What is your favorite method of technical analysis?

Perhaps you use Bollinger bands or Fibonacci? What about trend lines or moving averages? Have you back-tested and live-tested a few technical strategies and been disappointed with mediocre results?

If you are anything like me, you take the disappointment in stride. After all, a few bumps in the road isn’t going to stop the dream of becoming a professional trader.  And so, you double down. You test strategies with ATR, custom moving averages, the Ichimoku cloud, MACD, Stochastics’ and price action. Again, mediocre inconsistent results.

You purchase a number of technical courses taught by professionals or automated by a robot. You experience some success! But before long inconsistency takes hold and you start to become cynical and switch to another system. Why don’t these strategies work?

I have good news! They all work. They all are profitable.

Technical strategies are very profitable when applied in the correct market environment.  That’s why we spend a lot more time on the fundamental drivers and current sentiment than perfecting technical strategies. This doesn’t mean you forget about risk management and discard all technical analysis. You simply understand that the most important part of trading is finding a fresh reason to get involved in the market at that particular time.  

Consider two charts as we apply our technical tools. The first chart is the EUR/AUD from the 9th of November to the 18th.
 

EURAUD

 

Let’s apply the commonly used “breakout strategy.” Start at the left-hand side of the example above, it doesn’t take long to see that you would have inconsistent, frustrating results. The blue boxes represent areas where breakout traders would have nightmares. You would get sucked into trades only to have the market reverse on you. At this point, it’s easy to use hind-sight to repair our technical models and try to make them fool proof. We continue to add indicators, additional strategies and qualifiers and then repeat the cycle.

These technical strategies may boast a 5-1 risk to reward return. They may claim that a high winning percentage doesn’t matter because when you win you make more than you lose. There is a good reason this “breakout strategy” is failing on the EUR/AUD. Simply, there is no prevailing fundamental or sentiment driver in the pair. In fact, the currencies are conflicted with the EUR down and the AUD moving up. There is nothing pushing them in one direction. At Jarrattdavis.com we focus on three things in order of importance.

  1. Find a fresh fundamental or sentiment based reason to get involved with this market at this time.
  2. Use appropriate risk management
  3. Apply simple technical analysis

Instead, in this example, technical analysis is the most important and then perhaps risk management. Barely a passing thought is given to the fundamental drivers of the currency pair or the current sentiment.  

Instead, consider this example. This chart is the USD/JPY from 9th of November to the 19th

 

USDJPY

That is the same time period as the EUR/AUD, just after Donald Trump was elected president. The market recovered from its initial fear of a Trump presidency and started to get excited about fiscal stimulus. (Basically, any kind of spending on domestic projects to boost the economy.) This in turn prompted analysis that the fed would raise interest rates to keep up with inflation. All of this is very dollar positive. We also know that in a risk-on environment the JPY weakens. We also know the Bank of Japan is intent on printing additional money to stimulate inflation. All of these facts, give us a very bullish view on the USD and a bearish view on the JPY. These facts also tell us that there is a very current reason to enter long trades on the USD/JPY.

This is the environment that we want to get involved in. This is not simply a trend. It is a fresh reason that makes market participants eager to buy the USD/JPY.

Once you have a firm view that the dollar should be strengthening and the JPY weakening in the immediate term, then we can apply our technical tools. We learn that they are very profitable and consistent.

The blue boxes in the USD/JPY example above illustrate points where you could have taken a profitable trade using a breakout strategy. But it doesn’t stop there. You could have successfully used pullbacks to support and resistance. You could have used moving averages. You could have used pivot points. You could have used Fibonacci. You could have used the Ichimoku cloud and the list goes on. Many different technical tools would have given you the same result: Profitability.

 

 

At no time should anyone view the information presented anywhere on this website as advice, recommendation or proven. Everything reflected is merely opinion and may not be accurate. The purpose of the site is to express the opinions and views of Jarratt Davis. There is no intention to offer specific help, advice or suggestions to anyone reading any of the content posted here.

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Editors’ Picks

EUR/USD: Corrective advance could continue up to 1.0900

The American dollar finally gave up on Friday, easing against most major rivals on the back of dismal US data. After hitting a fresh multi-year low of 1.0777, the EUR/USD pair finished the week with modest gains at around 1.0850. 

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GBP/USD: UK-EU trade negotiations loom

The GBP/USD pair continued to recover on Friday, after bottoming early Thursday at a fresh 2020 low of 1.2848. The pair settled around 1.2960, still down for the week. Cable bullish potential limited ahead of the critical 1.3000 threshold.

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USD/JPY extends losses below 111.50 as coronavirus spreads outside China

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The coronavirus remains front and centre of the theme for forex at the start of this week. Friday's close leaves a consolidative tone for today's open, if not a risk-off bias which could continue to fuel a bid into the greenback.

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