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What Is Price Action? Before I begin discussing various price action strategies, methods and tools for reading and trading price action, I must begin with a working definition of 'what is price action'. From this broad working definition of price action, I will then talk about how it relates to order flow and the relationship between price action and order flow. By explaining these basic premises which form the root of my approach to trading price action, I will be able to further explore price action trading in my follow up articles. A Broad Definition of Price Action The broadest working definition of price action would be to define it as 'Price's movement over time'. Unfortunately, this is vague by itself, so I will expand this definition by saying 'on any timeframe'. Technically, this means that on a tick chart, if the price of the AUD/USD moves from 1.1000 to 1.1001, this one pip adjustment in price is a working example of price action. So in its’ rawest form, price action = price's movements over time on any time frame. These various price fluctuations will look different based on what time compression (time frame) you are using when looking at price action on any instrument. What Is Order Flow? Order flow is a general term which refers to the transactions (buying or selling) that cause the price of an instrument to fluctuate. Any transaction, whether it be a market order, a buy limit order, buy stop order, etc., is an order or transaction. All of these transactions on a daily basis refer to the order flow in the market, or the flow of orders, so this is what I am referring to when I talk about order flow on a basic level. Price Action and Relationship to Order Flow The bottom line is price does not move unless there are transactions or orders in the market to buy/sell the pair at whatever price the institution or trader wants to. Thus, all price movements and price action are the result of order flow. It does not matter if a participant bought or sold the EUR/USD because of a fundamental event, such as Ben Bernanke telling the market he is keeping interest rates on hold till 2014. None of that is why price moves. Price moves simply because of the transactions that are executed in the market. Because of this - price action is really the offspring of order flow. Many things can affect price action and how it manifests, such as; -The total liquidity available in the market for that instrument -The total number of buying and selling orders executed in the market -The volume (size of the position) of each buying and selling order executed in the market But ultimately, when there is a balance between the buyers and sellers in terms of orders, the market will have no directional bias. This creates a range-bound environment for price action. However, when there is an imbalance in the order flow between the buyers and sellers, this will create a directional bias in the price action, and it is this balance or imbalance we should be learning to read in the price action because it will communicate to us the directional bias, along with where the institutional players are likely getting in and out of the market. Thus, trading price action is not about trading simple patterns, like pin bars, inside bars, and just responding to the pattern. That leaves you totally un-empowered because there will be times when trading pin bars are optimal, and where they will fail miserably. Your success as a trader to use price action patterns successfully will be in your ability to read the price action and understand what it is communicating. Just some basics of what can be gleaned from learning to read price action are; -Speed of buying and selling -When a trend is likely to continue or reverse -Key locations institutions are entering and exiting the market -Optimal places to put your entries, stops and limits -Whether your price action signal is likely to succeed or fail and more... Thus, it is critical to learn how to read the price action and order flow behind it.
