Price action is drawn from technical analysis. There are many traders who love trading using this strategy. Yet, as it's the case with all other kinds of strategies, for some traders it works and for the majority it just doesn't.
This creates a debate among traders over the efficiency of price action.
On top of that, after I searched the internet, I didn't find not one place where information about this subject is centralized in an easy to digest format.
So, today, we will try to remedy that by answering the question: Does price action actually work?
First things are first. Let's start by defining what we are working with here.
What is Price action trading?
In technical analysis, price action trading is a style of trading that doesn't account for any fundamentals. It looks directly to price fluctuations to identify patterns. In other words, it tries to project human thought processes and emotions onto price charts. This is why it relies heavily on historical data.
To read price changes, or action, traders prefer to use candlestick or bar charts in their most naked form: Without any indicators.
But why is that? You might ask. Aren't indicators just another way of interpreting market data, so that it can provide us with some insights?
Yes, indicators are most certainly a valid way of reading the market. I have provided an explanation of how to use indicators to maximize profit in one of my earlier articles. However, price action trading takes a totally different direction. Because it operates based on 3 key principles:
- All indicators are, by nature, lagging interpretations of the market.
- All the information needed to read price fluctuations is already integrated in the price itself.
- The action of the price is, itself, the most reliable and accurate indicator.
Moreover, price action trading bases its logic on the assumption that price movements reflect the balance between supply and demand. Which makes it a perfectly suitable strategy for cryptocurrency trading.
This is due to the fact that cryptocurrencies are strongly influenced by this balance. As it is the case with stocks and metals, too.
It's like a marriage made in heaven. Isn't it?
But wait! Is the fact that a strategy is compatible with the law that governs a certain market enough to confirm its credibility?
It would be reckless to believe so. One superficial argument should never be enough. Therefore, let's dive deeper to substantiate the claims to the performance of price action trading.
Does price action actually work?
When it comes to testing the performance of technical analysis strategies, nothing is more trustworthy than statistical evidence. Nevertheless, there's a scarcity of scientific papers in this field. Especially when it’s about proving the efficiency of price action.
Luckily, there are some research papers that tackled this subject. Most prominently, a paper that was accepted June 1998. Titled "The predictive power of price patterns", by G. Caginalp and H. Laurent from the mathematics department of the university of Pittsburgh. Which was the first scientific test that has presented statistical evidence of the validity of price patterns.
The main subject of their research was candlestick patterns. Mainly, the Three White Soldiers, the Three Black Crows, the Three Inside Up, the Three Inside Down, the Three Outside Up, the Three Outside Down, the Morning Star and the Evening Star.
When tested on different assets, the candlestick patterns produced, on average, results that are higher than 50% win-rate. Where the win-rate is defined, for the sake of simplification, as the number of winning trades compared to the number of all trades performed. Denoting the fact that price action trading does provide a strong edge over the market.
Over a one-year holding period, the strategies were significantly profitable in terms of return on investment. For instance, the buy signal yielded three times the amount of the initial investment. More importantly, these results were statistically significant. Which means that there is a high probability that they are not due to chance.
Consequently, this proves that traders are, indeed, influenced by price behavior. In addition to that, traders can use candlestick patterns as an indication of the positions of other traders.
It's also important to note that the patterns that were the subject of study are only a few of dozens of other patterns a technical analyst might use. They can be tweaked or combined to draw a more accurate picture of the market.
How many traders use price action?
Price action trading is difficult to apply. It requires spending a substantial amount of time learning under live market conditions. However, does this make it any less appealing?
To answer this question, I proposed an opinion poll on Reddit. I asked traders about their preferred way of trading. The proposed answers to choose from were price action, indicators, fundamental analysis, a combination of methods and none of the above.
Among 1,406 participants, 613 chose a combination of methods, 406 voted price action, 115 prefer to use indicators, 109 like to use fundamental analysis and 163 traders don't utilize any of these methods.
So, 28.9% of the participants use price action and 43.6% of traders incorporate it as part of their approach to trading. Meaning that, approximately, 72.5% of all the people who voted consider that price action trading is a viable and profitable way of trading.
That's a considerable percentage.
If we consider this sample as representative of the general population, we can conclude that, despite its difficulty, price action trading is the most popular way of trading.
How many traders use price action SUCCESSFULLY?
No matter what asset you're trading, you'll always find a sharp contrast between the portion of traders that can make it in the market and those who can't.
According to the general consensus, only 10% of traders are consistently profitable. But after doing some research going over different brokers' regulatory disclosures, I found out that this percentage can go up to 25%.
If we make an educated guess here, we can say that 72.5% of the 25% of traders who are successful utilize price action in their trading. Therefore, around 18% of price action traders are consistently profitable.
Moreover, there are individual examples. For instance, there's Gary S. Wagner, a trader who relies heavily on candlestick patterns in his trading. He has been trading the markets since the 1980s.
There's Nial Fuller, an Australian trader, investor and entrepreneur. His total net worth is estimated to be $7.5 million as of April 2021. Kim Krompass, an extreme price action trader who targets profits of only 8 to 12 pips per trade over a great number of trades. Her controversial method permitted her to maximize the application of the price action method.
There's also Chris Lori. A Canadian bobsled driver and a successful technical trader who uses price action strategies in combination with other methods. According to Forbes and Business Insider, his net worth is approximately $1.5 million.
And the list goes on.
Conclusion
In conclusion, we can derive three main points:
- There's statistical evidence of the validity and the profitability of candlestick patterns.
- Price action trading is popular between all traders.
- Many successful traders apply price action strategies.
The fact that these statements are viable in different markets is not an argument against their compatibility with cryptocurrency trading. Not at all. Basically, price action trading can be applied on any asset, as long as you have access to enough historical data.
As stated in the beginning of this article, cryptocurrencies are traded based on supply and demand. Traders make the market move while being a part of it. Everyone is trading and, by that same act, everyone is making the price behave a certain way. This generates price patterns. Making crypto-assets very well suited for the application of price action techniques.
Article originally published on my official blog: Obsessive Cryptocurrency Disorder
Disclaimer: The information provided in this article is not to be taken as financial advice. It is to help you do your own research. At the end of the day, you're the only one responsible for your own trading decisions. Trade safely!
