The Psychology of Price Action
Price action is the fundamental technique to understanding market psychology. This is because it is the overall sentiment the market is experiencing at any particular time. Why? Because price action represents an overview of collective human behavior. Human behavior is what moves the market.
As humans, we have evolved to respond to situations in certain ways. If something makes us uneasy, we tend to get away from the situation. If we have good news, we tend to celebrate. This psychology applies to the market as well.
Understanding What Price Action Is
Simply put, price action is the reaction to supply and demand in the market. If the price increases, demand is there and the buyers are in control. When the price starts to fall, there is a surplus in supply, and bears start to take over.
Demand zones tend to look like support levels, all-time high breakouts, and high of day breakouts. Supply zones reflect resistance levels, low of day breakouts, and all-time low breakouts.
To get a good overview of price action on a stock, you must focus on the past charts. Previous important prices, resistance levels, and support zones are all able to be determined by going back on the chart. These prices over the past 3–6 months will give you an idea of how the stock is likely to move. History may not always repeat itself, but it sure likes to rhyme.
Price action is the movement of the stock, based on the emotions of the investors. By using candlesticks to determine how strongly a stock currently moving, and previous price history on how the stock moved in the past, you are likely able to determine how the stock will respond at these levels.
You are trading based off the psychology of the investors and how they react to the price of the stock. This is much more powerful than any other indicator because psychology is 70% of trading.
How to Trade With Price Action
To start trading with price action, the first thing you need to do is clear your chart entirely. This is called “naked trading.” You will have an empty chart sitting in front of you, allowing for you to properly mark up the support lines, resistance lines, and current trend lines.
Trading with price action seems so overwhelming to master, but all you need to understand is:
- Candlestick shapes
- IE: Hammers/shooting stars, bullish/bearish engulfing, and doji/spinning tops
2. Patterns
- IE: Ascending and descending triangles, head-and-shoulders, and double tops/bottoms
3. Trends
- IE: Uptrend, downtrend, sideways trend
These are the basics that make up the chart and determine how the stock will move. The candlesticks determine the sentiment of the market (bullish or bearish), which leads to patterns forming on the chart. In turn, creating a trend in the chart to determine how the market is moving.
Why You Should Trade With Price Action
Taking your trades based on price action helps to minimize confusion and reduces the market down to its core components. There is a time and place for indicators, but more often than not you are better off not using them.
They can give too many false signals and they clutter up your screen greatly. These indicators are usually lagging as well.
Having a clear chart often allows you to have a clear mind when trading. Having a messy chart can cause more confusion, stress, and mistakes while trading. When it comes to trading, the less background noise the better. If you do not have a calm mind, you will fail to make the correct decisions.
So not only does focusing on price action determine the overall psychology of the market, but it also helps improve your trading psychology.
In conclusion…
A clear chart equals a clear mind. By going back to the basics and learning how to trade strictly off of price action you will find yourself much calmer and more confident of what is going on.
In the signals group our instructor, Clayton, trades based on price action and he has an 87% hit rate on average!
If you want to start trading with price action, you need to focus on:
- Going back and understanding past price movement of the stock
- The specific candlesticks and charts that create telling patterns
- Managing risk and knowing when price action isn’t working in your favor anymore
What is your favorite way to trade? Let us know below in the comments.
