Why you should consider abandoning trend-line analysis

Aug 6 • Forex Trading Articles, Market Commentaries • 279 Views • Comments Off on Why you should consider abandoning trend-line analysis

There are many self-fulfilling prophecies involved in trading, these phenomena are especially relevant to any forms of technical analysis. Traders have a tendency to over-complicate technical trading analysis, they also have a habit of joining up dots that are, for the most part, totally meaningless. Seeing patterns which are irrelevant, have no value and that others can’t see, are often referred to as either apophenia, or pareidolia. These diagnoses can often be regarded as serious medical conditions and they can have relevance with technical analysis. Many technical analysts will think they can spot patterns of behaviour that actually have no relevance to market behaviour, patterns that might encourage them to take a trade off a particular time-frame, a diagnosis that will simply disappear if you move up or down the various time-frames.

Traders might use basic candlestick formations, individual indicators or combinations of indicators to make their decisions, they can become absolutely convinced that the patterns they see have relevance. Worse still, they may commit the trading sin of curve-fitting the various combinations when in back-testing mode to get the results they require, by altering the standard settings of the indicators and the time-frames. They’ll quickly discover that the analysis perfectly matched the past, but has no bearing on the direction price may take in the future.

One of the most dangerous use of technical analysis can be trend-line analysis. Traders will take various points of highs and lows of price, when measured over a series of sessions or days and then draw (approximate) straight lines. They’ll then attempt to convince both themselves and an audience that the trend lines are representative of the collective market deciding to shift sentiment, or to stay in the current trend. If the trend line becomes broken on a certain time frame, many analysts will call it out as a sign that a new market development has occurred.

The theory of trend lines been broken or failing to be breached as representing some form of change or a continuation of a current trend, would only have relevance if all market participants based their decision making on the same premise. For example, if all institutional level FX traders analysed the market for GBP/USD based on a trend-line break on a daily chart and thereafter decided to go long or short as a consequence, then trend-lines may have relevance. Trend lines occur only when traders draw them, after interpreting them as having significance. If they weren’t drawn by certain traders thinking they’d identified a point of interest in the market, then they’d be ignored.

A trend line is only a trend line on a particular time-frame, for example you may draw it on a four hour time-frame, however, if you then attempt to draw it on a daily chart, it’ll have no relevance, similarly it’ll have zero relevance on the weekly chart, or on lower time-frames such as the ten minute time-frame. A trend line can only indicate a specific trend on a particular time-frame, that’s its only use, it would be reckless to apply or attach any more importance or significance to this most basic of analysis tools.

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