Knowledge and skills are a must for successful trading. Traders gain experience by trading in different situations in the market. However, the skills cannot guarantee success. Traders need the support of technical indicator analysis tools to understand the market trends more clearly. These indicators help the traders to know how a market may perform soon. 

Typically, indicators can be classified into four categories; Volatility, Volume, Momentum, and Trend Indicators. All these indicators help in determining the market situation in their relative field. For example, Trend Indicators are used to determine the strength and direction of the market trend, while Momentum Indicators help assess the strength of the price movement. 

Many indicators fall under the above categories. This article will talk about two commonly used momentum indicators— Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD), which are typically used to indicate the movement of price and its strength. 

Many reports and leading investment companies ascertain that trading results through the RSI indicator were much more promising than through the MACD indicator. This statement is widely based on that RSI has proved to be more accurate, while MACD has given mediocre results. However, this is not the case with every trading scenario. In certain situations, MACD can work better than RSI. 

It all depends on the trading situation that determines which indicator is better. Before knowing which indicator is more efficient, first, we need to understand the working of these technical indicators. 

RSI (Relative Strength Index) Indicator 

The RSI or Relative Strength Index is a momentum indicator used to determine the situations of over-sales and overbought in the trading market. This helps in examining if the current condition in the market is actual or not. It is typically displayed as an oscillator that holds a value on a scale of 0 to 100, more likely a percentage. If the value is above 70%, it reflects the overvalued or overbought condition of an asset in the market. If the RSI value is below 30%, it is the situation of undervalued or oversold assets in the market.

 

Another tool that has a greater significance for the RSI indicator is the divergence. The divergence of the price action from the RSI signal indicates the possibility of a trend reversal. Many experienced traders have recommended this tool as an efficient tool in identifying trend reversal. Due to its reliability, the indicator is widely popular. 

Using the default setting of the RSI indicator, traders can plot the data from 14 trading periods. It is common among momentum indicators like MACD and RSI; the data is analyzed for the period depending upon the trading period used by the trader. The default setting of 14-day data is used for plotting for daily chart trading. For the hourly chart, 14 hours of data is used by the indicator. 

The default setting of the plotting data can be changed as per the trading period the trader is using. It is advisable when the market is more volatile. Traders use a shorter period; similar can be done using the MACD indicator. The reason behind using the shorter period is that RSI will generate results based on the recent price trends. This will reduce the chances of false short-term signals as there is a high probability of such signals during a highly volatile market. 

MACD (Moving Average Convergence Divergence) Indicator 

Moving Average Convergence Divergence or MACD is another technical momentum indicator used to estimate the difference between 2 EMA (Exponential Moving Average), typically 12-period EMA and 26-period EMA. It is a graphical representation of MACD line and signal line with histogram, along the centreline, representing the difference between short-term and long-term MACD, negative or positive. 

The trading time frame determines the period of the MAs (Moving Averages). The 12-period and 26-period EMAs generate output when the daily chart is being traded. When using the MACD indicator, the 12-period EMA and 26-period EMA are the standard settings for generating the output. The chances of making changes to these settings are pretty rare as it works efficiently well with almost all the trading strategies. As per some reports published by leading institutions, the default settings of 12-period and 26-period EMAs are used by most traders while using the MACD indicator.

Since MACD is a momentum indicator, it compares the long-term and short-term price momentum and helps determine the current price’s momentum. Read the following facts about MACD to get more information about the indicator. 

• The histograms below the centreline indicate negative MACD with downward momentum. In this situation, the short-term MA is less than the long-term MA.
• Histograms above the centreline represent a positive MACD. This indicates an upward momentum, where the short-term MA is greater than the long-term MA. 
• If the trader is not using the default settings of the indicator, then it uses the 9-period EMA to create a MACD signal line. In non-default cases, it may also use smaller EMA periods. 
• It is advisable to use shorter period MAs in the case of highly volatile markets. You can change the indicator settings to get more recent trading signals. 

MACD vs. RSI

RSI has slightly better performance than MACD. If we test major currency pairs where entry position is generated by MACD or RSI and set 1 Daily ATR stop loss and 1 Daily ATR target price as an exit strategy, we can see that in 52% of cases, MACD is profitable, and in 52.8% RSI is profitable. We didn’t calculate the spread in the test, and we used the last 20 years’ data.

