Day Trading Price Action Strategy — What Is It? (Backtest)

Last Updated on January 15, 2023

Day trading is becoming popular among retail traders in many markets. Many new retail traders want to try out a day trading price action strategy. What is it, and how can you be successful?

A day trading price action strategy refers to the pattern of price movement of an asset. Thus, a price action strategy is using patterns of price movements to determine when to enter and exit a trade.

The strategy can be used in different trading styles, including day trading, where the trader looks for such patterns on the intraday price charts.

In this post, we take a look at price action and we give some advice on backtesting price action trading strategies.

What is price action?

In technical analysis, price action literarily means the action of price. It refers to the patterns created by price movements. The analysis of the basic movements of the price, to use the patterns to generate signals of entry and exit in trades, is known as price action trading.

Price action analysis is a form of technical analysis since it looks primarily at the history of an asset’s price movement and ignores the fundamental factors of the asset. A day trading price action strategy can be based on both discretionary and quantitative/data-driven strategies (we’ll return to that later in the article).

What differentiates price action from other forms of technical analysis (with indicators) is that it focuses on price movements alone, with little or no input from indicators. It studies price swing highs and swing lows, as well as the characteristics of the individual price bars, trying to use it to explain the market sentiment and behaviors of market participants. That is, it incorporates the behavioral analysis of market participants as a crowd from evidence displayed in price movements.

At the macro level, price action traders observe the broad price structure — whether it is trending or range-bound — using trend lines, moving averages, and support and resistance levels. They look for chart patterns that may reveal how the price might move next. They may further look at the individual price bars, observing their size, shape, and development during the price sessions they represent.

Patterns traders look out for in price action trading

In price action analysis, traders look out for two kinds of patterns:

  • Chart patterns
  • Candlestick patterns

Chart patterns

These are recognizable structures on the price chart formed by a series of price swing highs and lows. Chart patterns often have the shape of physical objects, and they are named after whatever object they resemble. These patterns can be classified into the following:

Reversal chart patterns

These are chart patterns that form after a prolonged price movement in one direction. They can be seen in an uptrend or a downtrend and indicate a potential reversal of the existing trend. An example of a reversal pattern is the head and shoulders pattern that forms at the end of an uptrend, indicating a potential reversal to a downtrend. The inverse head and shoulders pattern forms at the end of a downtrend and indicates a potential reversal to an uptrend. Other examples include:

Continuation chart patterns

There are chart patterns that indicate a potential continuation of the existing trend. Examples include:

Harmonic patterns

These are advanced chart patterns that are formed by four consecutive price swings with unique configurations. They include:

Candlestick patterns

These refer to patterns formed by the shape of an individual candlestick or a group of candlesticks. Since a candlestick shows how the price moved during a given trading session, candlestick patterns may indicate market sentiment during the trading session. Examples of candlestick patterns include:

We made all candlesticks into trading rules and we backtested and ranked all candlestick patterns.

Is price action good for day trading?

Reasonably high levels of price activity are necessary for day trading. Day traders love to see volatility in the market.

The best strategies can be found in our….

Strategy Shop

Backtested trading strategies

However, in terms of price action as a form of strategy, it depends on individual traders. While some traders may prefer using price action analysis to spot their trade entry and exit, others may like to use technical trading indicators for that. Some day traders even trade based on news releases — trading the opportunity created by the increased volatility that follows a news release is their own strategy.

Price action indicators and tools

Pure price action traders don’t usually use trading indicators. They analyze the price swings and candlestick patterns to determine when to make a trade and close the trade. This category of traders may only use tools like trend lines to indicate the trend direction and support/resistance levels and pivot levels to mark important price levels.

Some other traders may combine price action analysis with indicators analysis. The indicator commonly used is the moving average to indicate the trend and provide dynamic support/resistance levels. Some traders also use the VIX indicator to gauge the market volatility when trading, while some use the RSI indicator to track the price momentum of price swings, especially as regards impulse waves and pullbacks.

Best price action strategy

It is hard to tell which is the best price action strategy. You need to backtest each price action strategy you create to know how well they performed in the past. But the problem is that price action patterns and strategies are difficult to code, so backtesting them won’t be easy.

