SCOTT WELSH TRADING BLOG

Is Price Action The Best Way To Beat The Market?

Is Price Action The Best Way To Beat The Market?

Mar. 13, 2019

The only truth in trading is price action.

Right?

Indicators are lagging. Moving averages are lagging. Everything is lagging.

Everything that’s not price action is an approximate, vague derivative of the real thing.

If we want to be professional traders, we have to stick the thing that matters most: what’s happening on the chart.

Here’s an example.

One of the best price action tools to use is the “key reversal.”

This occurs when today’s price goes below the low of yesterday. That means today is more negative than yesterday at some point. But then price shoots up toward the end of the day and closes ABOVE yesterday’s close. That clearly means today is more bullish than yesterday.

In one single day (or one bar), price showed it was more bearish than yesterday but then rebounded to finish more positive. That’s quite a mood swing.

And when mood swings like that happen, something big is underway. We then take advanatage of that price movement by going Long at the open of the next bar. (The reverse is true for Short trades.) Here’s a picture of a key reversal on the EURUSD. Notice in the ellipse how price goes below the low but closes above the previous close:

The price has told us what’s really going on. This has to be the best way to beat the market.

So let’s take a look. Here are the details of a system using our example.

  • System: The Key Reversal
  • Philosophy Behind It: Price action is the best way to trade and the key reversal capitalizes on manic price movement that signals the start of a trend.
  • Need Special Indicators? No.
  • Chart: Daily
  • Instrument: Forex
  • Long or Short? Long Only
  • Long Entry: 1) Low of current bar goes below yesterday’s low; 2) Close of current bar closes above yesterday’s close; 3) Enter at open of next bar
  • Stop Loss: $5,365
  • Take Profit: $520
  • Trade size: 1.0 lots
  • Hypothetical Profit: $66,481
  • Hypothetical Max Drawdown: $24,571
  • Hypothetical account size: $50,000
  • Test Period: 2005-2019
  • Number of Trades: 337

Multicharts Performance Report here:

Hmm. It just did okay. It wasn’t spectacular.

Even though it used a powerful price action pattern and had a win percentage of over 94%, it didn’t really beat the market.

The S&P 500 averaged about 8% per year (with dividends reinvested–which is a hot-button topic in itself!) while our Key Reversal system only averaged about 6.5% per year.

The max drawdowns for the market and the system were about the same.

Even worse, I optimized this system quite a bit to get to this point. These are the best inputs I could find for the EURUSD. And, when I tested other pairs, the results got even lower.

If price action is the only truth, then the truth is we might not be able to beat the market.

My mind says price action is the best way to trade. But the math says otherwise.

We’ll look at an indicator-based system next time and see which performs best.

 

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Disclaimer:
It should not be assumed that the methods, techniques, or indicators presented in these products will be profitable or that they will not result in losses. Past results are not necessarily indicative of future results. Examples presented on these sites are for educational purposes only. These set-ups are not solicitations of any order to buy or sell. The authors, the publisher, and all affiliates assume no responsibility for your trading results. There is a high degree of risk in trading.

HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN INHERENT LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT ACTUALLY BEEN EXECUTED, THE RESULTS MAY HAVE UNDER- OR OVER-COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFITS OR LOSSES SIMILAR TO THOSE SHOWN.