MACD rule:

BUY: Buy if MACD lines make crossover AND price is above histogram, stop 1 Daily ATR, target 1 DailyATR

SELL: Sell if MACD lines make crossover AND price is below the histogram, stop 1 Daily ATR, target 1 DailyATR

RSI rule:

BUY: Buy if the RSI value is above 50, stop 1 Daily ATR, target 1 DailyATR

SELL: Sell if RSI is below 50, stop 1 Daily ATR, target 1 DailyATR

Both MACD and RSI are similar in many ways. For instance, they are both momentum indicators used to determine the power of the market trend. However, many advanced traders apply these indicators to their trading strategies in different ways. As there is evidence that RSI has performed better in generating results compared to the results generated by the MACD indicator, this is not the case in every scenario. However, the situation has also been otherwise in some instances.

So, when it comes to comparing the two momentum indicators, to find out which one is better, it all depends on the trading scenarios in which one performs better than the other and generates more accurate results. 

The following are examples of a few scenarios, some of which are backed by researchers, in which one of the above indicators performs better.

MACD and RSI strategy

MACD crossover and RSI above 60 represents BUY order while MACD crossover and RSI below 40 represents SELL order. This strategy has an idea to define the strong bullish and strong bearish trend and to avoid false signals. However, if we test on major forex pairs there are is no significant statistical evidence that strategy will be profitable.

The additional bad thing is not just the low winning ratio (almost 50%). Our strategy didn’t count huge spread difference commission.

Trading Scenarios in Which MACD Performs Better 

The following are some scenarios in which the Moving Average Convergence Divergence (MACD) performs better than the RSI indicator.

MACD Is More Adaptable As It Provides Better Results in Different Market Conditions and for All Time-Frames

The evidence of the versatility of the MACD indicator can be seen in the research paper “Technical analysis of Forex by MACD Indicator” written by Ziba Habibi Lashkary in the year 2018. In her paper, she wrote about the study conducted on MACD indicators in Forex Trading. 

The study results stated that the MACD indicator could be applied in multiple conditions to generate more accurate results for both long-term and short-term periods. It also works efficiently well on different time frames, like monthly, weekly, or daily. Also, it gives the indicators the privilege to adjust the divergence of the moving averages according to the security they prefer. Therefore, it is unnecessary to keep it fixed to 12-period and 26-period EMAs. However, it works better in these two divergences, but that doesn’t mean it will work in every scenario. 

For example, when it comes to trading on a highly volatile asset for the long term, a trader would benefit if the trading signals were smooth so that the chances of false signals are reduced. This can be done by using longer-moving averages with MACD settings. It will flatten the medium to short-term volatility of the MACD signal. It is like getting a clear indication of when to buy or sell securities with high volatility.

Also, smaller moving averages can be used in MACD indicators for short-term trade signals when a trader is trading highly volatile assets. This helps generate trading signals derived from the most recent market trends. Therefore, there are fewer chances that outsiders manipulate your trading signals. 

More Accurate Signals When the Market Is Trending

The MACD indicator is more suitable for small-cap and large-cap securities. However, the results were unsatisfying for the mid-cap securities, where the trend lines emerged less organized. 

If we look at statistical data provided by the same study, the accuracy of the trendline predicted by the MACD indicator for small-cap and large-cap companies was 80%. We mean companies with a market capitalization above $10 Billion by large-cap companies. Companies with a market capitalization value of less than $1 Billion are considered small-cap companies. 

However, the same study shows that the MACD indicator failed to perform efficiently when the market was non-trending. When the market fails to take a particular trend, or in simple terms, the market is experiencing sideways movement, the indicator cannot form an accurate trendline. Therefore, as a result of the study, the MACD indicator is suitable when the market is trending and not fluctuating. In fluctuating markets, the RSI indicator tends to perform better. 

MACD Works Best for Short-Selling Securities

Another study conducted in the Australian market by Business Perspective in 2014 showed that the MACD indicator is better for short-selling securities if we compare it to RSI, which is not entirely compatible with short-selling. Further, this finding was backed by other researchers who conducted similar tests in Japanese and American markets in the past. 

