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
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.
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.
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.