The following is an excerpt from an email response to a trader who suggested that, “Price Action Trading is a lagging indicator (albeit short lagging indicator) methodology based on one’s reading of the future price direction through market/trend analysis with active management designed to scratch trades early if the market suggests one is incorrect on the future price.“
I understand completely what they’re saying; they’re essentially correct; although I have some concern over the use of the term lagging. Price action analysis is not about the past… but about the future.
Here’s my email response…
While it’s true that previous price bars show what occurred in the past, the current price bar shows what is happening right now. Our focus is not in the past but instead in the present and the future.
Situational awareness involves three components… perception of environment (what’s happening), understanding the meaning (what does that mean), and projecting forward in time (how will that impact me in future).
We aim to maintain situational awareness within the markets via (a) conducting analysis of the current price action (what’s happening), (b) considering the current action within the context of previous action, and identifying signs of strength and/or weakness (what does that mean), and (c) projecting that forward to identify areas where other traders may be exposed to stress and forced to act, thereby creating orderflow required for profit (how that will impact the future).
Essentially, we’re creating IF-THEN statements about future possibilities, then carrying out the appropriate actions based on whichever scenario develops.
eg. refer to the following chart:
Price has broken previous support, and has now returned to the vicinity of that breakout (what’s happening);
Although a high close bull candle, it’s only a new high by one pip and there is not yet any reason to expect a breakout above the resistance. Price has congested within this area for three candles now. Longs will be starting to doubt their position (although some will take confidence from the latest green candle). Bias is still bearish (what does that mean);
IF the pullback continues to stall for another candle or two, this will add further stress to the longs who will start to doubt their initial expectation of a reversal. THEN a break below point A will start to trigger their stops, leading to a cascading move lower as more and more stops are triggered and the downtrend resumes. This is our point of entry short. (how that will impact me in future)
IF however price breaks above resistance, THEN I’ll reassess my expectations of the future, aiming to possibly search for a pullback entry long.
In this way, we are not trading via lagging indicators. We are identifying potential opportunity in future price action; and then trading this opportunity only when price action conforms to our future expectations (as time advances).
This is not a lagging, reactive strategy. Rather, it’s forward looking and proactive.
Have a read of the following article, for another explanation of this concept through an aviation analogy: http://yourtradingcoach.com/trading-process-and-strategy/stay-ahead-of-the-aircraft/. Effective navigation and mission management must be forward looking. Effective price action analysis must also be forward looking.