A new scientific method in the technical analysis of forex charts
Introduction
Since there is a market, people are trying to anticipate price movements in the future. For this purpose they make charts where the behavior of the price is presented. A candlestick is a chart that displays the high, low, opening and closing prices of assets for a specific period. Black/red indicates that the stock closed lower and white/green indicates that the stock closed higher.
The main topic of this blog is the currency market - forex. In order to anticipate future movements on the forex, traders are closely following political events, climate change, social movements, scientific advances, and so on. This aspect of assessment is со-called a fundamental analysis. In addition, forex traders pay attention to the so-called technical analysis that deals with chart analysis. The essence of technical analysis is the recognition of very characteristic geometric shapes that appear on charts. When at some point the forex trader recognizes a certain geometric shape or combination of candlesticks that has already seen in the past many times, it expects the future chart to behave in the same way and, accordingly, undertakes a specific forex action: it buys or sells. In an effort to maximize the profit of its forex action, guided by purely geometric reasons, it estimates the highest/lowest price would be reached in this move (take profit), as well as the price when the stock exchange action should be suspended because the the loss is unacceptable (stop loss).
A new method in technical analysis
The subject of this site is a new method in technical analysis. It is not based on the recognition of well known geometric shapes (double top/bottom, head and shoulders, rising/falling wedge etc.) but on searching for a huge database that contains patterns that are most similar to the ones on the current chart.
Let us consider Figure 1. Red/green candlesticks show the behavior of currency pair EURCAD on June 11, 2018. It was shown a daily chart for a period of 100 days. This period is called the "past", while the period of next 50 days is called the "future". In further exposure, a special role will have the closing price of the last candle in the 'past' field. This reference level, presented on by a solid line, divides the field "future" into two areas, "above" and "below" this level. We will call that level a zero level.
Among few millions patterns in database it was found a set of 100 patterns which approximate closing prices of current chart in the best way. They are presented by dashed lines in both periods, "past" and "future". Maximal high price as well as the minimal low price for each of 150 points were shown by red lines.
As one can see, the behavior of a set of selected patterns is different in these two areas. In the "past" area the set of patterns describes current chart quite good. In the "future" area the set of patterns resembles a some statistical distribution. Just this statistical distribution will be the basis for forecasting the price movement in the future.
On the right side of the picture there are three columns marked with n, a (above) and b (below). The meaning of the number n is easy to see from the picture: n is the serial number of candle from the beginning of the period, the number a indicates how many patterns (of the selected 100!) has closing price above, while b is the number of patterns whose closing price lies below the zero level. The numbers a and b obviously have the meaning of the probability that the closing price of the n-th candlestick will be above or below the zero level.
Is forex forecast possible?
Modern economic science does not give any importance to technical analysis. The valid dogma is that the current price is formed freely in a market involving a large number of actors, so, accordingly, the movement of the price in time is a random process, i.e. the price movement in the future can never be predicted on the basis of its past behavior. And is that always so?
However, we all read a lot of books in which it says: "... The picture shows the so-called double top pattern. Based on the enormous experience, it is known that in 73.2% of cases, the price of the currency pair will continue to fall to the level ..." The question is: who calculated this percentage? How can we check it?
The method presented here is an attempt to recognizing patterns in forex charts place on real basis, i.e. that the above percentages for each pattern - calculates. In that manner a widely accepted technical analysis would get a "scientific look" based on the real one statistics.
Let us analyze the result presented in the previous picture. First, pay attention to the position n = 101 that refers to the first next day, i.e., on a tomorrow day. As can be seen, 63 out of 100 selected patterns had a closing price below the zero level, 33 above and 4 exactly at the zero level. In other words, two-thirds of selected patterns indicate that the EURCAD pair will not grow on June 12, 2018. If it starts to grow (which is less likely!) it will stop at a value not exceeding 200 pips. If, however, it starts to fall, there are also possible significant movements. In addition, the picture shows that price movement in the area below the zero level is much more likely over a longer period of time. Are these conclusions not relevant to someone who practices daily trading?
The method just described is applied to 18 forex pairs every day, and the obtained results are presented in the form of images (see picture above!). In a myriad of cases, the results will reflect the fact that the movement of prices in the market is completely accidental, i.e. it is equally likely that the price of a currency pair will grow or fall. It only happens occasionally that the probability of an outcome (price increase or decline) is significantly higher than 60% and then we will consider that the method presented, our new forex tool, recommends action on the market. What traders would say: a signal came up.
Results of calculation will be published every day in the form of a blog post. A post in whose title the date will contain a button for the download of a zip file with 18 images that interested readers can view. If a significant deviation from the expected (completely random!) behavior occurs in a currency pair, an image and an accompanying comment will be posted next to the zip file.