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Forex technical analysis: basic terms and effectiveness

Table Of Contents

  1. What are trend lines
  2. Basic figures of price graph
  3. Practical use
  4. Is Forex technical analysis effective

In trading like in any other fields of human activity complex things don’t always mean good things. Beginning traders may consider simplicity of a trading strategy to be a shortcoming. However, the simplicity of the trading strategy is an undeniable advantage. It is a mistake when beginners think that Forex technical analysis is more accurate if complex methods are applied. So, simple and at the same time effective system of trading on the trend lines leaves less space for miscalculations.

What are trend lines

Trend lines are one of the most simple and yet most popular method of technical analysis. To draw a trend line one can just connect lows and peaks of the currency quotes on the price graph. This simple action helps a lot during trading. The trader can easily identify the price trend direction with the help of the trend lines.

It helps him open positions on the corrections in the direction of the leading trend and close them when the price crosses the trend line. Thus, trading on trend lines gives the possibility to enter or to go out of the market at the most favourable moments while other traders are hesitating or suffering from losses.

Basic figures of price graph

Trend lines distinguish the following famous figures of the graphic analysis, i.e. price models which make Forex technical analysis possible:

  • Rectangles;
  • Flags;
  • Pennants in which price is situated in the flat that is a certain range.

In such situation technical analysis proves the opinion by Charles Dow that after the pullback the price will most probably follow the acting trend instead of going to the opposite direction. Taking decisions on the basis of trend line market analysis is not difficult even for a new comer. As a result, trading on trend lines allows starting earning on Forex very easily.

Practical use

Trend lines are greatly popular with the supporters of Elliott Waves theory who use them together with MACD and AO indicators. All these indicators can resolve current price movement into separate waves and forecast future price movements.

Is Forex technical analysis effective

Financial market players have been arguing about the mathematical or technical analysis that is based on the previous price dynamics with the purpose to forecast future trends for quite a long time. All the traders can be divided into those who believe in its effectiveness, those who hesitate and those who are convinced that it is completely useless. Here we will try to figure out whether this method gives certain results and whether it is worth being used.

A certain skepticism regarding the technical analysis had started growing since it appeared in early 20th century. Many researchers prove that long-term investments have much greater profit potential especially when it refers to the stock market as it has been growing for decades. However they are the tools of technical analysis that account for the significant profit on Forex.

Not long ago Saint Louis Federal Reserve Bank published an article describing the research of the effectiveness of Forex technical analysis. The authors of the article came to a conclusion that the effectiveness of Forex technical analysis had constantly been reducing since 1970ies and at the present moment only complex trade schemes could be profitable. Before making this conclusion authors had analyzed numerous researches and scientific woks.

The first large investigations occurred in 1960ies. They actively promoted effectiveness of technical analysis at the financial markets. Late 1960ies – early 1970ies witnessed stable trend of technical analysis effectiveness reduction. The most significant reduction of the effectiveness of technical trade strategies occurred during the last decades. It may be caused by widespread usage of complex high-frequency trade schemes which increase volatility, destabilize the market and make it unpredictable especially in the short term.

At the same time authors of the investigation say that Forex often sees trends. So, how should one consider their declaration about the reduction of effectiveness? They say that it is caused by the strong competition. Of course, there are a lot of possibilities to earn money. However, wide training of traders and increase of competition result in the situation when only limited quantity of traders can use all these chances. Intense algorithmic trade caused a kind of “arms race” at the financial markets. It is expressed in the eagerness to create more and more complex trade methods and strategies.

The research insists that more complex systems will make profit much longer than simple systems will do. When some strategies become less profitable there are always possibilities for the creation of new methods adapted for new conditions. That is why, in order to earn money on Forex you should continuously improve your trading methods. Moreover, it is better to trade on the markets (even if they are less liquid) where the competition is not very strong. It can be trading with exotic currency pairs, for example. Rather large spread for them is compensated with predictability and lower volatility.