What is price action?
Price action for swing traders is the art of looking at individual candles to determine the probable direction of a stock - without using any technical indicators.
Ultimately, analyzing price action tells you who is in control of a stock. It also tells you who is losing control: the buyers or the sellers. Once you are able to determine this, you can pinpoint reversals in a stock and make money.
Learn the price action tips on this page and I guarantee you that you will be a better swing trader.
Let's begin.
Tip #1. Identify support and resistance levels
This is a no brainer. Identifying support and resistance levels is one of the first things you learn in technical analysis. It is the most important aspect of chart reading. But, how many traders really pay attention to it? Not many. Most are too busy looking at Stochastics, MACD, and other nonsense.
Some traders think that a support or resistance level is a specific price. Wrong. It's an area on a stock chart. Let me give you an example.
The areas that I have highlighted are the correct support and resistance levels. Often times you will hear traders say something like this: "The support level for XYZ stock is $28.76." This is wrong. It's an area - not a specific price.
Tip #2. Analyze swing points
Swing points (some call them "pivot points") are those areas on a stock chart where important short term reversals take place. But not all swing points are created equal. If fact, your decision to buy a pullback will depend upon the prior swing point. Here is an example:
Look at the area that I have highlighted in green. You may have considered buying this pullback. Now look at the prior swing point high (yellow highlighted). There are two problems with buying this pullback. First, there isn't much room to work with! The distance between the pullback and the prior high is too small. You need more room to run so that you can at least get your stop to break even.
The second problem is this: The prior high (yellow area) is composed of a cluster of candles. This is a strong resistance area! So, it will be very difficult for a stock to break through this area. Instead, look to trade pullbacks where the prior high is only composed of one or two candles.
Tip #3. Look for wide range candles
Wide range candles mark important changes in sentiment on every chart - in every time frame. They mark important turning points and can often be used to identify reversals. Take a look at the following stock chart:
This stock was moving lower in October (highlighted) and then suddenly it dropped more significantly than on previous days. This created the wide range candle and it marked an important turning point (actually the bottom!).
You can also use wide range candles to identify when a stock might reverse. Looking at the same chart...
This stock reversed inside of prior wide range candles. Why would a stock do this? Because all of the traders that missed out on "the big move" now have a second chance to get in. This buying pressure causes the reversal. Simple, huh?
Tip #4. Narrow range candles lead to explosive moves
Narrow range candles can also tell you that a reversal is imminent. This low volatility environment can lead to explosive moves.
Narrow range candles tell you that the previous momentum has slowed down. Buyers and sellers are in equilibrium but eventually one of them will take control of the stock!
Tip #5. Find rejected price levels
On candlestick charts, lower or upper shadows on candles usually means that there is a hammer candlestick pattern or a shooting star candlestick pattern (if the shadow is long enough). Regardless of the name, these shadows mean one thing: A price level has been rejected.
Imagine what this hammer candle looked like during the day (before it became a hammer). It was really bearish! But, at some point during the day, the bulls rejected the lower price level. I can imagine the bulls saying, "Hey wait a just a second. You bears have taken this too far. This stock is worth much more than the price that you moved it to."
And the buying begins.
Tip #6. Learn the 50% rule
How can you tell if a candle is significant? Easy. Look to see how far it has moved into the prior days range. If it moves at least 50% into the prior days range, then it is significant. And, it is especially significant if it closes at least 50% into the prior days range. This usually shows up on the stock chart as a piercing candlestick pattern or an engulfing candlestick pattern.
Here is an example:
All of the important reversals in this stock happened only after a candle moved at least 50% into the prior days range (some moved much more than 50%).
This concept is so powerful that I am suspicious of buying any pullback unless it moves at least 50% into the prior days range.
Tip #7. The gap and trap price pattern
All gaps are important "tells" on any stock chart. But, there is one type of gap that is especially important when analyzing price action (and pinpointing reversals). This is called a gap and trap. This is a stock that gaps down at the open but then closes the day above the opening price. It is easier to see this on a chart...
You can probably see what is happening here. The stock gaps down at the open. Everyone thinks this stock is going to tank. But it doesn't! Buyers come in and move this stock right back up. You can look at one of these candles and almost see all of the confused faces on other stock traders!
Tip #8. Measure the depth of a swing
How far does a stock move into the prior swing? More than halfway or less? The answer to these questions are important because it can determine the future direction of the stock. Let me give you an example:
The price action moved about halfway down (arrow) into the prior swing (dotted line). This is good. If it retraced more than that, you may want to question the validity of the move. This is because a stock in a strong trend should not retrace more than halfway into a prior swing. It should encounter buying pressure sooner than the half way mark. And many times stocks will reverse right at the halfway mark.
Tip #9. Consecutive up days and consecutive down days
Stocks will reverse direction after consecutive up days or down days. So, it pays to keep this in mind when you are looking to buy or short a stock. Here is an example:
You should always look to short a stock after consecutive up days. And, you should look to buy a stock after consecutive down days. This is counter intuitive for new traders because they tend to associate a stock going down as "bad" (meaning sell) and a stock going up as "good" (meaning buy). In fact, it is just the opposite!
Tip #10. Location of price in a trend
You have heard the saying, "The trend is your friend." I say, "The beginning of a trend is your friend!" That is because some of the best moves occur at the very beginning of a trend...
This stock broke out (horizontal line) from a double bottom (circled). A new trend has begun. So, you want to buy this stock on the first pullback (arrow) after the breakout.
So, there you have it. These price action tips and tricks will make you money in the stock market.
You can use this information to make your own trading strategies and systems. Best of all, once you master this art, you will never have to rely on technical indicators again to make trading decisions.
They won't be necessary.
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