However, no matter how efficient an indicator is with a particular trading strategy, it is always advised to be sure about your skills and approach. Similar is the case with short-selling, which is considered one of the riskiest trading strategies. It requires skill and knowledge and is not suitable for the average trader to try short-selling if they are not confident. 

Typically, there are four stages of short selling in a stock market. It starts with borrowing the shares from an investment firm. Note that here the shares are not purchased but borrowed by the trader. Then these borrowed shares are sold to investors, and when the price is profitable for the trader, he repurchases the shares from the investors and earns profit from them. In the end, the trader returns the shares to the company from which he borrowed the shares. 

This was a complicated process as so much purchase, and repurchase was involved. At any step, things could have gone wrong. For example, if the price of the shares fell, instead of going up, traders would incur huge losses as they eventually have to return the shares to the company as they were borrowed and not purchased. Therefore, he might have to buy back the shares even at a loss. This situation can get distinctively complicated, depending upon the traded securities. 

However, for experienced traders, this can work well with the help of the MACD indicator. 

Trading Scenarios in Which RSI Performs Better 

Now that we know some of the situations where the MACD indicator works better, we will look at some of the scenarios, mostly the opposite of where MACD works better when RSI performs better and generates better trading signals.

Relative Strength Index and Fundamental Analysis

Sacred Heart University conducted a study in 2010 to analyze if technical analysis tools can help individual investors earn better profits from the stock market. The university examined RSI and other technical indicators, and the results declared that some of them and the RSI indicator could generate better results if combined with Fundamental Analysis. 

RSI and MACD indicators are used for a similar purpose: to find the power of the change in the security price to determine buy and selling points. The above study could find a general rule for using the RSI indicator. However, the results were much more promising when the RSI was combined with Fundamental Analysis. 

The study concluded that the technical indicator could not generate any insightful returns when used alone. Instead, it was the Fundamental Analysis that helped in deriving profitable results from it.

More Accurate Signals When the Market Is Non-Trending

On the contrary to the MACD indicator, RSI gives more accurate trading signals when the market is not trending or following a particular trend. The same study by Business Perspective indicates that, as compared to the MACD indicator, RSI is more reliable in a non-trending market. A non-trending market refers to a market situation when the market is not taking up a particular trend. Instead, it is more scattered or moving sideways. The movement is very regular between the support and resistance levels. This situation does not give rise to a particular trend continuation; the problem is rather abrupt. 

Due to the abrupt situation of the market, there is no guarantee of what turn the market will take, and hence the risk is higher. However, as per the study, the RSI could generate reliable signals, giving the traders opportunities to trade in such a high-risk market. MACD cannot expect such reliance in the non-trending market.

However, it doesn’t matter how reliable the studies may have shown a particular indicator; an indicator cannot be used alone to reach a trading decision. It must always be paired with fundamental analysis tools and technical analysis to support the signals generated by these indicators to make it more concrete. Therefore, even if you are using RSI or MACD, or both, make sure not to depend on the signals generated by them entirely and include fundamental and technical tools in your trading strategy.

Results Generated by RSI Are More Accurate but Less Frequent

The study by Business Perspective, which indicated that MACD works better for short-selling, was conducted to determine the significance of both MACD and RSI indicators. It was executed in the Australian market, focusing on the comprehensive profitability achieved through the signals from the above two indicators. 

The result showed that RSI generated profitable trading signals very frequently, but those frequent results were accurate. The capital invested increased with every trade, but it was RSI that was able to generate better results and not MACD. Therefore, the overall outcome is that RSI turned out to be better than MACD. 

Although it was frequent, whenever the RSI indicator created signals indicating the appropriate time to buy and sell a security, the result of the trade was profitable. Therefore, if a trader is looking forward to making a profit in the long term, RSI is the better momentum indicator. 

Summary

The two types of momentum indicators, Moving Average Convergence Divergence (MACD) and Relative Strength Index (RSI), are used for the same purpose to determine the strength of a market trend. The trading signals from these indicators can be used in the trading strategy of many assets or different markets. The markets that widely operate these signals are cryptocurrencies, stocks, and Forex. 

According to all the reports mentioned above, multiple studies were conducted to investigate how the two indicators perform in different market conditions. If we combine these results, then on average, both the indicators could perform optimally well in certain market conditions. However, their relative strength and reliability vary according to trading strategies and market conditions.

