Introduction

Price action is the motion of a security’s price in a trading chart. The price of a stock or a trading pair in forex moves up and down over time depending on the fundamental aspects of the trade. The footprint that the trader watches in the price movement is profits or gains made after engaging the trade.  Here, the main strategy involves studying the movement of bars and lines as opposed to adopting technical analysis tools that may complicate the price pattern.  If you track the price of the stock in the chart you will be able to see the market behavior. This information will be critical in developing the trading strategy.

Points to note

  1. What is the direction of the market? Is it a bullish (uptrend) or a bearish (downtrend) market? What is the trading range?
  2. You will need to understand the prior movement of the price. The security under analysis will move based on the previous motion.
  3. Get the market response to any technical levels established before such as support/ resistance, oscillations, or moving averages. However, moving averages (MAs) lag in time and may not capture real-time data as the price changes. They are still useful in filtering out any short-term fluctuations that may confuse the trader.    
  4. How do you analyze the volume of the price action? Does it matter in the final trading strategy?

Market direction

US Dollar Index Chart (2020-2021)

US Dollar Index Chart (2020-2021)

For this analysis let us consider the US dollar index (DXY) and how it has moved from 2020-2021. Our first stop in determining the movement of the price or the price action. This currency index has been on a downtrend since April 2020, then rose intermittently between mid-September and mid-October 2020 and continued the downward price movement until January 2021. So, the market direction in the first part of 2020 was bearish or downward. 

Price Swings identification

Price Swings identification

Prior price movements

Next, we have identified the price swings, which are a mixture of reversals and pullbacks as the currency index looked for stability. The price swings have been marked (repeatedly) 1, 2, 3, 4, and 5, denoting the wave pattern they form as the index moves across the chart. For example, number 2 (the first top part) shows a reversal from the downtrend, while number 3 shows a pullback back to the downtrend. As you follow the chart, you will notice that the price keeps dropping every time the swing takes place.

The market takes a certain trend after the swing process is repeated in a particular time frame. You will notice that the index price in March 2020 was 104.00. It fell to 89.00 at the beginning of 2021.

At some point, the market is exhausted, and instead of trading downwards, it begins to take a horizontal or range momentum.

Trading range identification

Trading range identification

The swings now do not expand in a downward fashion, but it seems they are gaining upward momentum. This identification is very important to the trader as it will enable him or her to avoid (for the moment) a short sell position. We must also remember that this analysis only considers the movement of the price, and no technical indicators such as the moving averages have been employed.

The trader will notice that the swings are constantly breaking out with new support levels as the price moves upwards. The trader will have to trade long as opposed to short.

The volume of the price bars

Wider candlesticks indicate higher trading volume. Narrow candlesticks dictate low-volume days. The red volume bars show low-prices while green bars show higher prices or a bullish trend. Before 2021, the volume of the candlesticks was highest among red bars.

Buy and Selling Points of the DXY

Buy and Selling Points of the DXY

A look at the volume of the bars helps you to know where to get in and out of the trade. Remember that strategic trading implies reducing losses and maximizing gains. Therefore, I have put the stop loss at the primary breakout point. The idea behind using the price action and volume bars is that it helps the trader enter the trade earlier than others. When the price hits 89.499, the reversing candles become stronger or higher in volume as compared to the bearish candles.

The first buy option has been placed above the 90.027 marks upon confirming the first bullish trend. As the trader, you will need to spot a market weakness or where the market is failing to sustain its trend. In our case, the bearish trend has not been sustained after March 1, 2021. In terms of the fundamental outlook, the trader will notice that the upsurge was a result of stronger market-related news such as the passage of Biden’s stimulus plan. But a look at the price action alone will help to solidify out long options in the current security.

As a trader, you will notice that the volume of the preceding trend changes as the price or the market direction changes. There are only three red bars in the first breakout signal, with the middle having a slightly higher volume. The trader should wait until the number of bars, as well as the volume, increases to sell or short the stock. If the volume of the red bar is higher than the preceding green, then that is a good opportunity to prepare to short or sell. If the green bar has a higher volume than the preceding red bar, a buy option should be initiated. Understanding the candlestick footprint is an important step in analyzing the price action.

Conclusion

Price action analysis entails following up on the movement of a stock’s price in a trading chart. The trader should understand the market direction to decipher the trend of the stock. Understanding the price action does not necessarily involve using technical indicators like moving averages. These indicators are essential, but a look at the price action alone can guide trade in real-time. Further, volume analysis is key in determining the trading strategy.