Price action, or trading with a naked chart, is the oldest form of technical analysis. It is said that the simple things in life are often the best. Well, the same principle applies to investing; a simple approach can often yield the same results as a sophisticated approach.
One of the dangers in today’s trading is that people use too many technical indicators to analyze a market and it can be a challenge to determine the right direction as there are too many factors to consider.
The notion of price action (also known as market geometry) is strongly connected with support and resistance levels. More precisely, investors use support and resistance levels from the past and project them on the right side of the chart.
Think of trendlines or areas where the price hesitates. Investors draw horizontal or dynamic levels on the right side of the screen with the expectation that the market will hesitate when reaching these levels.
There are two types of support and resistance:
- Horizontal, or “classic”; and
While the first one is easy to spot, as it forms against a horizontal area, the dynamic one is more powerful as it follows the price. Think of a trendline in a rising or falling channel. Effectively, it offers dynamic support or resistance to future price action.
Trading with a naked chart
As the purest form of technical analysis, trading with price action starts from a naked chart. In other words, a chart that has absolutely nothing on it, just like the one below:
This is the monthly EUR/USD chart. It may not tell you much, and many people will probably only see the ups and downs that the market made. However, a technical eye looks at the left side of the chart or at past prices, and projects levels onto the right side of the chart. The rule with support and resistance is that once broken, support becomes resistance, and vice versa: once broken, resistance becomes support.
Connecting the previous marginal lows on the EUR/USD pair and projecting the trendline further on the right side of the chart acts as a potential resistance if the price ever returns.
In the example above, the market returned and met resistance almost four years after the price broke the dynamic support given by the red line. The grey area shows a different kind of support and resistance: horizontal, or classic. For two years, the EUR/USD struggled and consolidated below this area which acted as resistance, and all investors had to do was to extend it to the right side of the screen. The price eventually broke higher, met the dynamic resistance, got rejected, and the horizontal resistance turned into support. It is no wonder that for the past two months the EUR/USD sits at the level, as the market is capped between a relatively tight range given the timeframe.
Investors knew about this ahead of time because they followed the price action, the purest form of technical analysis.
- Support and resistance can be classic or dynamic.
- Price action is the purest form of technical analysis.
- Once broken, support turns into resistance, and vice versa.
- Dynamic levels offer stronger support or resistance than classic levels.