Overview of Price Action Charts
If you browse the web, at times it can be difficult to determine if you are looking at a stock charts or hieroglyphics. When you see a chart with a ton of indicators and trend lines, it is likely a trader trying to overcompensate for a lack of certainty.
For example, I have talked with traders whose screens look something like the picture below.
I have even seen some traders that will have 4 or more monitors with charts this busy on each monitor. When you see these sort of chart configurations, you hope that at some point the trader will release themselves from this burden of proof.
When you remove all of the clutter from the trades, all that is remaining is price. To see a chart minus all of the indicators, take a look at the following image.
On first glance, it can almost be as intimidating as a chart full of indicators. Like anything in life, we build dependencies and handicaps based on self-doubt. If you have been trading with your favorite indicator for years, going down to a bare chart can be somewhat traumatic.
#1 - Outside Bar at Support or Resistance
For those unfamiliar with an outside bar, an example of a bullish outside bar would be when the low of the current day exceeds the previous day's low, but the stock is then able to rally and close above the previous day's high. The bearish example of this would be the same setup, just the exact opposite price action.
Therefore, it's not just about finding an outside candlestick and placing a trade. As you can see in the above chart of Cambrex (CBM), it's best to find an outside day after a major break of a trend. In the CBM example, there was an uptrend for almost 3 hours on a 5-minute chart, prior to the start of the break down.
After the break, CBM experienced an outside down day, which then led to a nice sell off into the early afternoon.
#2 - Spring at Support
A spring is when a stock tests the low of a range, only to quickly come back into the trading zone and kickoff a new trend. I like to use volume when confirming a spring; however, the focus of this article is to explore price action strategies, so we will focus only on the candlesticks.
The one common misinterpretation of springs is that traders wait for the last swing low to be breached. Just to be clear, a spring can occur if the stock comes within 1 to 2% of the swing low.
Trading setups rarely fit your exact requirement, so there is no point in obsessing a few cents. To illustrate this point, please have a look at the below example of a spring setup.
Notice how the previous low was never breached, but you could tell from the price action the stock reversed nicely off the low and a long trade was in play.
#3 - Inside Bars after a Breakout
Inside bars are when you have a number of candlesticks clumped together as the price action starts to coil at resistance or support. The candlesticks will fit inside of the high and low of a recent swing point as the dominant traders suppress the stock beneath the breakout in order to accumulate more shares.
To illustrate a series of inside bars after a breakout, please take a look at the following chart.
This chart of Neonode is truly unique, because the stock had a breakout after the fourth attempt at busting the high. Then there were two inside bars that refused to give back any of the breakout gains. NEON then went on to rally almost 20% in one trading day.
Please note that inside bars can also occur prior to a breakout, which strengthens the odds the stock will eventually breakthrough resistance.
#4 - Long Wick Candles
Are you able to see the consistent price action in these charts? If not, were you able to read the title of the setup or the caption in both images?
Just having a little fun here, don't get sensitive.
The long wick candlestick is one of my favorite day trading setups. The setup consists of a major gap up or down in the morning, followed by a significant push, which then retreats. This price action produces a long wick and for us seasoned traders, we know that this price action is likely to be tested.
Reason being, a ton of traders entered these positions late, which leaves them all holding the bag. The counter pressure will be weak in comparison, so what can't go down must go up again. This leads to a push back to the high on a retest.
That may have been a little tough to follow, so let's illustrate this point through the charts.
Notice how after the long wick, CDEP then had a number of inside bars, before breaking the low of the wick. After this break, the stock proceeded much lower throughout the day.
#5 - Measure Length of Previous Swings
Have you ever heard the phrase history has a habit of repeating itself? Well, trading is no different.
Well, that my friend is not reality. Did you know in stocks there are often dominant players that consistently trade specific securities?
These traders live and breathe their favorite stock. Given the right level of capitalization, these traders will also control the price movement of these securities.
What you can do to better understand the price action is to measure previous price swings. As you perform your analysis, you will notice common percentage moves will appear right on the chart. For example, if you are day trading, you may notice that the last 5 moves of a stock were all 5% to 6%.
If you are swing trading, you may see a range of 18% - 20%. Bottom line, you shouldn't expect the stocks to all of a sudden double or triple the size of their previous swings.
I fully understand the market is limitless; however, it's better to play the odds with the greatest chance of occurring versus swinging for the fences. Over the long haul, slow and steady always wins the race.
To further illustrate this point, let's go to the charts.
Notice how FTR over a 10-month period experienced a number of swings. However, each swing was on average 60 to 80 cents. While this is a daily view of FTR, you will see the same relationship of price on any time frame.
As a trader, do you think it would make sense to expect $2, $3, or $4 dollars of profit on a swing trade? At some point, the stock will make that sort of run, but there will be a ton of 60 to 80 cent moves before that occurs. Just on this one chart, I can count 6 or 7 major swings of 60 to 80 cents. If you are able to trade each of these swings successfully, you in essence get the same effect of landing that home run trade without all the risk and headache.
#6 - Little to No Price Retracement
Not to get too caught up on Fibonacci, because I know for some traders, this may cross into the hokey pokey analysis zone. However, at its simplest form, less retracement is proof the primary trend is strong and likely to continue.
Don't get so caught up on the many Fibonacci retracement levels. The key takeaway is that you want the retracement to be less than 38.2%. If so, then when the stock attempts to test the previous swing high or low, there is a greater chance the breakout will hold and continue in the direction of the primary trend.
Trading with price action can be as simple or as complicated as you make it. While we have covered 6 common patterns in the market, take a look at your previous trades to see if you can identify trade able patterns.
To test drive trading with price action, please take a look at the Tradingsim platform to see how we can help.