If there’s one thing that’s consistent among traders, it’s an inability to agree on the best approach to analyzing the market. The fault line comes down between two distinct groups of traders. On one side sits those that swear by the indicators trading style and on the other side sits those who preach the price level based analysis. Here we’ll attempt to lay out the pros and cons of each method. After careful review, traders can decide what is best for them and for their own goals and personality.
It’s important to mention that we’re not suggesting you follow any type of trading. The purpose of this article is merely to familiarize traders with different types of entry analysis so they can choose what is right for themselves and to understand the advantages and disadvantages of both systems.
Whatever analysis a trader uses, it’s imperative to consider the context of the market upon the formation of the patterns that are telling the trader to enter or exit the market. This means that a formation can happen anywhere but if you don’t consider the context of the market, you might be making trading decisions that are contrary to what the market is actually doing. This will land you a sticky spot where you’re actually following a false signal to enter. Understanding the context in which you’re seeing signals is very important for any type of analysis and decision making to be successful.
For example, let’s say you see the price going to resistance levels. You know that at resistance level you should be shorting BUT you still need to learn the context of the market. Maybe it’s a strong, bullish market that might ignore that level. You might take this signal while ignoring the context – the result could be a total and clean wipe out of your trade.
While there are more than just 2 types of broad analysis methods, the following two are the most commonly used by forex traders.
This method is an analysis of the market based on placing mathematical indicators which are calculated based on the given prices which have been plotted on a graph. Within this technique lives several types of indicators, such as oscillators, price averaging, indicators measuring volatility, momentum, volume, divergence, etc. The most effective indicator systems are those that are built with combinations of the aforementioned indicators in order to combine different aspects of market measurement. When combined logically, these indicators can help a trader conclude a future or probability signal in order to enter the market at an ideal time.
Since indicators are mathematically applied on prices and in most cases consider the past prices, most indicators are lagging the market. When an indicator points to a conclusion, that conclusion has usually already happened in the market.
For example, common practice states that if a price crosses a moving average, it should continue along on its path. But in reality, the price was already moving in that direction which indicates a lagging effect on the signaling of indicators.
For novice traders, trading indicators can be magical. Also known as the black box, these indicators need to be proven and built in order to determine which combination of indicators can be put together to create a complete and confident view of the market. This means figuring out what grouping best pairs together in order to give the least false signals, while also not giving too few or too many signals.
The more indicators and the more signaling indicators that are combined, the fewer conditions are needed to give a trader a signal. It’s important to find a very fine balance and to tweak the formula as different conditions emerge and according to different trading assets.
For traders, this analysis method can be a simple way to play the market. Indicators will appear like an easy, clear dashboard to follow. However, to get these signals, you’ll need to study the market intensely before you can put together a coherent indicator dashboard to follow as you trade.
The other main, broad analysis system, this method includes following support and resistance key levels analysis, Fibonacci levels, daily or monthly pivots, supply and demand, order flow, Wyckoff theory or Elliott Waves. These markers are all based on analyzing prices and seeing levels where the market tends to respect, hold, or struggle to bounce back.
The challenge with this type of analysis is that every trader will see the charts in a different way. For example, spreading Fibonacci can be changed from trader to trader. Plotting key levels based on support and resistance can also be different among traders. Therefore, it’s all about discretion and each trader learning how to be more keen on recognizing their individual strengths and weaknesses when it comes to adopting the analysis that works for them.
Price based analysis is also more theoretical than definite analysis system because it lacks a nuclear core of numbers that work for everyone. It’s dependent on skill and experience dealing with how to extract these levels and knowing what works. Like with indicator-based analysis, being considerate of the market context is also relevant with this type of analysis and trading plan.
But what’s great about this type of trading is that there is much less screen-staring. When you trade based on prices, you wait for the market to get to the price you want to act on. You have a prediction and a plan at a certain price. You can, therefore, leave your alerts and orders waiting to move when prices hit the point you’ve predetermined. You can analyze, set orders, and step away from the screen. This gives your eyes and brain a much-needed rest from the stimulation of a flashing screen.
Price Action & Candlesticks Patterns
Candlesticks patterns and price actions are two charting methods that are not specifically analysis though it feels important to mention under that larger headline. Although price action and candlestick formations readout market behavior, these two disciplines are more commonly used to confirm or disconfirm an analysis prediction.
Therefore two indicators should be considered as a tactic tool for supporting decision making while trading in the present time. Candlestick patterns should not be used in a standalone predictive manner, as their formations depend on the market and price action context.
Pros and Cons at a Glance
The two (plus price based analysis) methods laid out above are the most popular methods for chart-based analysis. One uses indicators, while the other uses prices. You’re also welcome to use candlestick patterns in tandem with either of these two methods however, they will not work as stand-alone analysis methods.
The pros of the indicators based analysis are that it’s easy to set up, understand, clear to see triggers, and it has a concise rule base. The biggest con is that you need to stare at screens for a very long time until you get your trigger. You’ll also have many false signals and false formations that will not actually work. Most indicator analysis systems will be lagging as well. If you use indicators to predict future moves, you won’t have an accurate point to enter, but rather a theoretical place which could lead you to suffer a long drawdown.
As stated previously, the more your system combines indicators, the fewer triggers you’ll get. If you use fewer indicators, you might have too many false triggers. Waiting for a confluence of indicators may be boring and tiring.
On the other hand, the pros of a price based analysis are that you’ll know ahead of time where you’ll want to apply. You’ll also be able to place your order and sit back and wait for the price to get there. You can easily set and forget your entries. This method also gives you the opportunity to buy at the cheapest prices and sell at peak prices because you’re not waiting for any lagging confirmation. The Cons are that when you enter the market, you never know for sure whether the market is going to respect the level that you’re working at.
Remember that analyzing a level, regardless of the method you’re using, is more theoretical and crafted by each individual trader. Everyone will have a slightly different way in which they see a level. This means this analysis might be less accurate unless you practice and learn and experiment. This method takes a long time to master in comparison to indicator based analysis.
These technical analysis methods are the most broadly used in forex trading and are based on charts and the price feed that brokers give us. Any method that you think is right for you should be applied only in a bigger picture context. Nothing we do in the market stands alone and nothing is purely technical.
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