Conventional Technical Analysis Conundrum

I was monitoring the NZDUSD pair for a while now and the move in the past little while has proved to be quite interesting. I figured this would be a good example to show and make a follow up post to the ‘Technical Analysis Demystified‘ one.

There are two commonly taught technical analysis tools. The first one is support and resistance and the second being trend lines. Regardless of the market you are looking at, the price is either strongly moving in a direction or moving back and forth horizontally. Now you can see where the trend line and support and resistance levels came from. If the market is moving strongly in one direction, then trend lines are used to “best fit” the movement. Notice I did not say predict nor determine, but “best fit”. This is because trend lines can be broken and often need to be redrawn. Take a look below at the chart I was monitoring for the past little while.

Trend Line Failure

This is a 4 hour time frame chart of NZDUSD. Notice that there are two trend lines. We will focus on the descending trend line. Conventional technical analysis interprets retracement touches as strengthening the trend. What this means is that the more time the price touches and reverses from a trend line, the stronger it is. As a result, these books will often say to buy or sell when the price touches the trend line rather than watch the price reacts. I have seen some authors work out this probability thing where you can, in this case, keep entering sell trades as the price touches the trend line. By the time the price actually breaks this trend line, you would close it out at a small loss. Overall, it would be profitable as you would have captured multiple trend movements. However, what most do not keep in mind is that a trend line breakout does not mean a trend reversal. Just because price broke through a descending trend line, that does not mean an uptrend is necessarily coming. In order to show this, let’s analyze this trade in real time.

Initial Trend Line

This would be our initial trend line as it connects a lower fractal high signalling a trend reversal. Before this we had a very strong uptrend. It seems very short, but this is really just the time frame perception. After connecting two trend lines, you would have closed out your sell trade when the price crossed over this trend line. The 1 Hour time frame chart shows this better.

Hourly Break Out

You see a move cutting right through this trend line and then price attempts to fall. However, you see a bearish candle with a long lower tail and then a doji followed by a bullish candle. This candle shows that buyers are trying to push the price higher and so you want to get in early with a buy order. Then of course, the 4 Hour time frame shows a drop in price causing you to close out your second trade at a loss.

This is my point that trend lines need to be redrawn. Redrawing the trend line, you would have pulled off a successful trade and then another failure.

Another False Break Out On Redrawn Trend Line

You redraw the trend line one more time and net another profitable trade before having an emotional and psychological break down.

The Blue Box Depression
The Blue Box Depression

This area would have caused quite the havoc for the beginner trader. I admit I would have placed three or four trades reversing buy and sell orders each time a few years ago. This is how I took the trade.

Actual Trade
Actual Trade

I zoomed in and focused on the 1 Hour chart. Here I drew a possible supply zone and looked at the price behavior. This ended up being just one trade and I can pretty much just let it continue run its course. In the posts to come, I will touch upon techniques to offset these issues.

Moving on to the topic of supply and demand, I have some issues with how this concept is presented. Once again I have “Naked Forex” open in front of me and here’s the image I was looking at.

You Call That Support?
You Call That Support?

Seriously? You call that support? On this page, the author was trying to illustrate the support turned resistance concept. Unable to find a proper support level I assume, the author chose this point to illustrate a support zone. If you were to zoom in on this 1 Hour chart, it would show a trading range followed by a break out. Where the author indicated as support, it is really supply. This is just the introduction to the difference between supply and demand versus support and resistance trading. I often use these two together and I do not believe there is anything wrong with that. These are just planning tools and why change them if they work?


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