Price action vs Indicators: The Stock market comprises various types of traders who use a different range of strategies to take positions in securities that can generate profits.
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These traders can be narrowed down to two types based on the strategies they use, they are price-action traders and indicator-based traders.
Individuals who are new to the market might face the dilemma of which of the two approaches they should use when they start their trading journey.
In this article, we will cover the concept of Price action vs Indicators based trading which will help you understand which trading approach is better suited for you.
What Is Price Action And Indicators?
In order to understand which of the following approach is suited for you as a trader, we have to take a look at the meaning, advantages, and disadvantages of each of these approaches which we will cover as we move ahead in this article
Price Action Trading
Price action is a type of trading approach that uses the price of a particular security to determine its future trend. It is an approach that involves analyzing the past movement in the price of a particular security to identify the potential movement it can make in the future.
As Price action trading does not consider the fundamental aspects and focuses more on recent and past price movement, it is reliant on technical analysis tools. The following are the tools used by the traders for the purpose of trading:
a. Breakout
Breakout refers to a price of a security moving beyond certain price levels (or range) that it was trading (in) for a certain period of time. Breakouts can result from different patterns including triangles, ranges, head & shoulders, flag patterns, and more.
Example: Suppose a stock has traded between the range of Rs.100 to Rs.130 for a certain period of time and then the price moves beyond the price level of Rs.130. It is an indication that there could be a breakout in the price of the stock.
Below is the weekly chart of ITC giving a breakout from the ascending channel.
b. Candlesticks
A candlestick is a graphical representation on the chart that indicates the opening price, the high, the low, and the closing price of a security for a specific time period. The candlesticks can be divided into bullish and bearish candlesticks.
c. Trends
Securities can sometimes continuously rise or fall during the day. It is referred to as a “bullish” trend- when the price rises and a “bearish” trend when the price declines. Traders can take trades based on these trends in the market
d. Support And Resistance
Support and resistance levels are those points on the chart where the price has reversed in the past. If the market trades near the high of the zone that it is referred to as trading at Resistance and if the price is trading near or at the low of the zone, it is referred to as Support. Traders identify these levels in order to find a good trading opportunity in the future.
Benefits Of Price Action Trading
- Price Action Trading is pretty straightforward and less time-consuming when compared to using indicators, as there are numerous indicators that can show conflicting signals
- Traders can easily identify the entry points, exit points, risks, and targets, based on which traders can execute their trades.
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Drawbacks Of Price Action Trading
- As Price action is based on one’s own analysis, different traders can have different outlooks for the same chart. A novice trader may find it difficult to draw a fixed conclusion due to these criteria.
- As Price action is done by traders on their own, there might be a possibility of traders being personally biased towards specific security, which will hinder them from taking rational trading decisions.
Indicator-Based Trading
Indicator-based trading is a trading approach that relies on indicators to analyze the price and provide trade signals. There are numerous indicators that are built on certain mathematical criteria, which give signals to execute orders. This approach is convenient for individuals who have just started their trading journey.
An indicator uses mathematical formulas, graphs, price data, and charts to create a visual signal for a trend in a market. Here are some of the commonly used indicators that are used among traders for the purpose of analyzing the trend of a security
a. Moving Average
Moving averages (MA) are one of the commonly used technical indicators in financial markets. It is an indicator that depicts the average value of a stock price over a period of time which is plotted along the closing price. Moving averages are plotted on an average of 10 days, 20 days, 50 days, 200 days, and so on. These moving averages can further be categorized into various types. Simple Moving Averages (SMA) and Exponential Moving averages (EMA) are commonly used.
b. Bollinger Band
A Bollinger Band is a technical indicator represented by a set of trendlines that comprise two standard deviations plotted away from a simple moving average of a security’s price. Bollinger band is used to determine whether a security is overbought or oversold. When the security is continuously touching the upper band, it is an indication of it being overbought and when it touches the lower band, it is an indication of it being oversold.
c. Relative Strength Index (RSI)
The relative strength index (RSI) is an indicator that represents if the stock is undervalued or overvalued. This indicator moves within the range of 0 to 100. The stock is considered to be oversold when the RSI moves below the Value of 30 and it is considered to be overbought when the RSI moves above the value of 70
Benefits of Indicator-based Trading
- As Indicators are based on mathematical calculations and programming, they are less prone to human errors. Also, due to its automated output, every trader will see the same results.
- The new traders may find it difficult to interpret the charts on their own, but the indicators can help them notice small changes which they have not yet learned to identify by themselves.
Drawbacks of Price Action Trading
- They are based on mathematical and statistical rules and sometimes the fundamental picture depicts a different story about the market and the indications from these indicators can be misleading.
- Technical Indicators do not give any additional information than what’s already depicted on the charts and candlesticks. Thus, it might be not beneficial to skilled traders.
Price action Vs Indicators-Based Trading – Difference
The indicators are automatically drawn based on the set criteria, whereas price action requires traders to draw their own charts.
As a result, indicator-based trading gives the same signal to all traders, and Price action trading is subject to the different interpretations of different traders.
As signals are automatically provided in indicator-based trading, novice traders can find it easier than price action trading.
Price Action Vs Indicators-Based Trading – The Better Of The Two
The answer to this question solely boils down to the preference of each trader. As the approach can only be good as the individual using it.
For example, an individual who uses an indicator-based approach for trading might make consistent profits using one indicator while incurring a loss when using some other indicators.
In a similar way, a chart might be interpreted in two different ways by two traders while using action and each one of them will end up at the opposite end in terms of profit and loss.
Also Read: Technical Analysis Vs Price Action – Which One’s The Better Bet?
In Closing
In this article on Price action vs Indicators-Based Trading, we discussed the meaning, tools, benefits, and drawbacks of Price action and Indicator based trading after which we discuss the difference between the two and which is the better two.
Instead of choosing solely to rely on one trading approach, it is preferable for traders to use the strengths of both approaches to complement the weaknesses of each other.
That is, using the objectiveness of the indicators to make your judgment based on the price action analysis.
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