For example, MACD performed better in short-selling securities trending markets and is adaptable to almost every time frame and market condition. While RSI gave more accurate signals but was frequent, it performed better during the non-trending market and worked better with fundamental analysis. 

However, it is a generally applied rule that your trading decision must not be based on a trading strategy that comprises only a single technical indicator. Instead, there should be multiple indicators and technical analysis tools that can support the signals of one another and form a solid foundation on which your trading decision can survive and generate profitable results. It doesn’t matter how good a technical indicator is; it cannot support your trading decision strongly without the help of other indicators. 

 

Technical analysis is an essential tool you may wish to use in trading. Is it, however, applicable to forex? In forex, technical analysis is adequate. However, the ability to forecast price fluctuations may be influenced by various factors. One aspect is the kind of currencies that are traded. Another element that can affect profitability is the technical instruments used. Finally, returns might also be influenced by the trading techniques used.

It may appear to be jargon when you’re unfamiliar with technical analysis. However, terms such as RSI, Bollinger Bands, and MACD, as well as Ichimoku & Elliott waves, all come to mind for indicators.

What is technical analysis?

Technical analysis represents investment valuation based on past market prices and statistical indicators. The primary goal of technical analysis is to identify trading opportunities, entry, stop loss, and target price levels.  Technical analysis does not predict future market prices. Technical analysts identify patterns on the chart analyze basic price levels.

Technical analysis is a basic technique for investors and speculators in the currency markets. Fundamental analysis and technical analysis together share the same goal, to help the trading decision.

The fundamental analysis considers political, social factors,  economics, and financial environment that impact the market. On the other hand, technical research in fx concentrates on past price data, charts, and price levels.

Technical analysis implies that price currently incorporates fundamentals; thus, there is no need to consider fundamentals while making selling and buying choices.

So, how well is price data considered in technical analysis? Technical traders utilize technical analysis in a variety of ways.

Some traders are looking at pricing chart trends. Others concentrate on technical indicators, which are statistical derivatives of pricing. Triangles and head & shoulders are two patterns you’ve probably heard of. You also may have come across double bottoms and double tops. These are only a few examples.

The RSI, MACD, and different indicators described above are indicators. However, there are several others from which to pick.

 

As we know, in jargon abbreviation “BS” means “but…it” or in polite version “nonsense” or utterly untrue statement. So let us answer one of the main questions:

Is Technical Analysis BS?

No technical analysis is not BS or nonsense practice. Technical analysis is just a practice that can improve profitability, decrease loss, enable traders to identify price levels where the probability for price reaction is slightly greater than without analysis.  

 

But why do traders think that technical analysis is a waste of time? Again, reasons are wrong expectations of beginner traders.

Using technical analysis can improve your performance a few percent, but you cannot be 60% accurate in your trading or 70% or 80%. But, on the other hand, your system can be a few percent better than 50%:50% if you use technical analysis.

Fundamental analysis is not better too. For example, in my experience as a trader, I saw six months in continuation insufficient fundamental data for one trading asset, and prices were in a bullish trend all the time. Additionally, there is a contrary example too. I saw excellent fundamental data, economic growth, and several months’ bearish trend for that asset several times.

Price on the market is based on supply and demand, buying volume, and selling volume. Usually, big traders look at fundamental data and make long-term trades, and because of that, we have significant bullish and bearish trends. So if we have excellent fundamental data, this is not a guarantee that the price will go up.

Does technical analysis work?

Yes, technical analysis work if your expectation is to find a good price level to enter into a trade or exit out of the trade, decrease average loss and increase average profit. However, if you expect to be 60% or 70% or 80% accurate in trading, technical, or any other analysis will not work for you.

How accurate is technical analysis?

If you measure technical analysis accuracy based on profitability increase (better price level for entering and exit), we can see that analysis increase several percent of our trading earnings. However, if you measure the accuracy of technical analysis where you use machine learning methods to predict future prices, your result will be around 50%.