Manual backtesting may not be an option because of cognitive trading biases. If you can find a way to code your price action strategies and backtest them, you would be able to know the strategies that work best for a given market.

Price action strategy rules

There are no general rules. It depends on each strategy and the market you want to trade. What works in one market may not work in another. The most important thing is to ensure the strategy is quantified through backtesting. It’s from backtesting and strategy optimization that you arrive at the definitive trading rules of your strategy.

One more thing: it is always a good idea to use different strategies and trade different markets to achieve diversification, which can help minimize risks in changing market conditions.

Day trading price action strategy backtest – does it work?

As mentioned above, it’s both challenging and time-consuming to make a price action strategy into specific trading rules and settings. A day trading strategy is normally more complex to backtest than a strategy based on daily data.

However, as an example, we’ll show you a strategy that we originally backtested on daily data and turn it into a potential day trading strategy:

We believe the trading rules are pretty straightforward: we want to enter a position after a series of lower lows and lower highs in a row. How many? In this backtest, we use three lower lows and three lower highs. We use hourly bars. Let’s list the trading rules:

  • We use hourly bars.
  • We enter at the close when the bar is the third lower low and third lower high in a row.
  • We enter a position only at 1030 local NY time.
  • We sell at the close of 1600 NY time.

We backtest the WTI crude oil futures contract that is traded on NYMEX. The equity curve looks like this (2000-2021):

Day trading price action strategy

As you can see, the historical performance is not good. We would be better off if we flipped the strategy and instead shorted: the average gain per trade is a negative 0.11%, and the win rate is 47.

Our strategy ends in July 2021. Let’s check the out-of-sample backtest on unknown data:

Day trading price action strategy backtest

There are only 21 trades but the average is 0.57%. After all these years, it seems like our strategy started working in 2021!

Day trading price action strategy – conclusion

Trading statistics and metrics give you a pretty clear indication of a day trading strategy’s potential. If you can’t backtest it, then why trade it? Why would you trade a strategy you have no idea if it’s working or not?

We suspect that most traders, especially price action day traders, have no idea if they have a long-term positive expectancy. To our knowledge, almost all price action traders use anecdotal charts to “prove” their strategies. But most of these traders are fooling themselves. What looks so obvious in hindsight and after the fact is far from evident. Almost all price action is random, and we can even make a profitable random walk trading strategy that presumably looks pretty good.

Of course, even data-driven strategies can look good even though they are based on randomness. But a backtest is just half the job. An out-of-sample test and/or incubation period will mainly remove the random strategies like a weed.

To sum up, any day trading price action strategy should be backtested. Backtesting is one of the five steps that can instantly improve your trading.

List of trading strategies

Since we started this blog in 2012, we have written many trading strategies that you can read for free, please see our complete list of trading strategies that work. The strategies are an excellent resource to help you get some trading ideas.

We have compiled the Amibroker code and logic in plain English for all these strategies (plain English is for Python trading). If you subscribe, you’ll get the code for the latter strategy (plus over 150 other ideas).

For a list of the strategies we have made please click on the green banner:

These strategies must not be misunderstood for the premium strategies that we charge a fee for:

FAQ day trading price action strategy

Let’s end the article with a few frequently asked questions:

What is price action trading?

Price action trading is a method of technical analysis that focuses solely on past prices plotted on a chart to identify trading opportunities. It does not rely on any indicators or automated trading systems and is based on the premise that past prices influence future prices.

How do I use price action in day trading?

Price action trading can be used in day trading by looking for patterns, trends, and other signals from the charts. These signals can be used to make decisions about when to enter or exit a trade, as well as identify areas of support or resistance. Traders can also use price action to identify potential turning points in the market or predict reversals.

What are some strategies for price action day trading?

Price action day trading strategies include trend following, breakouts, reversal trades, and scalping. Trend following involves looking for established trends and entering trades in the direction of the trend. Breakouts involve looking for areas of support or resistance and entering trades when the price breaks through these levels.

Reversal trades involve looking for momentum reversals and entering trades when the momentum is turning. Scalping involves taking quick profits on small price movements.

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