Price action trading is a trading methodology that, as the name implies, is based on price action. Not surprisingly, as it is the case with many other things, this terminology has been abused and misused by many. Of course, this is a free country and everyone is allowed to define things the way he or she wants. However, in the case of price action trading, a moving average of closing prices, for example, is not price action but some derivative of it.
This is simply because most of the times, except by coincidence, the value of a moving average is not a traded price level. In other words, it is not part of price action. The same holds true for trendlines. These are straight lines of the general type: y = mx+c. On a price chart, x is the time coordinate and y is the price. Thus, a trendline is a function of time. Points on a trendline and especially levels never traded, do not reflect price action. This is one reason that projections of trendlines rarely work as support or resistance levels in the future. Those projections work only on hindsight and fool traders about future price action. As a result, backtesting systems based on trendlines and support and resistance levels, which are special cases of trend lines where the parameter m in the linear equation above is equal to zero, rarely produces positive expectancy results.
So what is price action trading?
Price action trading is a methodology that bases trading decisions only on realized price levels, current and historical. This type of methodology has no relation to other methodologies based on naive technical analysis and unrealized price levels. Yet, many continue calling their methods and approaches that utilize unrealized price levels price action trading. As I said before, this is a free country.
