Price Action Analysis for Day Trading



In current days of coronavirus threat and extreme volatility in markets, it's risky for a conservative trader to enter with long positions, even in the short-term. With the SP500 now in a rebound (only due to portfolio rebalancings of investment funds and smart-money short-covering, not fresh money), the key is to see how the SPX will behave when it approaches the 50% of its Fibonacci retracement if it does. Historically in all crashes the Dow Jones (or SP500) have two minimums, the second even lower than the first. And with a world recession in the background, it is more than likely that this will happen in the next weeks.

Therefore, since the end of February, I closed my entire long portfolio and have no long positions when the daily session closes. In March the same: zero longs. I mean, I only do day trades on Index ETFs as SPY, QQQ and IWM. That's my "coronavirus strategy" in days of VIX above 50: preserve cash and do only day trades, closing the trade before the session ends to avoid morning gaps. Management risk at its highs.


The Price Action Analysis


Price Action or the movement of a security's price plotted over time, is the basis for all technical analysis of a stock. Basically, it is the discipline of making all of your trading decisions from a stripped down or “naked” price chart. With Price Action Analysis you can determine, at a glance, the underlying directional bias of the market: trending or no-trending (consolidating), just checking the presence of higher-highs and higher-lows for an uptrend, or lower-highs and lower-lows for downtrends. The absence of them means the stock price is consolidating, usually between support and resistance levels.

Price Action Analysis also improves your ability to spot and interpret trends, candlesticks, breakouts, and reversals, through the support and resistance levels.  And teach you an important lesson: never use signals of any technical indicators for an entry trade. Only use them to support what we already established by its analysis.  

Consider these three principles for a nice Price Action Analysis, for a day trading strategy:

1.  Find accurate support/resistance levels of the stock and identify clearly the short-term trend.
2. "Read" single candlesticks at a glance, and also the patterns it forms, mainly when price approaches an S-R level. Do always in conjunction with volume.
3.  Maintain clean your chart. Less is more. 

Let`s detail them.






1. The key: choose accurate Support and Resistance levels


My recommendation for doing intraday trades is to use Price Action Analysis, on a 1-minute chart for scalping, or 5-min for day trading. In any case, my week's main support and resistance levels were drawn in the 1-hour chart for a better view (forex traders use 4-hour charts, a good alternative). Remember we are day-trading, no need more greater timeframes.

To identify the trend, the exponential EMA50 is a good alternative in the 1-hour timeframe. It works simply: if the stock price is above the EMA50 for an extended period of time, it's good, it's in a healthy uptrend. If it's below, the stock is doing bad, showing weakness. It also can act as a form of support/resistance. And finally, the price crossing the EMA50 means a possible trend change.

Just for information, some lines for an excellent alternative for identify S/R levels and trends: the Range Bars, describe in an early post, due to its great property of filtering noise and exploit volatility (when it is high, more bars are printed), as you see in the SPY Range Bars chart, below.


Correction: Support 1 is at $250, Support 2 (at $240) is shown wrongly as Support 1.


The support and resistance horizontal lines shown (in yellow) are my main levels, lines that come from my 1-hour chart. Notice the green line that represents a powerful Fibonacci Retracement 23.6%. That was taken from SPY daily chart, and that pattern was drawing from its February highs to March lows. It is critical for the SP500 to overcome it and go towards the 50% line, its next resistance for the short-term.

Range Bars, work fine with the Ichimoku indicator, also shown in the chart, useful here only to determine the stock trend. It's critical to know the market bias before place any trade, and Ichimoku is one of the best trend indicators due to its different accurate signals it brings. Notice that on April 2nd. the price is moving inside the cloud, signaling an ambiguous trend for the session. Also is shown the accurate Awesome Oscillator, describe in a recent post, but with no practical use in Price Action analysis.




2. Understand single candlesticks and their patterns


In Price Action you need to "read" each candlestick at a glance and what it means (indecision, rejection, reversal, momentum). Into the one-candle ones you have the bullish Hammer, which represents the bottom of a trend, and its opposite, and the bearish Shooting Star, the end of an uptrend. Both need heavy volume and price action confirmation.

