There are a lot of scams in the forex market… A lot! From scam brokers to terrible trading signals, ineffective expert advisors, and misleading trading advice. All these are the things you should avoid to become profitable in the market. But what about technical indicators?
Unlike the aforementioned obvious scams, there’s a lot more nuance whenever you’re considering them. When used properly, technical indicators are invaluable tools that have been very useful for most traders. On the other hand, they could also be the Achilles heel to your otherwise excellent trading strategy. Let’s look at both of these arguments to find a solution.
Technical Indicators As a Guide
The financial markets typically have multiple factors affecting asset prices and influencing trading decisions. Forex markets are even more complicated because they can be affected by a myriad of factors that you may not be able to account for in your analysis. For instance, a freak weather event like an earthquake in one part of the world could have a ripple effect across all global currencies.
They Give a General Picture Of the Market
Such occurrences can never be predicted, but that doesn’t mean it’s entirely out of your control. Technical indicators are one way to at least mitigate your losses by helping you manage your trades wisely. Take the example of the extreme weather events caused by global warming primarily affecting Asia such as a cyclone that forced the closure of a gold mine in Australia.
While this and other similar events cause significant changes to asset prices, the changes don’t stray too far from historical patterns. Above you can see that, even when major catastrophic events occurred, prices remained within certain limits. A general picture of the market such as this, thanks to a technical indicator, should be a guide through your trading journey.
Another way in which technical indicators act as a guide is while formulating a trading strategy. Imagine you’re planning to create a strategy to trade an asset based on the release of central bank interest rate decisions. The chart below highlights a few moments when the Fed raised rates and the impact of these announcements.
Using the indicators overlaid on the chart, you can see that the prices were affected and that the changes remained within a predictable range/limit. This is because technical indicators, especially the most popular ones, are used by a majority of traders. It means that traders look at historical data to determine what might happen, hence the predicted outcome will often come true.
Therefore, that should help you create an informed trading strategy as opposed to one where you have no guidance whatsoever. For example, you will know the best time to close the position using indicators that mark the historical pivot points around which trends stop and reverse.
Less Is More
Finally, technical indicators are simpler. To figure out how prices might change through fundamental analysis requires a deep understanding of the markets to discern the truth. As it so often occurs, for instance, two different blogs or forums can have varying predictions of the same asset. And that’s before you get into social media where anyone can publish their own opinions.
Seasoned traders can filter the noise using their experience to spot a weak argument or faulty logic. This is a skill that takes years to hone but, fortunately, technical analysis isn’t as complicated. The same technical indicator will display the same information across all trading platforms in the world, so all you need is to know how to use it, which is easier to do while remaining just as competitive as every other trader.
When Technical Indicators Fail
Even with all their benefits, technical indicators are not foolproof. Nothing is, but with these indicators, the fault is usually due to the user rather than the tools themselves.
Technical Analysis Can Be Very Subjective
Although indicators are the same across all trading platforms, it’s up to the individual trader to draw meaning from what it shows. Even a simple trend line such as the one represented below can have different meanings to different traders as you can see, and therein lies the problem.
Here, two traders start charting a trendline from the same point looking for a trend reversal when prices rebound. The first trendline signals a potential rebound early and the trader places a buy order, only for the downtrend to persist and result in a loss. In the second, though, the trend reverses fully and results in a successful trade.
You can see here that even the same technical indicator can be used differently leading to diverse conclusions. That is why traders are urged to back up their analysis using multiple indicators or by combining other systems like fundamental analysis. If a trader had done that, the second trendline would have had more gravitas given it followed the Fed’s announcement to raise interest rates by 25 points.
Real-World Events Can Break the Markets
Wall Street investment firms have become ever more reliant on trading algorithms, which in turn rely heavily on technical analysis. However, despite many traders being replaced by algos as a result, these firms still maintain a core workforce of human traders. The reason is that investment firms acknowledge the benefit of humans who can react to unprecedented events.
The global health pandemic of 2020 and the subsequent decisions made by governments and financial authorities like the Fed and ECB were not accounted for in historical data. These are the moments when human traders are necessary to navigate uncharted waters. Unfortunately, technical indicators simply aren’t as effective during such times, and sometimes need to be used with a handful of salt.
Market analysis using technical indicators isn’t perfect as we have seen in the aforementioned examples. What we can say for sure is that they are not scam tools to be avoided completely. After all, technical analysis has been one of the most effective trading strategies for decades and continues to be used by all traders.
You too should therefore learn how to use indicators and apply this knowledge to improve your performance. However, keep in mind their shortcomings to avoid being shortsighted or caught unaware. And what better way than to start experimenting right now on your trading platform and testing your strategy through backtesting.