Trading stocks using price action can give you a trading edge that is all part of the foundation of technical analysis. Using price action can help find profitable trading opportunities for any type of trading style whether it’s shorter-term or longer-term. For shorter-term trading styles like day trading and swing trading, price action is used almost exclusively.
Interpreting Price Action
Knowing how to interpret price action can give you an edge in making better trading decisions such as with providing ideal times of when to buy or sell a stock (or even to “short” it). It will also help to identify where to set your profit targets and set your stop loss limits.
Personality Of Price Behavior
Each stock has its own unique personality and price action behavior. For example, the price action of a stock for a stable and mature utility company paying consistent dividends will most likely be substantially less volatile than a growth stock from a bio-tech company with a promising new cure on the horizon or a technology company that is revolutionizing the industry.
Volatility Of Price Action
By looking at a chart you can clearly see the volatility of price action. You can gauge the degree of price volatility by examining such things as:
- Are prices erratic and widely fluctuating all over the place?
- Are there gaps in price?
- Are the price differences between the highs and lows of one trading session significantly different to that of the highs and lows of other trading sessions?
- Are prices cruising right along in a steady tight trend and not exhibiting that much volatility? Or, is the trend swinging with wide gyrations?
The volatility of price can also be measured by the stock’s “beta” value which is a theoretical measure of volatility in the stock’s price compared to that in the overall market. Stocks that have beta’s greater than 1 are more volatile than that in the overall market, while stocks having beta’s less than 1 are less volatile than that in the overall market. The overall market is defined to have a beta of 1 which is customarily represented by the S&P 500 index.
(See Trading High Beta Stocks to learn more about the concept of beta)
Technical Analysis
Technical analysis is the study of price action that uses price, volume and charts over a given period of time.
Under the theory of technical analysis, everything that is collectively known about a company in the market place should already be factored into the price of that company’s stock and be reflected in its price action. To get a sense of such price action, you can display it on a chart using different time frames.
In making trading decisions, several methods of technical analysis can be used to provide stronger guidance as to what the price of a stock may possibly do next such as breaking out of a trading range or the continuation of an ongoing trend – or indicating the reversal of.
Technical analysis can greatly help you to identify ideal times of when to enter and exit trading positions as well as using it for risk management guidance.
Again, shorter-term traders (like day traders and swing traders) primarily use technical analysis almost exclusively.
Japanese Candlesticks
Candlesticks are very popular in dissecting the behavior of price action. There are many different types of candlesticks to imply either bullish or bearish price action behavior such as:
- “Hammer” (bullish) – can indicate the possible reversing of a prolong downtrend, especially when the hammer presents itself with bullish candles that come after it or prices that follow are maintaining themselves above the bullish hammer
- “Shooting Star” (bearish) – can indicate the possible end to an uptrend, especially when it presents itself when prices are having trouble in breaking through resistance levels to make new highs to the uptrend. In this case, the stock’s price may be prone to come tumbling back down
(to learn more about Japanese Candlesticks, click on Meet the Recognized Leading Authority Who Introduced Japanese Candlesticks to the Western World)
Chart Patterns
Chart patterns are another great way to follow price action. Upon the culmination of a chart pattern, prices have a tendency to potentially move according to the suggested theory as to that particular chart pattern.
There are many types of chart patterns to choose from for either bullish or bearish trading opportunities such as:
- Bear Flags
- Inverted Head and Shoulders
- Cup and Handles
- Ascending Triangles
- Double Bottoms
- Plus Many More Chart Patterns!
Check out our article about one trader who uses chart patterns almost exclusively – Former Pool Contractor Becomes Legendary Stock Trader Turning $11k into $42 MILLION in 23 mo.’s.
Indicators & Oscillators
Price action can also be measured by using different types of technical analysis indicators and oscillators including:
- Stochastics
- Relative Strength Index (RSI)
- Moving Average Convergence Divergence (MACD)
These popular types of indicators and oscillators can help give you an edge in gauging when to enter and exit trading positions for taking profits and identifying key technical areas for setting stop losses.
Summary
By learning how to interpret and analyze price action, it can greatly help you to find profitable trading opportunities both in the short-term and in the long-term as well as giving you guidance for the timing and management of your trading positions.
