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 a variety of 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.
When you’re unfamiliar with technical analysis, it may appear to be jargon. 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 isn’t to predict future market prices, but trading opportunities identification. Technical analysts identify patterns on the chart, analyze important price levels.
Technical analysis is a powerful technique for investors and speculators in the currency markets. Standard fundamental analysis is an example of another method for predicting price movement. While they all share the same goal, the methods used in each sort of analysis vary.
In forex, the fundamental analysis considers political, social factors, and economics. Technical research in fx, on the other hand, concentrates on past price data.
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 that 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 examples of indicators. However, there are several others from which to pick.
As we know, in jargon abbreviation “BS” means “bul…it” or in polite version “nonsense” or completely 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 waste of time? Reasons are wrong expectations of beginner traders.
If you use technical analysis you can improve your performance a few percent but you cannot be 60% accurate in your trading or 70% or 80%. 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 6 months in continuation bad 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 several times excellent fundamental data, economic growth, and several months’ bearish trend for that asset.
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 big 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 your expectation is 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 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%.
A lot of 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 and artificial neural networks and random forest were found to be 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, big hedge funds, huge 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 appear to agree on the fact 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 price area consolidating, declining new high prices, and signifying 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 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 is used to detect 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 is used to determine 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. Moving average techniques, on the other hand, 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 important price levels, and does not predict the future price in the market. The technical analysis should be observed as an optimization and evaluation technique and not as 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 that there is no assurance of success.
The findings indicate the possibility of significant losses. 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.