Last updated on May 12th, 2020
Price action. I’ll admit that if a trader is having trading issues, I will usually ask them about their experience with trading price action and if they are applying that skill to their trading strategy.
The problem is, we have to remember that understanding price action trading will not fix all issues. It may not fix any issues.
There are a few cogs to the trading wheel and your level of success in trading is limited to the extent you fully understand:
- Risk management
- Trading psychology
- Trading method
One of the biggest problems facing traders is self-created – it’s the tendency to focus efforts on a sole area of expertise within trading. This could be any one of the three cogs just mentioned.
But whilst mastering one of these is likely to be very useful, each one on its own is just one of the cogs in the trading machine.
In the same way price action ISN’T the Holy Grail and won’t fix every issue a trader will have.
“In a narrow market, when prices are not getting anywhere to speak of but move within a narrow range, there is no sense in trying to anticipate what the next big movement is going to be. The thing to do is to watch the market, read the tape to determine the limits of the get nowhere prices, and make up your mind that you will not take an interest until the prices breaks through the limit in either direction.“ Jesse Livermore
Why Price Action Won’t Always Help Your Trading
Let’s look at the 5 reasons that will help you see that while price action is important, it won’t fix every trading problem you have.
1. What’s the trading Holy Grail anyway?
The trading Holy Grail if it existed, would be a system, strategy or method that always produces results no matter what.
- It’d be easy to interpret.
- It’d be easy to implement.
- It’d be easy to make money with.
- It’d work effectively across all types of markets and all types of market conditions.
- It’d be great for small and large accounts alike.
Now of course, there are things that might be viewed by some as coming close, but I can’t say that I’ve come across something which meets all the above criteria and is foolproof. If you presented a group of people with a great strategy and all that they needed to be successful, most of them would still struggle to make it work without any guidance.
The trading Holy Grail doesn’t exist.
The Turtle Traders were all taught the same method and all had different results. If the trading strategy was all that it took for success, those results would have been almost identical across the board.
2. Happens all the time
Price action is happening all the time and the thing is, it’s happening in all places too – not just the places that might be relevant to you. So if you focus solely on price action, you’ll end up taking in a great deal of what some call noise. This can lead you to taking less than optimal trades at less than optimal prices and times.
Can you see the difference between watching price action at a major support or resistance level as opposed to in the middle of consolidation? What about at the end of an abcd pattern or at a pivot point as opposed to a candlestick in a trend?
On its own, price action can convince you of your feelings about direction, but it’s just not enough for consistently profitable trading. And just like any other form of technical analysis, it doesn’t tell you what will happen, just what might happen.
Having an idea of what might happen in a market and then reacting to the event in accordance with a tested trading plan – is the basis for some great trading.
3. It can make you short-sighted
Aligning yourself with a higher time frame participant is always beneficial. It’s something which traders strive to do even to the extent where people develop specialized approaches for “detecting” them.
Higher time frame participants are generally much larger and tend to initiate directional movement in the markets – get on the right side of this and clearly there’s going to be the opportunity to make some money.
The problem with price action is that it has the potential to draw you in to a smaller and smaller time frame. This is an approach that traders will take to get a more intricate look at what is happening on a chart. The question you may want to ask yourself is if it really adds to the trading outcome in a positive way.
But whichever time frame you’re viewing the market in, it’s very difficult to look outside (and over a bigger time frame) of this. This is because price action can change relatively quickly and you won’t want to miss anything.
But if you’re not careful, you’ll miss what the higher time frame participants are doing.
4. Getting sucked in
Getting sucked into the market when there’s no real reason to trade is one of the biggest plights of the day trader and price action can easily do this to you if you’re dependent on it alone.
Seeing markets that are moving quickly and maybe look like they’re about to present a great opportunity, even if you’re following price action rules, can get you to take some pretty dangerous trades.
Think of when there’s higher volatility than normal:
- Can you justify the increased size of stop you need to let a trade play out?
- Do you have the ability to balance the added risk by reducing size?
- Are you actually doing this?
It’s vital that the overall context and all the cogs of the trading wheel are part of your trading approach. I bet you never thought of a larger than normal stop in times of greater volatility and how that will affect:
- Whether you take the trade in accordance with your trading system
- Your decision making process as you see the large move that you are missing out on
- The level of exposure that your trading account can take especially if you go into draw down
5. Doesn’t help you with trade execution and management
Whatever the price action is telling you is more likely to happen, it doesn’t necessarily help a trader to manage a position effectively.
Money management can be supported by price action changing the unfolding picture, but the fact is that a big part of adjusting a position’s target and stop orders, rightly or wrongly, comes down to how far price moves relative to the position itself.
Think about the case of a trailing stop as an example. The stop can be hit without price action dictating that a change has even occurred.
Moreover, what price action doesn’t do (and perhaps for some, will do the opposite) is help a trader remain calm and follow their trading plan. Sticking to your game plan can be the difference between making a success of trading and not.
Price Action Still Has Merit
All of this said, although price action isn’t the Holy Grail, price action IS a very important piece of the puzzle if you’re using it as part of a holistic approach. Understanding it with context and an understanding of what markets tend to react to in terms of price, can give you a much better idea of the relative short-term direction a market is likely to move in.
Even with this, you still need to have a solid plan, a good strategy, trade management techniques, manage your emotions – fulfill every cog in that trading wheel.