Here’s one thing about price action: it represents a collective human behavior or mass psychology.
Let me explain.
All human beings have evolved to respond to certain situations in certain ways. And you can see this happen in the trading world as well:
The way multitude of traders think and react form patterns… repetitive price patterns that one can see and then predict with a certain degree of accuracy where the market will most likely go once that particular pattern is formed.
For example, if you see a major resistance level, price hits the level and forms a ‘shooting star’ a bearish reversal candlestick pattern. You can then say with a greater degree of confidence that Price is going to head down.
Because there are so many trader watching that resistance level and they all know that price has been rejected from this level on a previous one or two occasions and that tells them that it is a resistance level and that they can also see that bearish reversal candlestick formation… and guess what they will be waiting to do?
- They will be waiting with their sell orders…not just one sell order but thousands of them, some small and some big orders.
- But on the other side of the coin is that trader that have bought at a low price and now that the price is heading up to the resistance level, that’s where most of their take profit levels are. So once they take their profits around resistance levels, that means there are now less buyers now and more sellers. The balance tips in the direction of the sellers and that’s how the price is pushed back down from a resistance level.
Because price action is a representation of mass psychology…the markets are moved by the activities of traders.
So price action trading is about understanding the psychology of the market using those patterns and making a profit as a result.
There are 2 types of price action trading, the 100% Pure price actiontrading and the not-so-pure price Action trading. Let me explain…
Pure Price Action Trading
Pure price action trading simply means 100% price action trading. No indicators except price action alone.
Not-So-Pure Price Action Trading
This is when price action trading is used with other indicators and these other indicators form part of the price action trading system. These indicators can be trend indicators like moving averages or oscillators like stochastic indicator and CCI. (Please don’t go googling CCI and stochastic indicators!)