Price Action v. Indicators: Which Works Better?

June 27th, 2018

We now know that indicators have been given a bad rap.

Not only are they worthwhile, but they can beat the market easily.

And we also know that, when it comes to indicators, RSI is the winner (so far).

But what about price action, though?

I’ve heard a lot of traders talk about how price action is the only truth in trading. Again, I tend to agree.

Indicators have complicated math based on price movements, of course, but why deal with the middleman? Instead of creating an equation for price action, why not just look at the thing itself?

It seems to me that using price to determine entries would be superior to using a derivative indicator.

To do our case study, however, we’ll need to determine what we mean by “price action”.

For our testing purposes, price action will mean an entry signal based only on what’s happened on the charts.

Today, we’ll look at one of my favorite price action patterns: the Key Reversal.

The official definition of a Key Reversal is: “A key reversal is a chart pattern that consists of a new low and a higher close than the previous bar. When a Key Reversal pattern occurs, a long entry order is placed for the next bar at open.”

I like this because it appears to mean something important.

If price goes lower than the previous Daily bar, then the market is dropping, signaling that a downtrend might be upcoming.

However, instead of continuing down, price abruptly reverses back up and, in fact, closes above yesterday’s close. The market thought things were bad and then dramatically changed its mind.

To me, that’s significant and is something we should be a part of.

Here’s a picture of a Key Reversal. Notice on the bar with the red arrow how the low goes below the previous bar and then the close is higher than the previous close. We enter at the open of the next bar:

https://www.screencast.com/t/sMjIg9ZRE3

So, using the same parameters as we have previously (1 contract, 60 day exit, $25k account, ES, 1998-now), let’s take a look at how price action performed.

Pretty well, it turns out.

Entering on a Key Reversal and getting out 60 bars later produced $64,934 of profit. This beat buying-and-holding the market by 143% (Key Reversal 259%, buy-and-hold 116%).

Price action does appear to matter.

What about drawdown?

The close-to-close drawdown of the Key Reversal was -$40,594. Considering that’s more than our hypothetical $25k account, that means we’d have to have a bigger account and the return percentage would drop. So that’s not good.

But the Key Reversal max drawdown was still better than the buy-and-hold max drawdown of -$55,625.

However, as you remember, the RSI close-to-close max drawdown was -$15,828 while producing $68,772 of profit.

RSI beat Key Reversal in profit and max drawdown.

The top-ranked indicator (so far) is better than this type of price action.

But they both beat the market.

Is there a different price action pattern that might be the best yet? We’ll find out in Thursday’s YouTube video.