Price Action Trading Strategies – 6 Setups that Work

 

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 chart or hieroglyphics.  When you see a chart with many indicators and trend lines, it is likely a trader trying to overcompensate for lack of certainty.

For example, I have talked with traders whose screens look something like the picture below.

Too Many Indicators

Too Many Indicators

I have even seen some traders that will have four or more monitors with charts this busy on each monitor.   When you see this sort of setup, you hope at some point the trader will release themselves from this burden of proof.

What if we lived in a world where we just traded the price action?  A world where traders pick simplicity over the complex world of technical indicators and automated trading strategies.

When you remove all the clutter from the trades, all that is remaining is the price.

To see a chart minus all the indicators, take a look at the following image.

Price Action Chart

Price Action Chart

At first glance, it can almost be as intimidating as a chart full of indicators.  Like anything in life, we build dependencies and handicaps from on pain of real-life experiences.  If you have been trading with your favorite indicator for years, going down to a bare chart can be somewhat traumatic.

In this article, we will explore the six best price action trading strategies and what it means to be a price action trader.

Chapter 1: What Makes up Price Action

Before we dive into the strategies, I want first to ground you on the four pillars of price action.

  1. Candlesticks
  2. Bullish Trend
  3. Bearish Trend
  4. Flat Market

If you can recognize and understand these four concepts and how they are related to one another, you are on your way.

Pillar 1 - Candlesticks

I have listed candlesticks here because this is the most popular form of charting in today's trading world. Historically, point and figure charts, line graphs and bar graphs were the raves of their day.

Not to make things too open-ended at the start, but you can use the charting method of your choice. There is no hard line here.

However, for the sake of not turning this into a thesis paper, we will focus on candlesticks. The below image gives you the structure of a candlestick. To learn more about candlesticks, please visit this article that goes into detail about specific formations and techniques.

Candlestick Structure

Candlestick Structure

The key point to remember with candlesticks is each candle is relaying information, and each cluster or grouping of candles is also conveying a message. You have to begin to think of the market in layers.

Pillar 2 - Bullish Trend

This is a simple item to identify on the chart, and as a retail investor, you are likely most familiar with this formation.


A bullish trend develops when there is a grouping of candlesticks that extend up and to the right.

Think of a squiggly line on a 45-degree angle.

The key thing to look for is that as the stock goes on to make a new high, the subsequent retracement should never overlap with the prior high. This ensures the stock is trending and moving in the right direction

Bullish Trend

Make sense?

Pillar 3 - Bearish Trend

Bearish trends are not fun for most retail traders. Shorting (selling a stock you do not own) is likely something you are not familiar with or have any interests in doing. However, if you are trading this is something you will need to learn to be comfortable with doing.

This formation is the opposite of the bullish trend. This is where a security will trend at a 315-degree angle.

Bearish Trend

Pillar 4 - Flat Market

Flat Trend

Get ready for this statement, because it is big. The market in general terms is flat about 80% of the time for day traders.

Rarely will securities trend all day in one direction. You will set your morning range within the first hour, then the rest of the day is just a series of head fakes.

If you can re-imagine the charts in these more abstract terms, it is easy to size up a security's next move quickly.

Flat markets are the ones where you can lose the most money as well. Reason being, your expectations and what the market can produce will not be in alignment. When the market is in a tight range, big gains are unlikely. The main thing you need to focus on in tight ranges is to buy low and sell high.

Chapter 2: Price Action Trading Strategies

#1 - Outside Bar at Support or Resistance

For those unfamiliar with an outside bar, an example of a bullish outside bar is when the low of the current day exceeds the previous day's low, but the stock rallies and closes above the previous day's high.

The bearish example of this would be the same setup, just the opposite price action.

outside down day

outside down day

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 breakdown.

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

Spring at Support

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 kick off 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 zone in on the candlesticks.

The one common misinterpretation of springs is 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.

Spring Example

Spring Example

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 many 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 to accumulate more shares.

To illustrate a series of inside bars after a breakout, please take a look at the following chart.

Inside Bars

Inside Bars

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 inside bars can also occur prior to a breakout, which strengthens the odds the stock will eventually breakthrough resistance.

This is honestly my favorite setup for trading. I love it when a stock hovers at resistance and refuses to back off. This is a sign to you that things are likely going to heat up.

The other benefit of inside bars is it gives you a clean set of bars to place your stops under. This way you are not basing your stop on one indicator or the low of one candlestick.

#4 - Long Wick Candles

Long Wick 1

Long Wick 1

Long Wick 2

Long Wick 2

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 again.

Reason being, a ton of traders, entered these positions late, which leaves them all holding the bag.  The counter pressure will be weak comparatively, 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.

Long Wick 3

Long Wick 3

Notice after the long wick, CDEP had many inside bars before breaking the low of the wick.  After this break, the stock proceeded lower throughout the day.

#5 - Measure Length of Previous Swings

Measure Previous Swings

Measure Previous Swings

Have you ever heard the phrase history has a habit of repeating itself?  Well, trading is no different.

As a trader, you can let your emotions and more specifically hope take over your sense of logic.  You will look at a price chart and see riches right before your eyes.

Well, that my friend is not a 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 select traders can 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, 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% to 20%.  Bottom line, you shouldn't expect 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 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.

