Forex Market: Is Technical Analysis Dead?

Every year the confidence of many traders is growing that classical technical analysis in its pure form does not work anymore. Think for yourself, all the main books on the technical analysis of the financial market were written in the 90s and early 00s. Then it was quite understandable and interesting, because the access of a wide range of investors and traders to computer analysis programs was limited, and studying technical analysis had a clear advantage, seeing pivot points and levels on the charts.

Now the question is: how can it work now, when using a free trading terminal, every schoolchild can put on the chart all possible figures and indicators of technical analysis? What is the logic? Coloring no longer works, and HFT traders delivered a decisive blow to technical analysts in the mid-00s, which Michael Lewis told us in detail in the “Flash Boys”.

Robots demolish stops that are tied to levels based on technical Analysis, and only unique strategies created based on traders’ own observations and trial and error approach have a chance to avoid this.

In the passage below you will find a story about how technical analysts began to lose confidence when scientists began to check the results of their work. Interestingly, it was along with the creation of the MetaTrader trading terminal, that technical analysis spread around the world, outside Western countries, and thousands of forums started looking for grails in crocodiles, golden sections, Gann fans, etc.

In the West, interest in this has long disappeared, and now you rarely find charts with the classic technical analysis ruler from famous traders. Statistical calculations and all sorts of correlations - yes, and coloring with levels is no longer interesting to anyone. Nevertheless, many dealing centers and brokers continue to regale their clients with daily mailings with similar garbage, and the comments of the “analysts” in them differ little from the example below.

Neither the level of income, nor the size of dividends, nor the degree of risk, nor bank interest rates can divert technical analysts from their main job – studying the dynamics of price movement. Such a commitment to numbers has led to many jokes and anecdotes in financial circles, which have become a kind of folklore on Wall Street.

Students sometimes ask university professors the question: “If you are so clever, then why are these poor?” This question does not give rest to the professors themselves, who feel that, having devoted themselves to science, they have missed the earthly riches. The same question can also be addressed to technical analysts. After all, in the end, the main goal of technical analysis is to make money. It is quite logical to assume that the one who preaches the methods of technical analysis must himself successfully apply them in practice.

On closer examination, it turns out that these analysts often have leaky shoes and worn collar shirts. Few people personally know the technical analyst who would achieve wealth, but many have seen a lot of losers among them. Oddly enough, none of them admits their mistakes. If you find yourself so tactless that you ask him what the cause of such a plight is, he will not blink his eye to tell you the story of how he made an ordinary human error and did not believe his own diagrams.

The appearance of computers temporarily facilitated the work of the “technicians”, but sometimes this innovation turns against them. The fact is that just like technical analysts make charts, trying to guess the dynamics of the market, academics draw up their own graphs and charts, demonstrating how effective these methods are. Computer verification of the predictions made on the basis of technical analysis has become a favorite activity of scientists.

Does market inertia exist?

Fans of technical analysis are convinced that knowledge of the past of a particular action can help predict its future fate. In other words, the sequence of price changes in the past can help predict the price on any particular future day. This theory is sometimes called the "wallpaper principle". According to her, a technical analyst predicts future currency prices just as you can predict a pattern behind a mirror based only on how it looks around the mirror.

The basic assumption is that combinations and sequence of prices are repeated in space and time. Technical analysts believe the market has inertia. It is assumed that the currency, the value of which is on the rise, will continue to grow, and vice versa, if its price decreases, this decline will continue in the future. Therefore, investors are encouraged to buy and hold rising currencies. As soon as the stock price begins to fall or behave unusually, the analyst advises to sell it immediately.

If we take stock market as an example, we will see that these technical rules are checked for archival data of the two largest stock exchanges, which have been conducted since the beginning of the twentieth century. The results show that the past dynamics of stock prices can not reliably predict their future value.

The stock market has a very short memory, if it exists at all. If the market shows some inertia from time to time, then there is no regularity in this, and the strength, such inertia is not enough to overcome the negative influences of investors' actions.

The easiest way to verify the truth of this statement is by comparing changes in the value of a stock in different periods of time. "Techniques" claim that if the stock price rose yesterday, then it will most likely continue to grow today. The audit shows that some coincidence of price movements in the past and present is still observed, but the percentage of matches is very close to zero.

Last week's price change has nothing to do with changes this week. If any patterns are noted, they are very weak and have no economic value. Positive or negative price changes over a period of time do not occur more often than with experience with a coin.

In the same way, constantly repeating patterns of diagrams are found no more often than a certain sequence of cards in card games. It is this circumstance that economists mean when they say that the behavior of stocks very much resembles a “random walk”.

Author: Kate Solano, Forex-Ratings.com