You have probably heard of this technical analysis practice before and wondered why it’s so popular and traders using price action are so in love with this method of analyzing the market.
The truth is, once you have learned and become comfortable looking at the market with “price action glasses”, it would be hard to not wear those glasses every time you’re looking at a chart.
In this article, we’ll cover what price action is and hopefully, by the end, you will have a basic understanding of price action.
You can also read: Merkle Trees and Merkle Roots
The most useful definition for price action is also its most simple definition. So, what price action truly means? Price action means any change made on a chart of any time frame.
The smallest unit of change is called a “tick” which has a different value in every market and its value depends on the market.
Although tick can mean 2 things:
- The smallest unit of change in a market. Which is usually 1 cent.
- Tick is any trade that happens during the trading hours of the market. So any trade that takes place is a tick, even if the price of the security traded is the same as the last trade.
So the slightest possible change in price is called a tick and it’s different for every market.
There’s no universal definition for price action and this is because price action is a method in which you use every piece of information you can get your hands on to try to figure out the market’s trend.
In price action, each one of the candles tells us a story about market sentiment and could be used to figure out whether you should buy or sell. In other words:
Each candle could be a signal for a potentially great trade.
While price action is a modern technical analysis method and is relatively young, traders who use price action to write their trading strategy have been reporting how great price action is and how it could be more useful than other methods of analysis. While this could be true this doesn’t mean that price action is the perfect method for analysis and trading. Simply because there is no perfect, not in the financial market, or anywhere else.
Also, the act of analysis is a very subjective area, and thus it’s a zero-sum game, traders who made money get paid by the money lost by wrong traders.
Let us cover that in more detail in the next section.
Some expert traders will look at a chart and decide that it could be a great place to open a long position as the market won’t go down anymore, so they take a long position (a long position is a contract that will cause in your profit if the market goes up) with a firm belief that it would be impossible for the market price to go down even by 2 ticks.
While other expert traders will look at the same chart and will decide that it’s a very good opportunity to open a short position (a short position is a contract which will be profitable for you if the market goes down) believing that the market can’t go up even for a tick.
Both groups could look at the same chart and one group finds out a bullish pattern while the other group will find the bearish scenario more probable. A lot of things can affect their understanding of the trend, it could be because of fundamental reasons or some news they might have heard of when they were having breakfast or any other reason. The result is, one group will be right and the other group will be wrong.
If the buyers were wrong, when markets go then tick, then another tick, then another tick, they will eventually find out that they were wrong and it may be time to start selling and exiting their positions. Selling their positions will make new sellers out of old buyers and so their decision will cause the market to go down even more. And the sellers, either if they are new sellers or they were buyers who had to get out of their long position, will continue entering the market. At some point, new buyers will start entering the market. Buyers could be new buyers or sellers who are saving their profits or new sellers who are at loss now and have to cover their position. The market will continue to go up and the cycle will be repeated.
High-Frequency Trading (HFT) is very important for you to understand because most trades done on stocks, valuable metals, currencies, cryptocurrencies and ETFs (etc.) are calculated and carried out by companies that are trading with high frequency (HFT) using algorithms figured out by legendary traders.
Programmers who create these algorithms are professional mathematicians, physicists or programmers who are top-notch at their job and for their efforts, they’re able to make up to 1 million dollars a year.
Some algorithms open and close positions in a matter of seconds while other algorithms stay in a position for an hour or two.
Their goal is to trade and work based on statistics rather than how much profits they make in a trade. Even if a trade has a very small profit, if you make thousands of them every day, theoretically you should be able to maintain a certain amount of daily profit.
In October 2010, CBS reported that 70 percent of daily volume and more than 1 billion stocks are being traded daily by HFT companies.
These companies main goal is to use accurate and very fast algorithms which can make them money every day, they are spending thousands of dollars monthly to make sure their hardware is up to date and their algorithms are still profitable.