Measure the Swings

Measure the Swings

Notice how FTR over a 10-month period experienced many 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 more 60 to 80 cent moves before that occurs.

Just on this one chart, I can count 6 or 7 swings of 60 to 80 cents.  If you can 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

No Price Retracement

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 positive the primary trend is strong and likely to continue.

little retracement

little retracement


The key takeaway is you want the retracement to be less than 38.2%.  If so, 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.

This is especially true once you go beyond the 11 am time frame. This is because breakouts after the morning tend to fail. So, in order to filter out these results, you will want to focus on the stocks that have consistently trended in the right direction.

Chapter 3: False Setups

Trading comes down to who can realize profits from their edge in the market. While it is easy to scroll through charts and see all the winners, the market is one big cat and mouse game.

Between the quants and smart money, the false setups are everywhere.

As a price action trader, you cannot rely on other off-chart indicators to provide you clues that a formation is false. However, since you live in the "now" and are reacting to directly what is in front of you, you must have strict rules to know when to get out.

For me, in lieu of a technical indicator, you can use time as a gauge.

Time

Just to be clear, the chart formation is always your first signal, but if the charts are unclear, time is always the deciding factor.

I did a study of all my winning trades and over 85% of them paid in full within 5 minutes.

If you have been trading for a while, go back and take a look at how long it takes for your average winner to play out.

Let's review a few head fakes to get a feel for what we are up against in terms of false setups.

 

Head Fake 2

Head Fake 3

I just showed you two examples of head fakes in both equities and futures markets.

In each example, the break of support likely felt like a sure move, only to have your trade validation ripped out from under you in a matter of minutes.

 

Chapter 4: How to Protect Against the Head Fakes

Protection

There are many ways you can protect yourself against head fakes.

For starters, do not go hog wild with your capital in one position. Make sure you leave yourself enough cushion, so you do not get antsy with every bar that prints.

Also, let time play to your favor. I know there is an urge in this business to act quickly. However, there is some merit in seeing how a stock will trade after hitting a key support or resistance level for a few minutes.

If you think back to the examples we just reviewed, the security bounced back the other way within minutes of trapping traders.

Where to Place Your Stops

One thing to consider is placing your stop above or below key levels. Since you using price as your means to measure the market, these levels are easy to identify.

Now one easy way to do this as mentioned previously in this article is to use swing points. A more advanced method is to use daily pivot points.

Now I know what you are thinking, this is an indicator. Well yes and no. Unlike other indicators, pivot points do not move regardless of what happens with the price action.

So, let's see how you can use pivot points to avoid getting caught in false signals.

Avoid False Breakouts

Avoid False Breakouts

Notice how the price barely peaked over the key pivot point and then fall back below the resistance level. In order to protect yourself, you can place your stop below the break out level to avoid a blow-up trade.

Another option is to place your stop below the low of the breakout candle.

This is honestly the most important thing for you to take away from this article - protect your money by using stops. Do not let ego or arrogance get in your way.

Chapter 5: Price Action Traders

Price action traders are the Zen traders in the active trading world.

These people believe the human brain is more powerful than any machine.

Please do not mistake their Zen state for not having a system. The price action trader can interpret the charts and price action to make their next move.

Benefits of Price Trading

Benefit

Processing Data

For starters, there isn't as much information to process, so you can focus on the chart action.

Secondly, you have no one else to blame for getting caught in a trap. Don't bother emailing the guru with the proprietary trade signal that had you on the wrong side of the market.

The biggest benefit is that price action traders are processing data as it happens. There is no lag in their process for interpreting trade data.

Chart Patterns

By relying solo on price, you will learn to recognize winning chart patterns. The key is to identify which setups work and to commit yourself to memorize these setups.

The next key thing for you to do is to track how much the stock moves for and against you. This will allow you to set realistic price objectives for each trade. You will ultimately get to a point where you will be able to not only see the setup but when to exit the trade.

Challenges

Challenges

Price action traders will need to resist the urge to add additional indicators to your system. You will have to stay away from the latest holy grail indicator that will solve all your problems when you are going through a downturn.

The real challenge is it's extremely difficult to trade purely on price. It's not something you can just pick up and start doing right away.

You need to think about the patterns listed in this article and additional setups you will uncover on your own as stages in your trading career.

First, learn to master one or two setups at a time. Learn how they move and when the setup is likely to fail.

This, my friend, takes time; however, get past this hurdle and you have achieved trading mastery.

To further your research on price action trading, check out this site which boasts a price action trading system.

In Summary

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 tradeable patterns. The key thing for you is getting to a point where you can pinpoint one or two strategies.

To start, focus on the morning setups. The morning is where you are likely to have the most success. Avoid the lunchtime and end of day setups until you are able to turn a profit trading before 11 or 11:30 am.

To test drive trading with price action, please take a look at the Tradingsim platform to see how we can help.

Much Success,

Al

Al Hill Administrator
Co-Founder Tradingsim
Al Hill is one of the co-founders of Tradingsim. He has over 18 years of day trading experience in both the U.S. and Nikkei markets. On a daily basis Al applies his deep skills in systems integration and design strategy to develop features to help retail traders become profitable. When Al is not working on Tradingsim, he can be found spending time with family and friends.
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