You might have seen ads with amazing track records with a 95% success rate and promises that just by paying a couple of hundred dollars to the developers you will be allowed to join the ever-growing crowd of happy millionaires.
Imagine there are so benevolent people that they painstakingly create something close to an ultimate money-making machine that would in about 5 – 10 years make them gazillionaires or at least as rich as Warren Buffett, BUT instead of selfishly keeping the wealth to themselves, they allow YOU (and thousands of other traders) to trade the same signals or a system! That’s just amazing! It just sounds almost too good to be true!!
Well, guess what? It is. Those readers that have been around for some time have seen these ads more than their share and are now looking only for material that is solid and helpful. In this article, we will take a look at what I believe to be the best market analysis tool there is: Price action. And as usual, I am not asking you to blindly believe me but rather encourage you to consider some of the facts I present below and do your own research.
So, what reasons are there to believe price action is highly important, if not the most important analysis tool? Why aren’t the technical indicators or market fundamentals even more important?
First of all, indicators are just derivatives of price. Whether we are talking about RSI, Bollinger Bands, Parabolic SAR or MACD they all are just following what the price does. None of these indicators lead the price action. Rather they just react to changes in price and at best are a very limited approximation of the price action itself. Therefore, traders that know how to read price action know how the indicators would behave in certain market regime (e.g. ranging or trending markets).
How about fundamental analysis? Many successful investors and traders use fundamentals. Yes, that is true but at the same time, most of them use both price action and fundamentals.
They have an investment thesis based on their interpretation of macroeconomic trends but at the same time, they look for price action to help with timing. They want to see if other traders focus on the same economic trends or changes that they themselves are. If not, they patiently wait until the price action starts to confirm their thesis.
Furthermore, if we want to focus on the first and foremost drivers of any market then the obvious choice is supply and demand. You might ask how supply and demand manifest in the markets. It’s quite simple. When supply and demand are in imbalance and there is more demand than supply, the prices go up. When there is more supply than demand the prices go down. And, when the demand somewhat meets the supply (they are in relative balance) the prices don’t trend but stay in a tight range. As we know, prices never move up or down in a straight line. The fact that people focus on different timeframes (e.g. intraday traders vs. swing traders) causes prices to fluctuate. Some people take profits sooner than others so this increase in supply causes the price to retrace some of the earlier up
Therefore, it is safe to conclude that it is the price action that dominates gives us the most direct best understanding of market drivers. While fundamentals can move the markets in the long run the prices could go against the trader for an extended period of time before confirming the fundamental view the trader holds. Too much focus on fundamentals could lead to the trader ignoring price action for the detriment of his trading account.
Likewise, someone focusing on indicators and ignoring price action is likely to lead to sub-optimal performance or losses. Net profitable traders often focus on a variety of factors, including the key price levels. They might add an indicator or two in the mix and pay attention to what the central banks are doing but they never ignore how the price reacts to the key price levels and the flow of macroeconomic news.
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Chief Market Analyst
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