Thursday, December 20, 2007

Why Technical Indicators Do NOT Work

For some of the people reading this post, the title must be a shock. Technical indicators do not work ? But almost all trading systems are based on indicators ? right ? Well... Yes and no. Many trading systems are based on indicators and yes, some of these systems may well be giving profit, but, is it truly because of the indicators ?

What does an indicator tell you ? Technical indicators are just graphical aids which are simply generated through pretty simple (or rather complicate) arithmetic operations on the information you already know. Yes, simply the information that is already there, in front of you, in every candlestick.

I mean, I could make an indicator that took the closing price, added it to the opening price, divided it by 200, added 20 and then (to make it more complicated !) divide by 10% of the previous bar. This indicator, which I will call Magic, would give us a fancy line, we could change some numbers, it would give as another line. We could observe what Magic does, and we could start generating signals. Like, when Magic crosses blabla then we buy or sell or whatever.

But what I am telling you now is that there is only ONE thing that matters inside a chart. THE PRICE. Nothing else, nothing more. The price, the way it moves, the way it reaches highs and lows, that is all there is to now about the market. Indicators, they obviously lag, because they only reflect the price. And hey, price cannot predict itself. That makes sense, right ?

So next time you plot your fancy MACD or your 20 different moving averages. Think about the chart, the patterns appearing inside it, how prices open and close, where ? why ?. Think about the logic behind the market. No fancy indicator will tell you anything the price does not.

If you want to earn money in forex and understand the market. Then, do that. Understand the market through the only information it gives you : prices !

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