Is Price Action Trading Better Than Using Indicators ?

If you’ve ever spent any length of time in online trading forums, you’ll have noticed there is often a huge argument underway between the traders who think price action trading is the best way of trading the markets, and the traders who think using technical indicators is the best way to trade. The price action traders always say price action trading is better because it doesn’t lag behind the markets action, whereas the indicator traders state that trading with indicators is simpler than trading with price action, because you only have to lean what the indicator is showing you in order to use it, you don’t have to learn about lots of additional things like candlestick patterns, support and resistance levels, trend lines etc like you would if you were a price action trader.

Today I want to settle this argument once and for all, by first breaking down the differences and similarities between the two methods, and then by giving you my thoughts on which one you should use to trade the markets with.

Lets start by taking a look at the differences.

 

The Differences Between Price Action Trading Vs Trading With Indicators

Considering how different price action trading is compared to trading with indicators, it’s amazing how many similarities they actually share with one another. Both price action traders and indicator traders will make all of their trading decisions using a price chart and they will both determine which direction the market is likely to move in using just the market price. The big difference between the two, is in the way they both analyze the price to make predictions about the future.

Price action traders will typically tend to analyze the current market price in relation to the past market price to figure out which direction the market is likely to move in, whereas indicator traders will only analyze the past market price to try to find out where the market is going to move. All indicators are derived from past market prices, which essentially means the indicator traders are trying to predict the future using only the past. Price action traders do this too but with one very important difference, they are trying to predict the future by combining what happened in the past with what’s happening in the present.

A typical price action trading strategy will be one where the price action trader will determine a level in the market that’s formed based on the past price history, and then watch the price to see what happens when the market returns to the old level. If the market comes back to the level and produces a price action pattern the trader has knowledge of, he could see that as being a sign the market wants to reverse and move away from the level, in which case he may enter a trade to try to make some money from the reversal.

In this example, the price action trader has used the past in conjunction with the present to formulate a hypothesis as to where the market might be heading in the near future. He knew the market had reversed at the level in the past, but he doesn’t know if it is going to reverse at it in the future. So instead of just jumping into a trade betting the level was going to cause a reversal, he waited until the market returned to the level before seeing if the resulting price action confirmed the level had a high chance of causing a reversal.

This is how most price action traders trade, they either use the past combined with the present to make their trading decisions or they just base their decisions solely on what’s happening in the present.

Now the main difference with indicator traders is they make all of their decisions on things which have happened in the past, they don’t combine the past with the present like price action traders do, they just use the past. The reason why is because all trading indicators are calculated from the past price action, so they don’t show the trader information based off what’s happening right now, they show them information based off what has happened in the past.

For example, one of the most popular indicator trading strategies is the moving average crossover. The moving average crossover is a strategy in which the indicator trader will place a fast-moving average and a slow-moving average on his chart and then wait for the fast average to cross over the slow average. When they cross, the indicator trader will enter a trade in the direction to which the fast average has crossed the slow average, as one average crossing the other is supposed to be a signal the market has reversed and is going to move in the opposite direction.

image of moving average crossover Here’s an image of a moving average crossover which took place on the 1hour chart of USD/JPY.

The red squiggly line shows the fast-moving average and the black line shows the slow-moving average. When the fast average crosses over the slow average the indicator trader will enter a buy trade. The thing is because the averages are calculated off of past price history it means they can only cross one another once the market has already moved in the direction to which the reversal has took place. In other words, if you look at the image you can see the market begins to reverse to the upside at the point I’ve marked with an arrow, but the moving averages don’t actually cross each other, and thus signal to the indicator trader a reversal is taking place, until the candle I’ve marked with an X forms.

This delay in signalling when something is taking place is true of all indicators used in the market. It occurs because they’re based off the past price action. The traders who make all of their decisions using indicators will always be late in reacting to changes in the market, no matter which indicator they use or what strategy they use the indicator with.

Another, more obvious difference between price action trading and trading with indicators, is what your charts will look like when trading with indicators compared to what they’ll look like when trading with price action.

image of chart with indicatorsHere’s an image of the 1 hour chart of AUD/USD. I’ve placed a few of the most popular trading indicators on this chart so you can see for yourself just how confusing it can be trading the markets using indicators. In the image it’s pretty difficult to even see what the current market price is. It gets even more confusing when you realize that each one of these indicators is a variable the trader must check before entering a trade. If all the indicators aren’t lining up properly ( in terms of what they suggest the market is going to do ) the indicator trader will not place a trade and will have to wait for another opportunity to arise.

image of support and resistance levels Here’s the same image again, only with all the indicators now removed.

The image above is typical of what price action traders will be looking at when analyzing the market for potential entries into trades. The three black lines you can see I’ve marked ( called support and resistance levels for those who don’t know ), identify some points in the market where price action traders will look for entries into long and short trades. Usually these levels are all a price action trader will use to trade the markets with along with some additional tools which will help in finding the best places to look for trades.

 

Why Price Action Trading Is Better

So now that we’ve had a look at some of the similarities and differences between price and trading and trading with indicators, I think it’s time for me to explain why I think price action trading is the much better method.

image of price action before moving average crossoverHere’s the image of the moving average crossover we looked at earlier, only I’ve moved the chart forward slightly so you can see what happened in the hours after the averages had crossed.

As you can see, a couple of hours after the averages crossed the market fell below the point where the indicator trader would have entered his buy trade. At this point, despite being at a loss on the trade the indicator trader will not close his buy trade due to the fact he still believes the market is going to continue rising. You’ve got to remember, the indicator trader makes all his decisions using the indicator, it doesn’t matter to him if the market has reversed and the price is already falling, until it has fallen enough for the averages to cross back over again he doesn’t believe a reversal has taken place.

A short time after the market had fallen below the point where the indicator trader had got his buy trade placed, the fast average crosses below the slow average and the indicator trader closes his losing long trade.

When it comes down to it, the reason why this trader lost was because his trading strategy is based on trying to predict the future using just the past. The moving averages cannot cross until the market has already reversed, so the indicator trader is always late into realizing when a reversal has taken place in the market.

image of reversal on 1hour chart of eur/usd If you look at the image above again, you can see I’ve marked two candlesticks with ticks and one with a down arrow.

These two candlesticks marked with ticks were an early warning sign the market might be getting ready to move higher. A price action trader would have seen these candles and knew that a reversal could be about to occur at point A. When the candle marked with a down arrow forms the trader would know the market is likely to begin falling, as it’s bearish engulfing candle, a candle which signals a reversal. The indicator trader would have never had access to this information because he relies solely on his indicators to tell him what’s happening in the market. When the bearish engulfing candle formed the price action trader would have probably closed his trade, but the indicator trader would’ve continued to hold onto his trade, as he hasn’t seen the averages cross over again, so in his mind the market is still going to continue moving higher.

The is why I think price action trading has a huge advantage over trading with indicators.

By understanding how to read the price action you can react to changes in the market much quicker than any indicator trader can, which allows you to anticipate market events well before they take place. You saw in the example how the moving average trader only realized a reversal was taking place AFTER the market had already reversed and moved higher. A trader proficient in reading price action would have been expecting this reversal to occur based on the price action that was forming before the move higher had even began.

 

Summary

I hope you can now see the clear differences and benefits price action trading has over trading with indicators. Whilst I do think it’s possible to generate decent profits using a combination of price action and indicators, I don’t think it’s good idea to use a trading strategy based solely on reading indicators, because you’re just going to end up being one step behind the market all the time, and losing money because you were too late into reacting to the changes taking place.

Thanks for reading, please leave any questions in the comment section below,.

 

 

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