When selecting a trading methodology that is effective in the long run, a trader needs to ask himself what type of approach would work best for accuracy and reliability.
First there is the fundamental approach which works best for the long term trader/investor. Warren Buffet is a good example of a trader with a very long term “macro” perspective of his investments. His holding period is usually measured in decades.
The shorter term trader needs to rely more on a technical approach. This arena of trading has two schools of thought: technical analysis using indicators and pure chart reading.
All technical indicators are derived from price action. Indicators of all types are readily available today thanks to the personal computer. Some of the more popular ones are MACD, RSI, stochastics, moving averages, CCI, etc. The list is endless as technicians of all stripes continually massage price to develop new fangled indicators.
The pure chart reader, however, makes trading decisions based on patterns as depicted on a price chart only. He may employ price-based tools such as Fibonacci ratios that on chart patterns.
Well, which approach is more effective for trading in the long run? Let’s take a closer look into the differences between indicator-based methods and trading that uses pure chart patterns.
Since all indicators are derivatives from price action as mentioned earlier, they are one step removed from current price action, and therefore must lag. This delay can be detrimental to trading if the lag is great enough. Secondly, all indicators can be “optimized”. You can insert any parameter into any indicator you want. This opens up the question as to which one makes the most sense to use. Is a 20 day moving average more effective than a 22, 30, or any other period moving average? Same goes for all oscillators. After a while, you’ll discover infinite combinations if you use multiple indicator. Is this good because you can always adjust these parameters as the market changes? But when do you change them, after a series of losses? And when do you change back? In the end they are all just various shades of grey.
Chart reading has been around much longer than most of the latest indicators. Great legendary traders of the early 1900’s used predominately price action as most were chart readers. I use some of their principles in my SuperStructureTrading approach.
These chart patterns have gone through the test of time. For example, if a retracement is very shallow or if price action has broken above a high or low, there can no argument among traders. Price is price, which is the truth. The approach using proportions in structural patterns also doesn’t change when you adjust time intervals since the market is said to be fractal. Little patterns seen on an intraday chart behave very similar to those on a daily chart for example.
Many traders who lean heavily on indicators may inadvertently forget about basic price patterns, which can cause whipsaw. Several years ago, there was an automated computer trading program that only uses the crossing of a green line over a red one to generate trading signals. The developer went as far as insisting users to not even look at any price chart even though he refused to disclose the indicators that generated those colored lines. This extreme form of indicator-based trading is akin to trading with your eyes closed.
There may be a learning curve when a trader forgoes overrated lagging indicators and embraces pure chart reading. But in the end, engaging the market directly will eliminate any lag when a signal is generated from price structures. The trader will learn to anticipate price moves by properly reading patterns once he fully understands what the market is broadcasting. Reading trend direction and trend strength using simple price patterns is available to the trader once he opens his eyes to the few rules that work time and again.