The bullish and bearish engulfing is one of my favorites. It involves two candlesticks and reveals trend changes, but you need to verify the subsequent price action to confirm the reversal.

And the Morning and Evening Stars, both three-candle patterns that signal the end of downtrend and uptrends respectively. Set up your system with these patterns and forget Doji and the many other candlestick patterns for an intraday chart.

On the other hand, price patterns are known by all traders: keep an eye in up or down trendlines, channels, triangles, wedges, head & shoulders, cup & handle, and double top/bottom, all well described in technical sites as StockCharts or Incredible Charts.

Finally, consider the two following ideas during your price action analysis:

- Consider that price is never "too high" or "too low". Just follow the trend and trust in your analysis with your tools (candlesticks and recognizable price patterns, supports and resistance lines, trendlines) to predict the next movements.
- When price breakouts a level, there are no pullbacks if the price moves with heavy momentum, shown by big candles.


3. Less is more: maintain a clean chart


Use a few technical indicators when you use price action in an intraday analysis. A trend and an oscillator, are enough. And for entry/exit levels, use the Pivot Points and the Volume Profile, this last to be developed in a future post

- Consider the popular VWAP, detail in a recent post, as a trend indicator. Hugely follow by traders and smart money, give nice signals in strong uptrends.

- The Relative Strength Index RSI is the most simple and popular oscillator. Ranges between 0 and 100, and its reading over 70 indicates an overbought situation, and below 30 an oversold situation. Traders use the peak RSI as a buy or sell signal, others wait for a crossover above or below the 70 or 30 levels to open a buy or sell. Especially useful are its divergences with the underlying price.

- In a different category, and also recommended, is the static Pivot Points. It's a popular support-resistance tool that averages high, low, and closing prices from the previous trading day or week. Support and resistance lines (S1, S2, S3, R1, R2, R3) are projected based on the pivot point calculation. A price moving above the pivot point is a bullish signal, below is bearish. And its S-R lines could be used as a reversal or confirmation trend level, which depends on price action and your trading plan. The ideal is set it for both day (gray) and week (purple) calculation.





4. Finally, use these considerations in your day trade




During the intraday session of the SPY, shown in the 1-minute chart above, we can find several opportunities for scalping, all of them based on the price action of this Index ETF.

As you notice, I draw color horizontal lines to distinguish my levels: daily Pivot Points PPD and its sub-lines R1 and R2 (in gray) remain static only the current session, while weekly Pivot Points PPW and its sub-line R1 also, but for all the sessions of the current week. As they are hugely popular among traders, their levels are well respected and the price usually expected to pause there due to the concentration of demand or supply. The yellow horizontal lines are the same Support 1 and Resistance 1 and 2, taken from the previous SPY 1-hour chart, representing major levels in which price did reversals in recent sessions.

The trend indicators VWAP (in brown) and EMA50 (in light blue) also are drawn, and the oscillator RSI helps only to review at a glance the overbought or oversold state of the price, not for any trading signal.

The grey circle (or ellipse) 1 shows the first trade opportunity: price breaks the yellow downtrend line and overcome its VWAP (and also EMA50). A buy signal there. Then price rises, testing levels and overcoming easily two resistances (Support 1 and PPD) thanks to momentum candles that show bull's commitment with the move. The next resistance PPW seems difficult to exceed, and the price starts ranging with short candles between the predefined levels (circle 2), squeezing for a next breakout. A cautious trader closes its position at the PPW level for a decent gain.

The circle 3 is similar to 1: price breaks a downtrend line with a big candle that signal bullish momentum, good for entry. Then price enters in a fighting area between bulls and bears, which ends when overcomes VWAP, EMA50, Support 1, and PPD, reinforcing the bullish bias, closing the day trade near the end of the session. In coronavirus days it's dangerous to maintain open any position due to extremely high volatility.

As you suppose, there are many interpretations of the same price action. Two traders usually don't match opinions: where one sees a trendline, the other one sees a head and shoulders, and so on. Just trust in your analysis and always compare the pros and cons before you decide a trade.