Forex Technical Studies: The Staple of the Analyst

We have charts, prices, bids and asks, but we also have a lot of confusion and chaos in the markets. It is difficult to create a meaningful forex strategy from the raw data; in fact, it’s difficult to do anything with the raw data since it is just a huge list of time periods and prices. The tools of technical analysis were developed at the beginning of this century to deal with this problem by fitting the data into mathematical patterns defined by careful scrutiny of the price action. The Dow Theory, as it is termed, was defined as early as the 1900’s, but throughout the following decades traders and analysts have added to the cannon by devising their own methods, indicators, and strategies.

At its simplest, technical analysis is built on the premise that prices trend, and markets discount all information available to the public. Technical analysis posits that since the price quote is created by the collective action of millions of traders each of who is staking money with the sole purpose of making money, their combined point of view must naturally provide the best interpretation of the data available to the market. Traders are immediately aware of any news release right after its release, and their trading decisions incorporates them best into the price action, according to the fundamental beliefs of technical analysis. As such, the attempt at evaluating news and statistics independently, and trying to evaluate the price action on that basis is like adding water to the sea. Since technical studies attempt to interpret the price action, analysts also claim that the price action is not random. They draw our attention to the many periods where the price showed obvious directionality in hindsight, and on that basis they declare that the trending nature of the markets ensures that they can be analyzed by technical tools and methods.

What are those tools and methods? Many of us are very familiar with indicators such as the RSI, the MACD, or trend lines. These tools are created to interpret the price data so that trade signals telling us to buy or sell an asset can be generated. As we can observe, raw data says nothing about whether a price is too high, too low. Indicators are used to determine these values which can then be exploited for profit. Similarly, traders like to identify certain shapes in the price action the frequent occurrence of which is then thought to symbolize a possible to technical configuration. A triangle, for instance, is expected to signal continuation of the present trend, while a head and shoulders pattern signifies a reversal. There are many kinds of indicators and patterns, but the purpose is always clarifying the data for acquiring tradable signals.

We’ll conclude by noting that technical analysis is built on probability analysis. In other words, technical tools never signal certain outcomes, but merely alert us to the scenarios which can be exploited profitably if events develop as expected. Still, technical analysis is a very useful and proven method used by countless traders all over the world, and no trader who neglect its study do so at their own risk.