Auction Theory – Price Action Trading

Auction Theory – Price Action Trading

Auction theory is an applied branch of economics which deals with how people act in auction markets and researches the properties of auction markets. There are many possible designs (or sets of rules) for an auction and typical issues studied by auction theorists include the efficiency of a given auction design, optimal and equilibrium bidding strategies, and revenue comparison. Auction theory is also used as a tool to inform the design of real-world auctions; most notably auctions for the privatisation of public-sector companies or the sale of licenses for use of the electromagnetic spectrum.

General Idea

Auctions take many forms but always satisfy two conditions:

They may be used to sell any item and so are universal, also
The outcome of the auction does not depend on the identity of the bidders; i.e., auctions are anonymous.
Most auctions have the feature that participants submit bids, amounts of money they are willing to pay. Standard auctions require that the winner of the auction is the participant with the highest bid. A nonstandard auction does not require this (e.g., a lottery).

Price Action Trading

The concept of price action trading embodies the analysis of basic price movement as a methodology for financial speculation, as used by many retail traders and often institutionally where algorithmic trading is not employed. Since it ignores the fundamental factors of a security and looks primarily at the security’s price history — although sometimes it considers values derived from that price history — it is a form of technical analysis. What differentiates it from most forms of technical analysis is that its main focus is the relation of a security’s current price to its past prices as opposed to values derived from that price history. This past history includes swing highs and swing lows, trend lines, and support and resistance levels. At its most simplistic, it attempts to describe the human thought processes invoked by experienced, non-disciplinary traders as they observe and trade their markets.[1][2][3][4] Price action is simply how prices change – the action of price. It is readily observed in markets where liquidity and price volatility are highest, but anything that is bought or sold freely in a market will per se demonstrate price action. Price action trading can be included under the umbrella of technical analysis but is covered here in a separate article because it incorporates the behavioural analysis of market participants as a crowd from evidence displayed in price action – a type of analysis whose academic coverage isn’t focused in any one area, rather is widely described and commented on in the literature on trading, speculation, gambling and competition generally. It includes a large part of the methodology employed by floor traders[5] and tape readers.[6] It can also optionally include analysis of volume and level 2 quotes.

The trader observes the relative size, shape, position, growth (when watching the current real-time price) and volume (optionally) of the bars on an OHLC bar or candlestick chart, starting as simple as a single bar, most often combined with chart formations found in broader technical analysis such as moving averages, trend lines or trading ranges.[7][8] The use of price action analysis for financial speculation doesn’t exclude the simultaneous use of other techniques of analysis, and on the other hand, a minimalist price action trader can rely completely on the behavioural interpretation of price action to build a trading strategy.

The various authors who write about price action, e.g. Brooks,[8] Duddella,[9] give names to the price action chart formations and behavioural patterns they observe, which may or may not be unique to that author and known under other names by other authors (more investigation into other authors to be done here). These patterns can often only be described subjectively and the idealized formation or pattern can in reality appear with great variation.

This article attempts to outline most major candlestick bars, patterns, chart formations, behavioural observations and trade setups that are used in price action trading. It covers the way that they are interpreted by price action traders, whether they signal likely future market direction, and how the trader would place orders correspondingly to profit from that (and where protective exit orders would be placed to minimise losses when wrong). Since price action traders combine bars, patterns, formations, behaviours and setups together with other bars, patterns, formations etc. to create further setups, many of the descriptions here will refer to other descriptions in the article. The layout of descriptions here is linear, but there is no one perfect sequence – they appear here loosely in the sequence: behavioural observations, trends, reversals and trading ranges. This editing approach reflects the nature of price action, sub-optimal as it might appear.