As far as I know, there are only 2 ways of trading that produce positive results in the long run for retail traders.
Method #1: Short Term Price Action
This is a reactionary approach to trading.
Allow me to explain.
Imagine a large boulder rolling down a hill, towards a wall.
Now, depending on what that wall is made of, the boulder will either smash through it, or be stopped by it.
If the wall is made of straw, the boulder is going to break through it and continue rolling down.
If the wall is made of thick concrete, however, the boulder is going to be stopped by the wall.
Now imagine that instead of a boulder, you’re looking at falling prices.
Prices are dropping aggressively, towards a support level.
Depending on the strength of the support level, prices will either break through that barrier, or be stopped by it.
In this manner, price action trading essentially involves taking trades based on how moving prices react to support/resistance levels.
So it’s a reactionary approach because you’re trading based on the interaction between 2 conflicting forces (i.e. falling prices vs. the support level). How these forces interact determines how you trade.
The Downside Of Trading Short Term Price Action
On its own, price action trading tends to be relatively unpredictable because there are larger forces at work ‘behind the scenes’ that the trader may be unaware of.
In predicting whether the boulder will smash through the wall, amateur traders simply look at how large the boulder is, and compare it to the strength of the wall.
If it’s a large boulder and the wall looks weak, they bet on the boulder.
This works, sometimes.
Other times however, the amateur trader loses money even though the boulder is large and the wall is weak:
What would happen here?
The boulder would smash through the straw wall, but the larger (steeper) hill on the right would cause the ball to roll right back!
In this way, price action trading focuses only on what’s happening immediately on the chart while ignoring the bigger (environmental) picture.
So while it can be an effective way to trade, price action trading is vulnerable to the larger fundamental (i.e. economic) forces that could easily override it…
… which brings us to the next trading approach:
Method #2: Longer Time Frames With Fundamentals
This approach involves understanding the larger context of the market.
It’s like understanding the surrounding geography of the rolling boulder:
When you understand the fundamental context of the market, the immediate price action becomes less significant.
Price action is important… but when faced with conflicting fundamental forces, it usually gives way to the latter.
The Dangerous Middle: Technical Indicators
Price action trading looks at the immediate, short term time frame, while fundamental trading looks at the larger time frames.
I’ve found these two approaches to be the most reliable ways to trade.
Now, in the middle of these two extremes is trading with technical indicators.
Imagine the same boulder rolling down a hill.
Now it is approaching a wall.
Technical indicators (such as the moving average) would at this point suggest that since the boulder has been rolling down all along, it is likely to keep rolling down.
This method ignores the wall type, and the bigger environment – all it pays attention to, is what the boulder did in the past.
When walking forward, do you keep your eyes on the footprints behind you? Because well, there’s basically what most technical indicators do.
Technical indicators simply re-organize the price information that’s already known (i.e. historical price data). They do not consider new information (like price action does), or information outside of the trading chart (like fundamental analysis does).
And so the reason I don’t use technical indicators is that they lag too much compared to price action, while at the same time provide no understanding of the bigger fundamental (i.e. environmental) picture.
The day I broke free from technical indicators
I remember the day I decided to delete all the technical indicators off my charts.
It was uncomfortable at first, as I was so accustomed to the feelings of certainty and security that they provided.
Staring at the bare price chart, I was struck by a sense of helpless uncertainty.
Without some structure of technical indicators wrapped around the candlestick