Effective price action trading strategies

With price action commonly perceived as the most important thing to look at in trading, this article focuses on three effective trading methods that can be employed across a host of market conditions. 

Price action chart
Source: Bloomberg

Price action is the most crucial thing in trading, with the movement of the price ultimately dictating whether a trade is won or lost. While some will get caught up in the use of increasingly complex indicators, there are many who believe that the price is the only thing you need to tell whether a market is likely to go up or down. The utilisation of drawing tools such as trendlines, horizontals, and Fibonacci retracements are often employed as a means to supplement the purely visual price action. Through the study of key swing highs and swing lows, it is possible to analyse trends and place trades in favour of that trend. You can also use price action to spot and trade market reversals. Add to that the ability to find tradeable patterns, and it is clear that price action alone can provide all you need as a trader.                      

Trend following retracement entry

The first strategy is related to playing the trend. On this occasion, we have a clear downtrend in play, with lower highs and lower lows being created. The key swing highs and lows are circled accordingly. As long as we do not see the most recent swing high broken, the downtrend remains in play.

By using the Fibonacci retracements, you can look for short positions at a beneficial price. Here we can see that each pullback hit the 50% retracement, three of the four hit the 61.8%, and two of the four retraced 76.4%. Given the fact that we would need to see a break back above the previous swing high to negate the trend, that’s where we would put our stops. Thus the deeper the retracement, the smaller the potential loss (closer stop loss). As such, taking trades at either the 61.8% or 76.4% would have been very profitable on this occasion. Ultimately, the trend is negated at the bottom right, when the price breaks above the 7911 swing high.

Trend following breakout entry

A tweak to the above technique is centred on an explosive market which will bring above shallow retracements, such as the 23.6% or 38.2% levels. This can be particularly powerful at a time of significant change in that market, following the release of earnings beat or a fundamental data point with notable implications. Ideally this would be traded in the direction of the prevailing trend.

Looking at the chart below, we can see a sharp move, followed by a shallow retracement of 64 points. The break back through ¥102.39 provides the buy signal, with the stop placed below the swing low of ¥101.77. As seen, on this occasion we see the price hit the 3/1 extension higher, yet some traders might wish to opt for lower risk-to-reward profiles to gain a greater chance of success.

Head and shoulders reversal trade

A head and shoulders pattern is one of the most famous patterns out there, with the uptrend reversing with the creation of a lower high, followed by a break below key support. The usage of the right shoulder for the stop loss means we are looking for the continued creation of lower highs and lower lows as instigated by the break of the neckline.

The image below highlights that the break of a strong neckline support can often spark a strong subsequent move. On this occasion we can see that a 4/1 trade would have worked out well, yet there are different targets traders will be looking for. 

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