Last updated on April 14th, 2020
If you’ve ever seen the movie “Trading Places”, you’ve seen how crazy it can be trading in the pits. A lot of yelling, screaming, and hand gestures with everyone trying to get the price they’ve been waiting for.
The modern trader of today uses trading charts to monitor price but what did the pit traders use?
Maybe they looked at charts before/after the pit session but they had simple items during the trading frenzy:
- Stats on various products they were interested in
- Eyes, ears, and their brain
The stats included prices of interest and they were location at a reaction at those prices.
But then what?
- What if there isn’t a reaction?
- What if the price action is not what was expected?
- What was the price action prior to the price of interest?
- What happens next?
You judge the market by the action it takes at prices that are of interest to you and make a decision on which side, buyers or sellers, are the stronger part of the equation.
This way, the market is really just moving from point to point making a series of decisions along the way.
The Four Stages Needed For A Trading Decision
Let’s assume you have a way to reliably work out prices which may hold some interest to the market in the future. This is only part of the picture as levels are there to be broken otherwise we’d be eternally range bound.
So then you need to define the other aspects mentioned in the points above in order to work out where the balance lies.
What’s is the reaction of price?
1) The market bounces hard.
2) The market hugs the level or area
3) The market breaks through and accelerates
4) The market seems to ignore the level with little to no initial reaction
Is The Price An Important Level For You?
1) It’s a very important price
2) It’s not a very important price
What Was The Price Action Before The Level Was Hit?
1) It’s been ranging one way then the other
2) It’s been trending in one direction all day
3) It’s already rejected a level strongly on the other side of the range
4) It’s already tested a level on the other side of the range and struggled to move away strongly
What Does Price Do Next?
See “What’s the reaction of price?” above for how the market reacts to the next level.
Using these simple ideas a trader can get a better picture about what’s going on and therefore what’s potentially likely to happen next.
However, interpreting the market this way isn’t a trading strategy as such but can be used in combination with a strategy in order to give a trader the confidence of their own convictions.
Price Action Analysis and Reactions
As an example, I’ve looked at some very simple price levels only chart the obvious swing extremes, the opposite extreme of large momentum style bars and the prior session’s high/low. I’m also noting previous days closing price (which is often retested) and the current session opening price (current session high/low would also be worth noting but I haven’t done so here as they weren’t retested).
With these simple levels added (and I can assure you I did not cherry pick them) we can take a look at some of the action from the early part of the day.
So what’s the use of this information?
We can see that very early in the session, the market was unsure of what to do. Several attempts to trade lower into previous days range (and possibly towards previous days RTH close) weren’t strong at all, but also the attempts to take out the 1451.50 level weren’t particularly strong either.
Then the market resolved this action by breaking higher fairly strongly, possibly validating the higher open.
In the face of the quickly rising market, sellers only just about overcame buyers at the 1457.00 level with it pushing slightly higher to 1457.75. They managed to overcome the buyers and this fact is important to note.
The market then drifted lower to retest the 51.50 level which did not hold as the test of the opening price was then more important. This held (again, more potential for validation of higher opening) and moved reasonably quickly up away from it.
What Is The Meaning Of Price Action Here?
Breaking this down, we can see that the low which tested the previous days high was not rejected with much conviction. If it were to be retested, it could be susceptible and a move towards the close is possible.
The high was made on “strongish” buying and sellers had a bit to do to reverse the market.
The “strongish” move up and subsequent retest and failure of the open suggest the higher open was valid and so there is a chance the highs will be retested at some point. Given that sellers had to work to hold it the first time around, any break higher could well see a decent continuation.
It’s also important to be aware that important economic news can bring in additional activity and significantly alter the current balance of trading activity.
Is It Worth The Hassle For Your Trading?
Recognizing how the market moves is important in order to gain that all important context and give yourself and your strategy a greater chance of success. When the market moves to extremes, decisions are made and depending on the way the market moves, what is likely to happen next might just become a little bit clearer.
The simple explanation is usually the best and trying to read too much into the price moves can cause analysis paralysis.