 1987 Stock Market Crash, another
is a recent Forex currency market, and the third is gold. Can you tell which is
which? Of course not, and the reason is that the same people and computers
are trading all of them and they are using the same techniques for all markets
and time frames. (The answer is the chart on the left is a daily chart of GE, the
middle chart is a 1 minute chart of the EURUSD foreign exchange market, and
the one on the right is a 5 minute chart of gold.

Any type of chart is good for trading

The charts below show that it does not matter what type of chart that a trader
uses because they all are just different representations of what is taking place in
the market and traders can see the same setups on all of them.
This is a 5 minute chart of PBR, the stock of a Brazilian company.

This chart has 300,000 shares per bar and the setups are just as clear as on the
5 minute chart.
This chart of PBR has 1,000 ticks per bar.

This is a Range chart of PBR, which again shows the same setups.
This monthly chart of PBR shows the same patterns that traders see on 5 minute
charts and daily charts. Markets are fractal, which means that the same patterns
occur on all smaller and larger time frames.

Every tick matters

You sometimes hear traders refer to some movement as noise, as if the
behavior was random. What they do not appreciate is that the market is
controlled by hundreds of computers that never rest. They are constantly
crunching numbers and executing trades. The movements are very precise
because all of the algorithms are aware of the key prices. These are support and
resistance levels and act as magnets that draw the market to them. Once there,
the market then decides on which magnet it will then test, and the move can be
up or down.

Every little move is an example of price action and traders never dismiss
anything as unimportant. Sometimes something very small leads to a big move.
Traders who understand what is going on will often take these trades. The stop
of sometimes very tight, which means that the risk is small. Small risk always
means low probability, but the reward can be so large that it more than offsets
that low probability.
Something very minor often leads to a strong trend, as happened here within
the tight trading range near the high of the day. There was a small double top
within that tight trading range, and it formed just one tick below the high of the
day. Alert traders shorted one tick below the signal bar, risking 5 ticks to make a
reward that was many times larger. After the market began to trend down, the
probability of lower prices increased and many traders waited to take later
entries. You can see the big bear trend bar that formed once everyone agreed
that the bears had won and that the market was going lower.

Price action is a reflection of human behavior

All of us have a good understanding of how to buy and sell things, and how to
determine a fair price. We do it every time we buy something at the store or sell
something to someone. Our behavior is logical and it is a survival skill, and
humans have optimized it over thousands of years. We do it very well.

Markets are simply forums for buying and selling and are entirely controlled
by human behavior, which is in turn controlled by our genes. This means that
price action has been the same since markets began and it will remain the same
unless we evolve into a new species. Computers make decisions faster than we
do, but ultimately they come to the same logical decisions as us. This means
that price action has not changed, even though 75% of the trading is now
automated.
This is a weekly chart of the Dow Jones Industrial Average during the Great
Depression. There were no computers at the time, but the chart still looks the
same as any chart today, on any time frame.

Trading is difficult
As every beginning trader soon discovers, making money as a trader is much
more difficult that websites, books, and ads make it seem. However, it is not
impossible. Although trading is not a zero sum game in the long run because the
economy has grown forever (the total dollars in the stock market are about 10
times more than during the 1987 crash…there is vastly more wealth today), it is
essentially a zero sum game over the course of the next several weeks. There
will always be traders who are better than others and they will consistently
make money. That should be the goal of every trader…to trade consistently
well. We do not have to trade perfectly, but we do have to trade well, and that is
something within reach of all of us. However, to do anything consistently well for
many years is always difficult, but the challenge is part of the appeal. That is
why we play tennis or golf, or watch soccer or football. We like to compete.

Market inertia
Traders focus on the current bar and hope to figure out what the bars just off
the screen to the right will look like. As everyone knows, the best predictor of
tomorrow’s weather is what is happening today. Well, the same is true with
trading. The bars to the right that we do not yet see probably will look like those
to the left. Markets have inertia and tend to continue to do what they have been
doing. My 80% rule is that 80% of trend reversal attempts will fail, and 80% of
trend breakout attempts in trading ranges will fail. Trends have a strong
tendency to remain as trends, and trading ranges are very resistant to change
as well. The market is constantly testing the strength of traders who hold the
opposite view because it knows that eventually they will be right, but successful
traders know that traders betting against inertia will be wrong 80% of the time.
They therefore like to bet against those other traders and buy reversal attempts
in bull trends, betting they will become bull flags, and selling bottoms in bears,
betting they will become bear flags. They also buy low, sell high, and scalp in a
trading range, betting that all of those strong rallies and selloffs will fail and
then reverse.

The lure of candlesticks & indicators

People are naturally hopeful. We want to believe that the world is good and fair,
and that we will succeed in whatever we are doing. The trading world is filled
with websites, videos, and books that make trading sound easy. The message is
clear…just memorize a dozen candle patterns or use a secret indicator and you
will get rich. Traders quickly learn that this is untrue, and they discover that the
only way that they will succeed is by working very hard to understand how
markets behave. There are no secrets. Everything is right in front of them.
Covering it all up with indicators only reduces their chances of success.

60 minute EURUSD foreign exchange market chart with many indicators, which
make it very difficult to see the price action. Beginners are often afraid of the
market and try to hide it with lots of indicators. Yes, they create a psychological
barrier between the trader and the market, but rather than protecting him from
the dangers of the market, it prevents him from seeing what the market is doing
and therefore he is unable to trade profitably.
This is the same 60 minute EURUSD Forex market chart without indicators. It is
easy to see what the market is trying to tell traders if they are willing to listen.

If not candlesticks or indicators, then what is price

action?
Traders correctly believe that Goldman Sachs, high frequency trading firms, and
hedge funds make a fortune. However, they are not using candlestick patterns
and indicators to do so. So, what do successful traders do instead? Carefully
listen to technical traders on CNBC…they tell you every day!They repeatedly
talk about support, resistance, channels, prior highs and lows, and trend lines,
and you rarely ever hear anyone mention a candle pattern or an indicator.They
also talk about whether a trend is strong or if the market is in a trading range.
They mention higher highs and lows in a bull, and lower highs and lows in a
bear, and they assess buying and selling pressure, probability, risk, and reward.
Finally, they often talk about trade management, like where to put stops and
when to take profits.
Traders are always thinking in terms of support and resistance. This means that
as soon as they see two reversals, they draw a line and then watch what the
market does when it tests the line again. They also see if the market reverses
down when it tests a prior high, as it did here.

The 5 minute chart of the SPY formed a double top and a wedge top at bar 7, a
double top at bar 5, and double bottoms at bars 4 and 8 (both had 2nd entry
buy signals).
Many traders do not think of this pattern as a double top bear flag, but it is
common and reliable. Double tops and bottoms are rarely perfect and often look
very different from how they are usually described in books and websites.

Many traders often incorrectly refer to these charts as price charts, which is only
half correct. They are two dimensional, which means that they have a second
variable…time. These are price versus time charts, and time is often more
important than price. If the market begins to have a series of trend bars in one
direction, it is a sign that one side is winning and that a trend might soon
become obvious.

Bottom line
There is nothing magical to trading and the institutions cannot hide what they
do. It is all right in front of all of us every day and on every chart..and it is called
price action. It is the key to successful trading, but trading well takes much
more work than simply memorizing a handful of candle patterns or relying on a
secret indicator. However, if a trader takes his job seriously and works very hard
to learn his craft, the reward can be everything that he hoped it could be.