NAKED CHARTS
Advantages:
The chart is clean, clear, and simple. It is easy to spot support and resistance levels as there is no confusing mess of lines, moving averages, and indicators drawn on the chart. It is a very practical way to focus attention on the bar-by-bar price action. To traders who are used to charts like this, the lines only add confusion and clutter that slows the reaction time and thought process involved in trading. This chart uses the price action of the current candle relative to the historical candles as confirmation for taking a trade, which is probably a more pure form of trading.
Disadvantages:
Not everyone can easily remember support or resistance areas, so a trader may feel the need to draw a few lines here and there across a naked chart to help identify key levels. Other traders aren't comfortable going bar-by-bar as they are constantly changing their minds about which position they should take.
Important: It would not be appropriate to set rules about what should and shouldn't be on your chart. Rather than argue about what type of trader you are, it would be better to view yourself as a profitable trader, no matter the style. The ultimate goal in trading is to find what suits your eye and personality. After all, if you aren't comfortable looking at the chart, you probably won't be making the kind of decisions that will benefit you in the long run. Experiment a bit with a naked chart, see if it helps you focus on the price action or if it causes hesitation due to seeing nothing on your chart but price.
LINE TOOLS & MOVING AVERAGES
Let's start with the chart above. Many price action traders will use trend lines, channels, or even moving averages to alert them to potential turning points in the market. Let's look at a few of these tools in a bit more detail.
Trend lines:
A trend line can be a very powerful tool if drawn correctly. Many of our training videos use and discuss these simple yet powerful tools. A trend line is most effective for active traders when it's in the earliest stages. Once the trend line has formed and has been tested repeatedly, it's usually time for cleaning the stops, as everyone has identified the trend line by this point and taken positions. An efficient market will then shake out the weak hands before wandering off to another price level.
Two or more trend lines may be drawn to highlight pennants, wedges, triangles, flags, bases or consolidations, and so on. Are these to be considered indicators? No, they are drawing or line tools which help to focus one's attention on potential entry zones, targets, and stop areas. Once this area has been reached, a decision is made by looking at the price action.
Channels:
One of the favorite tools of many price action traders are channels, such as the one shown above. A simple definition of a channel would be two trend lines drawn parallel to each other. One would be across the highs, the other across the lows. It could be up trending, down trending, or sideways, doesn't really matter. A powerful strategy addressed in one of our training videos is in making the assumption that a channel is forming before it actually completes. If done correctly, this powerful method can pinpoint profitable entries long before everyone else becomes aware of the channel which has formed.
Moving Averages:
Many price action traders will use a moving average, or even a couple of moving averages. However, they don't necessarily use them in the fashion that many traders do. For example, a common strategy using moving averages is to use two averages - buy/sell signals are given when the moving averages cross. A price action trader may use a cross as a setup, but will typically still take their entry trigger from specific price action once a cross occurs. Or they may simply use one moving average and watch price action as it nears the average.
PRICE ACTION VS. INDICATORS
Come forward through the years as computers made possible rapid calculations - indicators were becoming more common. Mathematicians were trying to quantify price movement through complex calculations. In the long run, indicators never really helped. It is estimated that 85-90% of traders still lose money - this despite powerful charting platforms with hundreds of built-in indicators, cheap commissions, and virtually instant executions.
Why haven't all the indicators and oscillators helped? There are some potential negative qualities with all indicators - virtually every one of them are based on a combination of price, volume, time, or rate of change. Therefore, by their very nature, indicators are lagging the price to a degree significant enough that the entries they give are usually too late to be effective.
We might liken this to driving down a winding road by looking in the rearview mirror - we can tell we were on the road in the past, but it doesn't help us see the curve in the road ahead. By the time we see in the mirror that we are no longer on the road, it's too late! So it goes with indicators.
Let's talk about another potentially negative effect of indicators. Look at the two charts above - one clearly shows support and resistance levels, allows for easy identification of trends, and is simple and clear. The other is so cluttered that you can't process the information contained - it leads to paralysis by analysis.
Might a person who is contemplating switching to price action use something like volume without considering it an indicator? Absolutely! Volume is a very powerful tool - however, most veteran traders don't consider volume an indicator - it is a factual statistic of the number of contracts or shares traded, not some mathematically altered formula trying to predict or confirm price movement.
The right knowledge of volume can make a big difference in a person's trading, especially if they are able to track volume flow on a Time & Sales window. Since we feel that Tape Reading is one of the most important skills you can have, we will deal with this separately on our Tape Reading page.
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