Technical Analysis Works In Forex Markets

Technical analysis, or the statistical analysis of past price changes with the objective of forecasting future price changes, has been a hotly debated topic met with skepticism in many financial circles. Most traders and investors fall into one of three camps: Those who believe it's a science that works, those insisting that it's a self-fulfilling prophecy and those convinced it's worthless as a tool of prediction. TUTORIAL: Technical Analysis: Introduction

Today's technical analysis is a far cry from what existed in the past. The development of neural networks, genetic algorithms and similar technologies, has dramatically improved accuracy in predicts and may mark a shift in the industry. In this article, we'll take a look at some empirical evidence to finally put this question to rest, with a specific focus on the foreign exchange (forex) market. (To know more about genetic algorithms, read: Using Genetic Algorithms To Forecast Financial Markets.)

Does Technical Analysis Really Work?
Researchers have been skeptical of technical analysis ever since Eugene Fama and Marshall Blume found buy-and-hold preferable to any filtering techniques in "Filter Rules and Stock-Market Trading." However, research focused on foreign exchange markets has shown unusually large profits driven by technical analysis, that have challenged the efficient market hypothesis.
In 1995, Blake LeBaron published a study called "Technical Trading Rule Profitability and Foreign Exchange Intervention," which proposed a possible reason why technical analysis was so effective in foreign exchange markets. The report found that predictability is largely reduced, if not eliminated, when discounting days that the Federal Reserve was actively intervening.

The underlying reason for the effectiveness of technical analysis in foreign exchange markets may, therefore, be that the priorities differ between major players. Unlike unpredictable equity markets, central banks have a strong incentive to keep currency prices at certain levels, which may make price movements more predictable, especially when they intervene. (To gain some knowledge about technical analysis practitioner, read: The Pioneers Of Technical Analysis.)

Neural Networks and Technical Analysis
With their ability to identify obscure patterns in data, neural network models have been growing in popularity. The models can approximate any nonlinear function to an arbitrary degree of accuracy, which makes them ideal for forecasting in many different settings. Moreover, modern software has made these networks accessible to even individual traders and investors.
Recent studies have been focused on using neural networks to identify underlying technical trading rules. In "A Case Study on Using Neural Networks to Perform Technical Forecasting of Forex," Jingtao Yao and Chew Lim Tan found that buy-and-hold strategies may be better than trend-following, but neural network models outperformed both, even when using just simple indicators like moving averages.

Another study called "Using Recurrent Neural Networks to Forecasting of Forex," provides more empirical evidence that neural networks can provide statistically reliable prediction of foreign exchange rates. The model used in the study reportedly obtained 80% accuracy in prediction, confirming that neural networks can be very effective in making foreign exchange predictions. (To know more about neural networks, check out: Neural Networks: Forecasting Profits.)

Components of an Effective System
There are several key considerations to take into account when developing a technical analysis-based trading system for the foreign exchange markets, according to the aforementioned studies on the topic. Here are a few key points to keep in mind when developing a system:

A Word from the Opposition
The effectiveness of technical analysis-based trading systems is still disputed by many researchers. By using suspect testing data samples or excessively-customized trading systems, these researchers believe that the results from these studies may be misleading. Ultimately, this is difficult to tell without applying the system to new data sets, but traders should be aware of the concerns.

The two key concerns include:

The Bottom Line
Technical analysis may not be proven to work in the equity markets, but there is growing evidence of its efficiency in the forex markets. The success has largely been attributed to the predictability of interventions seen largely in safe-haven currencies by central banks. However, some researchers remain skeptical, given the potential for at least two types of misleading analysis techniques.

Which indicator is best for forex trading
Success is what everybody wants when first enter the forex market. Just for success they do learn how to trade themselves, hire brokers and cooperate with each other. They try to invent some new option that will suit them perfectly and bring the maximum of profit. But what leads to success?
The Stages Of A Forex Trend
A trend is simply a tendency for prices to move in a particular direction over a period of time. Trends can be long term, short term, upward, downward, and even sideways...
Using The ISM Manufacturing Index To Find Forex Trends
The foundation of any economy is its manufacturing sector. That's why the market is always aware and focused on the Institute of Supply Management's (ISM) manufacturing surveys. This is particularly true in the case of the United States - where the sector contributes roughly 12% of U.S. overall economic growth...

OANDA Rating Rating
Tickmill Rating
Grand Capital Rating
FIBO Group Rating
XM Rating

Anyoption Rating
OptionBit Rating
Empire Option Rating
EZTrader Rating
OptionsXO Rating
OptionRally Rating