Forex Technical Analysis: You’re Doing It Wrong

“The Forex market is the most liquid in the world…” the Guru continued, “so technical analysis is especially applicable.”

My eyes lit up. That was exactly what I wanted to hear. “Yes!” I thought to myself. Forex trading is going to be sooo much better than stock trading.

“Now look at chart example 2A. What chart patterns can you see? List them out…” the Guru instructed us with the confidence and charm of a young Tony Robbins.

We looked down at our chart handouts, and started drawing lines on them.

Double top, bear flag, inverse head and shoulders. Technical analysis sure is fun!

Beginner Traders Love Technical Analysis

Among all aspects of trading, technical analysis (TA) is the one that typically gets the most attention because it’s visually stimulating and gives traders a sense of control.

These days, anyone can pull out a price chart and draw all kinds of indicators, shapes and lines on it, in less than a minute. You can play around with a hundred different colors, settings and indicator combinations, and continuously tweak them to suit your changing preferences.

The ability to manipulate almost everything on a price chart gives traders a sense of being ‘in control’, and this is something we can quickly get addicted to.

This is why, I think, retail traders tend to fill their charts with a variety of indicators, shapes and patterns. The more of these there are, the safer trading feels.

However, the most important thing on the price chart is the one thing we have absolutely no control over — the market price.

The Indicator Illusion

If you look at a random ink blot long enough, you’ll start seeing patterns in it. That’s what human brains have evolved to do.

More often than not though, the meaning you derive from those patterns say a lot more about your personal perspective, than the reality of the world you’re trying to understand.

In applying a variety of technical analysis tools to price charts, I suspect that the majority of retail traders are doing the same thing. They’re trying to find patterns in market prices that are, for the most part, random.

“But I can see a clearly defined ‘head and shoulders’ pattern on the chart!” you might say.

And you’d be right. That might indeed be a textbook example of a ‘head and shoulders’ pattern. But… so what? Trading is about anticipating the future, not about what you’re seeing right now.

You see, it’s not the identification of chart patterns (or indicator signals) that’s the problem… but what you think it means, that is.

Most people are taught in their early days of trading, for example, that a double bottom chart pattern indicates an impending price reversal… or that a moving average crossover indicates a change of the trend.

But why would it?

Convenient Answers To Difficult Questions

Given time, pockets of order will form out of randomness, just like how an infinite iterations of a monkey banging on a typewriter will eventually produce the complete works of Shakespeare.

The average retail trader will take one look at the document and conclude that the monkey possesses a rare talent. In reality though, he has been fooled by randomness.

Technical analysis is a convenient answer to the difficult question of: “how do I predict the future with a reasonable amount of accuracy?”

Unfortunately, few people take the trouble to examine the validity of technical analysis. How often does it correctly predict future market prices? As far as I can tell, the answer is ‘not often enough’.

This said, the easy answers that technical analysis provide is a very seductive option.

Well… how’s that working out for you?

When Theory And Practice Diverge

Technical analysis theory is simple, specific and straight-forward. Real-world market prices however, tend to move in complex, messy and erratic ways.

If you’ve been trying to trade with TA alone for more than 6 months you’d probably have noticed a significant difference between TA theory, and the real world that it attempts to describe and predict.

It is probably not a coincidence then, that the majority of retail traders rely solely on technical analysis, and that most of them walk away with less money than they started with.

You see, the implicit assumption of TA is that only a minority of traders are aware of, and apply it. Because if TA is common knowledge and everyone applies it, the potential for profit would be rapidly competed away.

In other words, If everyone is trading in the same way, who are they making money off of? The answer is no one.

Technical analysis theory assumes that Reflexivity does not exist. Unfortunately, the world’s richest trader George Soros, disagrees with that assumption.

How I Trade

At this point, I should probably mention that I do apply some TA concepts to my trading… but they are not the primary way in which I identify trade setups.

In order to effectively anticipate market prices, you’ll first have to understand what drives them… and it should quickly be apparent to any rational person that market prices are not driven by TA any more than his actions are driven by his shadow.

You see, technical analysis is merely a way to describe and perceive market prices on a limited dimension, just like a how a photograph of a forest captures how it looks, but does not convey the temperature, humidity, or sounds of the place.

To use another example, trying to understand the Forex market based on TA alone is like trying to understand a juicy beef steak based solely on its picture. Until you explore the other dimensions of smell, sound and taste, you will never get the full story.

Such is the case with technical analysis, market prices, and economic fundamentals. Once you learn how to interpret economic indicators, they provide valuable insights to financial markets that TA is completely oblivious to.

This is why I base my trading decisions on a variety of dimensions, with economic fundamentals being the prime consideration. The characteristics of a country’s economy alone can tell you a lot about what’s going on, before even having to look at a price chart.

So if your trading performance has been less than satisfactory, you might want to start looking at the other aspects of trading that you’ve previously ignored.

Try learning about how to incorporate economic fundamentals into your trading… you might be surprised how much they will enhance your application of technical analysis.

By |2019-02-01T11:36:39+00:00February 1st, 2019|Fundamentals, Philosophy|6 Comments

6 Comments

  1. Arthur Seme March 17, 2015 at 5:44 pm - Reply

    You have certainly hammered home the point especially with the monkey’s example. Also about one’s shadow driving his actions. Well put. As a student of Icarus, I completely agree.

  2. Kevin (TDT) Harper March 19, 2015 at 12:43 am - Reply

    Hi Chris
    As usual a really good article
    Having said that I believe that one can trade successfully using just Ta & Pa …. provided it is approached in a way and in a time frame and time zone that “suits them”
    I believe that if we are not careful introducing fundamental analysis will create confusing “noise” for some traders

    It is up to the individual traders to discover for themselves (With the help of great teachers like yourself) what style of trading best suits them

    Really appreciate your articles as they always get the old grey matter ticking over
    Cheers Kevin

    • Chris Lee March 19, 2015 at 2:45 pm - Reply

      Hey Kevin,

      Good point. A trading approach that makes sense would not be enough unless it suits the trader.

  3. Paul odibeli April 9, 2015 at 11:33 am - Reply

    Another,nice piece from Chris. He says it as it should be.
    A combination of both fundamentals & candlesticks activities(as per chris lee’s materials)gives you an edge.Please folks go for it.once again,thanks Chris.

  4. pete g April 23, 2015 at 6:12 pm - Reply

    trading is not about Technical Analysis, its about what is happening now, NOT 2 days ago, 1 week ago, 6 months ago, sure you can see all sorts of patterns, and patterns within patterns, Then on top we have multiple oscillators but its all pointless, so many books peddle this rubbish, Unless you can understand individual candlesticks, groups of candlesticks, because these are present price actions happening in the here & now…..a plain chart with a couple of horizontal lines are all you need, its simple but humans make trading hard work………

    • Chris Lee April 24, 2015 at 1:10 am - Reply

      Hi Pete, thanks for sharing your thoughts. 🙂

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