Most people should know the legendary sci-fi film, The Matrix, and the pivotal scene of the ‘red pill’ and ‘blue pill.’ The red signifies learning a wholly different yet life-changing truth, while the blue represents staying in ignorance.
In a weird yet interesting way, most traders face a similar dilemma between relying purely on indicators or price action. There’s a great divide in forex communities over which is superior to the other.
Some people believe price action is life-changing and indicators are for the uninformed. This premise is prevalent for those initially introduced to indicators or who spent considerable time using them before switching.
So, it begs the question, which is objectively better between price action and indicators? Should this even be a debate running through hundreds of threads on Forex Factory? At their core, both methodologies visualize price information in different ways.
One mechanism uses patterns primarily, while the other employs mathematical formulas. Ultimately, beauty is in the eye of the beholder.
Although it’s difficult to give a completely unbiased answer, observing the fundamental differences and exploring the myths between the two makes more sense.
The fundamental differences between price action and indicator-based trading
Technical analysis is a complex endeavor, and the markets are chaotic with high levels of uncertainty. However, we are confident not all price movements are completely random, meaning we can exploit repeatable patterns in the long run.
Within the realm of technical analysis, we primarily deal with price action and indicators. Both strands are fundamentally distinct and align with different human personalities.
Generally, price action is more subjective while indicators are more objective; one is more art (creativity, flexibility), and the other is more science (formulaic, rule-based). In price action, traders interpret particular structures and patterns based on market psychology.
With indicators, you simply act on the output of mathematical calculations. Deciding on the preferable method is a personality thing and your confidence in that particular technique.
Moreover, there undoubtedly is a proportional correlation between this assertiveness and the coherence of your trading results, and this is what matters. Now, let’s explore the common myths between price action and indicators in forex.
Myth #1: Price action is leading; indicators are lagging
Traders categorize strategies as leading and lagging. The former refers to tools that produce a signal before a market moves, while the latter produces a signal after a market has moved.
Truthfully, there is technically no leading tool in forex. Whether traders use technical or fundamental analysis, the information we receive is based on an event in the past.
One uses this data to make their trading decisions; if it’s happened before, it’s likely to happen again at some point.
Let’s consider how traders identify a pattern like a pin bar. Generally, analysts consider the pin bar a reversal sign. When you spot this pattern again on any chart, there is no way of knowing it will produce the same outcome until you execute a position.
Essentially, you’d be looking at past price action, and the market would have already moved from an optimal entry point. Indicators function on the same principles.
If there was a real leading indicator, it would be possible to have a ‘holy grail’ and a 100% winning strategy.
Instead, profitable traders rely on probabilities and the random distribution of wins and losses. There certainly is a luck element involved regardless of the method anyone employs.
Ultimately, everyone is using past information and cannot always predict the future until after something in the markets has happened.
Myth #2: Price action is simpler and better for the novice
Another prevalent argument when traders debate between price action and indicators is that the former is simpler than the latter. Actually, both methodologies are equally complex and leave a lot of room for interpretation.
With price action, it takes considerable skill to observe different candlestick formations. There are no universally accepted rules of definitively identifying a hammer pattern, for instance, since each trader modifies the guidelines according to their preferences.
Similarly, when using indicators, one relies on their own interpretation of a Moving Average Crossover or an oscillator divergence. Therefore, both methods are inherently complex, even if you may find one simpler than the other based on personal experience.
Myth #3: ‘Naked’ trading (price action) is better than messy indicators
Another popular belief between price action and indicators is that the former is cleaner and more minimalist than the latter.
Of course, it’s common for traders to ‘plaster’ four or five different indicators on their charts, which will naturally be cluttering and overwhelming. So, yes, indicator trading can get messy with an untrained person.
Yet, price action isn’t inherently better. Plus, this trading style can also become messy considering the number of support/resistance levels, trend lines, channels, and graphical components one can add to a chart.
So, while the ‘less is more’ approach works with most endeavors, including trading, it’s rather the effectiveness of each portion you incorporate that’s the difference-maker.
Final word: a better solution
Whether you believe price action or indicators are better, both avenues ultimately provide data and not signals. Too many traders rely on a single factor before buying or selling in the markets.
Instead, analysis is about adopting a holistic approach where you consider numerous aspects in your trading decisions. In other words, you cannot solely rely on a few candlestick patterns or a Moving Average crossover to execute a position.
Price action and indicators provide information on facets like the trend, momentum, volatility, support, and resistance, etc. Along with other confluent elements, we connect the dots and fit the pieces of the puzzle to form an idea of where a market may be heading next.
Being more holistic in your approach by combining both price action and indicators is how you create impactful trading ideas offering the most favorable risk-to-reward scenarios. Therefore, we should see both essential spheres as working together rather than separately.