Many scientific research papers in leading science journals try to use technical analysis to predict price in the future or to compare technical indicators. This approach is usually wrong. Support vector machines, artificial neural networks, and random forest were the most used machine learning algorithms for stock and forex market prediction. I believe that the market is very efficient because, at any given time, all information is factored into the price of any given asset. Algorithm trading, significant hedge funds, colossal liquidity – everything is complicated and very hard to break.
Over the years, a lot of research has been done on this matter. And the findings of that research differ. However, the majority appears to agree that technical tools work in the fx market.

While we have already shown that technical analysis works in foreign exchange, there are certain limitations. 

Its efficacy, for example, may be affected by the currency in which you trade. Furthermore, the technological tools you employ or how you utilize them will impact the results.

We may learn about the techniques that appear to work by reviewing the research on the strategy.

However, remember that because something performs over time does not guarantee that it will always provide favorable outcomes. There may come a moment when winning tactics begin to falter.

However, these are a few of the specialized techniques that experts have discovered to be helpful in forex:

Support and resistance as a technical analysis technique

Support represents a hypothetical price level or price area supporting, or holding up, prices and signifying more forex buyers than sellers. Support is often viewed as a “price floor” because traders hypothetically expect that price change direction and begin to rise based on past performance.

Resistance represents a hypothetical price level or area that consolidates, declines new high prices,  and signifies more forex sellers than buyers. Resistance is often viewed as a “price roof” because traders hypothetically expect that price change direction and begin to fall based on past performance.

Technical analysis is a widely used method to predict trends and earn returns in the stock, forex, and several markets. Traders find it useful as it is quick, adaptable, and helps them conclude quickly. However, does it land them at the correct conclusions?

The preciseness in the technical analysis is dependent on the creation of strategies and the capability of the investor to implement the fundamentals in technical analysis. This strategy may be helpful for some traders and yield good results, while for others, it may fail due to wrong discipline, application, etc. 

Meaning of technical analysis

Technical analysis is how traders use charts and other indicators to forecast trends and future price movements. The notion for the strategies here is that the trading market has a semi-cyclical nature. For instance, the resistance and support levels will likely be reached, and the change in direction will inevitably occur after some time.

Technical analysis aims to point out these possibilities in the future market by comparing the reactions in the same situations from the past.

A typical technical analysis starts by looking at the charts: resistance and support levels, Japanese candlesticks, averages, Bollinger banks. Parabolic SAR, etc., to determine the future stance of the market. The tools help calculate the previous price movement and draw conclusions that are likely to occur in the current market.

Technical analysts formulate this strategy around a focal point. For example, if you are a trader who considers the moving average the foundation of price change, you will enter trades in directions with a Moving Average Crossover. They plot the points for accepted moving averages and trace them until they see an opening to enter a trade.

The degree of preciseness in technical analysis 

Technical analysis is not 100% accurate. No analysis can give you sure-fire predictions in the volatile financial market. The perfect technical analysis has a considerably more winning rate, which sets it apart. From the above example: your moving average crossover strategy might provide an 80% success rate when applied.

The accuracy of the technical analysis strategies is tested through the “backtest” rules to check the market’s response to the same method previously. Above 655, precision is considered good, especially when traders risk 2x the amount for profit. This ratio is called the PRR ratio (Positive risk-reward ratio).

However, the first step is to practice some strategies before determining the accuracy for the same. For instance, an 80% secure strategy also leads to 20 loss trades before making the 80% profitable investments. The ideal way to implement a technical system is to compare its success rate and follow its course to get results.

The factors that affect technical analysis predictions

The robustness 

As discussed, the technical analysis combines various strategies and tools that lead to its effectiveness. This strategy should be compared with the market’s historical data to ensure a reasonable winning rate in the real market. The entire fundamental concept of this is that the financial market repeats history or becomes similar when the same conditions are repeated.

However, the problem comes when the technical analysts implement strategies without being aware of the natural way to predict the movement of the price. In certain instances, the analysts acquire the strategy from online forums from a stranger trader, which leads to short-lived success but long-term disappointment.

To create a robust technical analysis with proper strategies, you have to understand the functionality of every tool. You also must ensure that this strategy is backed by ten years of trading in various markets. To check this, run the backlist with the help of R: R ratios.

The strategy that returns 2x profit on your risks is mostly more than 655 accurate. As this rate falls, so will your chances for success.

