Technical Analysis is definitely difficult to resist. By using the wide array of technical tools available, it is possible to create masterpieces of modern art.
It’s true that technical analysis can be a functional tool for defining and managing risk, timing potential entries and understanding potential trouble zones. However, I have personally never met a long-term successful trader that doesn’t start his analysis/preparation by observing the weekly macroeconomic calendar and going through session wraps or some bank research.
Hence, in this article we shall explore a way to combine fundamental analysis and technical analysis to enhance our odds.
On False Certainty
The main contention I personally have with technical analysis is that it gives a sense of certainty where there is none. All traders (including myself) would love to be certain about their decisions in the market. Unfortunately, that just isn’t possible. However, hoards of aspiring traders turn to technical analysis as a means to interpret and understand where price wants to go next.
Unfortunately, even some more experienced traders going through a rough patch tend to fall prey to the same mental biases that aspiring traders display:
- blinded by hindsight, they go and find the indicator or setup that would have allowed them to avoid the most recent loss (recency bias)
- hurt by the loss/losses, they look for a tool that will help them avoid future losses (anchoring)
- they don’t realize how much of their current thought process/analysis is impacted by their negative emotional state (attention al bias)
- they fail to think long-term (clustering bias)
We need to constantly remind ourselves that we’re playing an elaborate poker game. We are in the realm of uncertainty, basing our trades/bets on our best assessment of the situation. No technical indicator can predict the future, because indicators require inputs and hence they are all derivatives of price movement.
Furthermore, it is frustrating when a solid chart pattern or analysis method suddenly fails. Sure, “it may be one of those days”…but how can you be sure? So how can you continue to have confidence in your charting method, without constantly questioning the validity of each signal you get?
What Price Charts Represent
All chart patterns & technical methods are based on price behaviour. However, don’t think of “price” as an immaterial object or being. Edwards & Magee, in 1948, had already defined price action appropriately:
“The market price reflects not only the differing value opinions of many orthodox security appraisers, but also the hopes and fears and guesses and moods, rational and irrational, of […] buyers and sellers, as well as their needs and the resources…”
Price movement is determined by investors’ decisions in response to a complex mix of psychological, sociological, political, economic and monetary factors. In other words: price is the reflection of the aggregate perception regarding the future of whatever asset we’re trading. We’re observing expectations of future outcomes.
How are these expectations formed? Simple: through the evolving fundamental picture.
Fundamental analysis is the process through which we should strive to understand how price could react to:
– headline data (for example inflation data)
– top tier data (for example central bank decisions or NFP)
– themes (for example monetary policy divergence between the USA and the Eurozone or the weakness in Iron Ore currently pressuring the Aussie)
The release of this data, and the evolution of the themes that the market is currently focused on, changes the economic mindset of participants – and this is what creates the reaction from investors. To be even more precise, it’s not even the release of the data or the event that creates a re-allocation of capital: frequently, it’s the expectation of such releases/events that gets things moving.
Case in Point: GBPUSD
It has been a very volatile start to the week with the Pound gaining around 2% across the board. That’s a big move in FX, by any standard. But was it possible to identify the trade opportunity in real time?
On Tuesday, GbpUsd started trading in positive territory towards the 1.2600 handle which had capped the uptick on Monday. There were certainly technical setups to short GBP based on the reaction from the big figure, but the real drop was on news that UK PM May would be holding a surprize press conference later in the morning.
The markets do not like to be surprized so the knee-jerk reaction was to sell GBP before even knowing what was up. After about 30 minutes the speculation about PM May stepping down, or having health issues, subsided and the truth emerged: she was going to call for new elections in June because a stronger majority was needed in Parliament, in order to push ahead with Brexit.
There was a swift recovery from the lows, a tight consolidation and then (marked with the green line) a boost foward. The sell-off was not based on anything other than a knee-jerk reaction to a surprize event. Once the dust settled, traders recognized that new elections, for now, means that Brexit is on hold and that the probability of a “soft” Brexit is higher than before. No clear political majority means difficult decision making, with lots of compromise and a “hard” Brexit is just not in the cards with these conditions.
So all the “technical” shorts had thier stops plucked just above 1.2600, and then the ensuing rally caused a shift in positioning on behalf of longer term players that no doubt were holding shorts since the beginning of 2017. Finally, there was a final boost through the highs of Q4 2016.
Over to You
I certainly admit that being on that trade could be attributed to luck just as much as it could be attributed to skill. Without doubt, chance has an important role when betting in uncertain conditions. But more often than not, we tend to make our own luck in the markets.
With proper preparation, you can consistently position yourself in line with the odds and experience your fair share of good fortune. Obviously, this does not mean you will be insulated from stop outs, but at least it won’t be because you read the flows incorrectly.
The bottom line is that you don’t require a heavy background in economics in order to enhance your odds by combining fundamental information with technical tools. It only takes a bit of direction and lot of practice. So get in touch with us, and your trading will never be the same, for the better.
About the Author
Justin Paolini is a Forex trader and member of the team at www.fxrenew.com, a provider of Forex signals from ex-bank and hedge fund traders (get a free trial), or get FREE access to the Advanced Forex Course for Smart Traders. If you like his writing you can subscribe to the newsletter for free.