i. Price action traders look for price patterns and trade based on it.
ii. Indicator traders look for buy and sell signals from indicators and trade them.
iii. Price action trading is more discretionary and indicator trading is more analytical.
What is price action trading?
Price action trading is a type of technical analysis that is widely used by traders all over the world.
Price action is basically how the price of currencies move and this is analyzed in relation to the way in which the price of the same currency has moved in the previous trading sessions.
Hence, price action allows traders to read the previous and present price movements and take trading decisions accordingly.
Price action trading looks to exploit the psychology of demand and supply prevalent in trading. It is based on the popular principle that the markets are not perfect but are inefficient as the traders are humans after all that allow emotions to take the better of them.
These traders will leave behind patterns of demand and supply which can be exploited and capitalized on by traders trading the price action method.
Price action traders identify levels on charts that indicate psychological activities around them. These levels include support and resistance levels, big round number level, swing high and swing lows, decision point, day high open low close, etc.
Price action traders also make use of certain price patterns. These price patterns that have occurred in the past are applied to the current price movement.
These patterns indicate whether the prevailing trend might continue or there might be a possibility of a reversal in the price trend. These price patterns consist of chart patterns or even candlesticks patterns.
Some examples of chart patterns include wedges, triangles, head, and shoulders, etc. Some examples of candlesticks patterns include engulfing patterns, pin bars, evening star, etc.
Why should traders trade price action?
Price action trading is simple. In this type of technical analysis, traders trade what they see. There is no requirement for any additional tools that are to be applied on charts.
All that the trader requires is the price chart of the currency and some experience in spotting patterns on these price charts, and the trader is good to go.
The barrier to entry in price action trading is not so high. Traders do not need a deep understanding of the market conditions or the macroeconomic global scenario.
Price action trading is all about spotting patterns and trading based on them. This is one important reason for the wide use of price action trading.
Traders can use the technique of price action trading to trade all types of time frames. These techniques could be used by traders that scalp trade, day trade, swing trade, or even for even longer-term trades. There is no limitation on the usage of price action in this scenario.
It is a basic trading principle that consistent profits can be earned from the markets if the risk is mitigated properly and sound trading plans are applied to capitalize on the price movements.
Price action assists traders in all of these. It allows traders to pre-determine risk and targets, this in itself is a sound trade plan.
Price action trading - The spoilers
As mentioned already, price action traders trade based on certain levels on the price charts.
These levels have had some heavy price action taking place around them in the past, traders would expect if not the similar behavior of the price around these levels but at least some sort of price behavior around these levels.
This is a disadvantage for price action traders as they are compelled to sit back and wait for the currency’s price to reach these levels, the price may spend some time around these levels, the trader will then look for certain confirmations and confluences in order to enter into trades.
Hence, the price action trading method can be a bit time-consuming type of method. It requires traders to possess a certain level of patience.
It is also the mass psychology around price action trading that sometimes seems to be a disadvantage of its own.
So many traders use this technique and each one of them can have different interpretations which makes it sometimes seem a bit haywire.
What is indicator trading?
Indicators are mathematical tools that have been developed by several traders in order to assist them in making trading decisions.
It is basically a set of calculations that are applied to historical data of price or volume of the currency in order to predict the price’s movement in the coming trading sessions. Indicators are widely used by technical traders around the globe.
Indicators give the trader a set of rules according to which trades are to be taken. Indicators are also based on price, they are tools that filter, quantify and measure price.
These indicators are mainly of two types, overlays, and oscillators. Overlays are those indicators that are plotted on the price chart itself and use the same scale.
Oscillators are those indicators that are not plotted on the price chart itself but are either plotted above the price chart or below it. The values of these indicators oscillate between a maximum value and a minimum value.
Why should traders trade indicators?
Indicators make life easier for traders. It gives clear-cut indications based on which traders must act.
If an indicator gives a bullish signal, traders are supposed to get into long positions and if the indicator gives a bearish signal, traders are supposed to get into short positions.
New traders often start out on their trading journey by using indicators. The ease of interpretation is the reason for the same.
Indicator Trading - The spoilers
The main inputs in the calculations of indicators are the price and volume of a currency. Hence an Indicator would give out signals when the calculations are run on the recent data.
These signals sometimes fail because the overall market condition is not taken into consideration.
The markets are not efficient but are based on psychology or sentiment. Indicators are sets of rules applied to a set of data that does not account for other factors playing a role in the markets.
Hence the indicators give out mathematically correct signals but in incorrect market conditions. It is for this disadvantage of indicators that are often called lagging tools as it does not account for the present price movement or the prevailing market conditions.
One disadvantage about indicators is that there are different categories of indicators. There are indicators that measure the momentum in the price, or the volatility of the market and even gauge trend.
If a trader uses indicators of the same category then it is highly possible that he receives inconsistent signals from such a combination of indicators.
Hence, traders have to incorporate different indicators in their trading plan and have to work out a way to analyze signals from these indicators in relation to each other and then have to enter into trade.
Using too many indicators can lead to analysis freeze, which means that at any given time one indicator can give a bullish signal while the other indicator can give a bearish signal.
Which is better?
Coming to the main question - price action or indicator? In reality, none are better unless proper risk management techniques are used along with these.
All arguments about price action versus indicators are based on the subjective and objective of the respective technical tools.
Price action requires traders to make their own decisions hence it is subjective in nature, whereas indicators just require traders to act on the output of the calculations, hence Indicators are objective in nature.
Supporters of price action trading argue that price action takes into account the humane attributes. It gauges the psychology of the market by determining the demand and supply which in turn leads to quality trades. They argue that indicators are basically robots as it is only based on calculations and rules.
On the other hand supporters of indicators argue that human emotions have a negative impact on their trading decisions and that traders are better off using pre-defined rules to take better trades.
Humans are built differently having their own distinct personalities. There are traders out there that are better off using price action rather than Indicators.
While there are also traders that have had more success in trading based on indicators rather than using the price action methods. It all comes down to one's personality.
Traders that are more structured and analytical in their thinking can be more inclined to trading based on indicators, whereas traders that follow a more creative and flexible mindset can find price action better.
Choosing the right method according to one’s personality is nothing but confirming one’s confidence in a particular method.
It should be noted that it is not compulsory that traders with an analytical mindset would be best suitable for indicator trading or traders with a flexible mindset will be better off trading price action.
It all depends on how the trader trains his mind in order to think according to the method. This will eventually lead to a trader gaining more confidence in that particular method. And I believe that confidence in a method is directly proportional to consistency in trading results.
The purpose of this blog post was never to declare the better method of the two but rather to lay the nuances of both methods. Ultimately, you are in a better position than us to decide what works for you and what does not.
You should know about both methods and then must backtest them before taking live trades.
I would also suggest that you try and incorporate both price action and indicators in your trading plan. This will allow you to utilize the advantages of both methods while also compensating for the disadvantages of each method.
But not to forget that in the end, it’s all about what works for one and what does not.
What type of trader are you?
Are you a price action trader or a technical indicator trader? Do let me know. What kind of strategies do you use?
Also, did this blog post make it easier for you to make a decision regarding which method to follow?
Share this blog post with others and do reach out to me through the comments section for absolutely anything.