Discipline

Once you have settled down on a strategy that has fair chances of success, you will have to implement them with utter discipline to get the benefits. If you ignore the rules and make them as you scour through the market, accuracy will dwindle. Hence, you have to enter a trade when a strategy predicts, exit it on time, and risk only the feasible amount.

Risk is an integrated part of the trading market, which you can influence by good technical analysis.

Hence, if you see two traders with similar strategies but different outcomes, know that the discipline factor is in the play.

Market conditions

The technical analysis predicts the future price movement. However, the financial market is volatile, and it does not follow a single path all the time. Volatility will cause it to rise and fall all the time. That means that if your strategy was creating 100 successful trades this year, it might make only 70 successful trades the next. On the other hand, it can also give 200 successful trades at a breakout point.

The best techniques will predict the market movement and provide the best probabilities for success.

Instrument related issues

The EURUSD pair was aggressively volatile compared to the past 20 years’ data. Technical analysis that considers it a factor will not be as successful as in 2010. The general strike and winning rate might’ve fallen significantly, but the lucrative trades are affected.

The technical analysis in such situations often changes the pointers of the strategy by recalculating by considering the Average Daily Range as a prime factor. Others may also take low profits or imitate the same strategy on different pairs. Other factors that affect the impact of the technical strategy include changes in spread, swap, or leverage in the transaction costs.

Is there an alternative?

You can use fundamental analysis as opposed to technical analysis. However, that cannot be practiced by everyone. You can find many blogs and forums where the debate is that fundamental analysis is ideal and technical analysis is not very effective. However, the forex market is subjective.

Hence, it would help if you tried what works the best for you. However, a trader cannot get substantial gains by using the fundamental strategy.

You need to understand the economics of the tool in-depth and be proficient in reading business and global political pulse. It would help if you also kept an eye on the market by subscribing to a news feed that is accurate and fast. That is a lot to take in for an average trader. In several examples, you will see that technical charts also trace the effect of fundamental strategies on forex and the financial market.

 

Technical Indicators in technical analysis

In 2016, research called ‘Technical Trading: Is it Still Beating the Foreign Exchange Market” used technical analysis to analyze 30 US currency rates. The data set included 45 years, from 1972 to 2016. 

It investigated over 20,000 trade regulations. The following are the guidelines with a few of the signs commonly used technical analysis indicators:

• Oscillators: Utilises oversold or overbought circumstances that may cause prices to reverse.
• Momentum trading: This is a leading indicator strategy because momentum refers to the inertia of a price trend to continue either rising or falling for a particular length of time.
• Moving averages: They follow trends.
• Support-resistance: Rather than looking for rebounds, this method detects trend continuations. According to the theory, the value must take the path of the breach of a resistance level or support level.
• Channel breakouts: It determines the degrees of support and resistance throughout time. Breaks imply that the trend will continue in the area of the breakout.

The researchers discovered that these indicators were significant predictors. That was the situation for 26 of the 30 currencies.

The highest performing rules generated annual returns of around 6.9 percent on average. It was a recovery in the developed currency. The return on fluctuations in exchange rates was even more remarkable, with an annual gain of 9.5 percent.

There were discrepancies in which technical analysis functions better. Trend line rules, for example, have performed well in established currencies. Support-resistance and Filter criteria produced the highest returns in developing exchange rates. On the other hand, moving average techniques performed well in terms of risk-adjusted outcomes.

However, it is crucial to remember that performance differs by currency. This emphasizes the importance of choosing the proper asset to trade rather than just the methods and right tools.

Conclusion of technical analysis

The technical analysis conclusion can be that this analysis, in simple terms, identifies patterns on the chart,  analyze basic price levels, and does not predict the future price in the market. Therefore, the technical analysis should be observed as an optimization and evaluation technique rather than a holy grail.

We have talked enough about why technical analysis works in forex. Price patterns, in addition to technical indications, are helpful. The dark cloud cover and piercing line patterns were two examples we witnessed. However, the research showing how technical analysis performs in forex suggests no assurance of success.

The findings indicate the possibility of significant losses. But, of course, much is determined by the technique and currency used. In other terms, like with any other thing, you must choose the appropriate instruments for the task.

Technical analysis is a broad term, and the accuracy depends on how you implement it. There are many things to consider in this division of foreign market analysis, and you need to try different approaches to find the one that fits you the best.