How the news can destroy Technical Analysis

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How the news can destroy Technical Analysis

Good Day everyone,

In this article I will share with you my trades and I am going to discuss the impact of the news to the price. First of all, take a look in my results.

As you can see I had one ITM trade and one OTM trade. The OTM trade is because of the news the time I took my second trade. Some traders, trade the news but I will discuss this tactic in a next article. In this article I am going to explain you how the news can make Technical Analysis useless if you will trade the time that we have news announcements. Let’s go to see the first screen shot of the day.

It’s from EURUSD currency pair.

As you can see the time I took the trade the market was ranging above the daily pivot (the blue horizontal line). The red horizontal line is our resistance. When the price hit the resistance and it was trying to retest it our 3 period RSI was overbought near to the 92 level. I took a put and it was a solid ITM trade. After that, the price is moving down, makes lower- highs and we have a new down trend. Notice that I am working in 5min charts in these trades.

Now, let’s see the second screen shot from my second trade. It’s from USDJPY currency pair.

In the beginning of the chart the price is moving slowly without important volume. Then, we have a move up and the price makes pull backs about 30 minutes in the red horizontal line which is our resistance. Our RSI made a move down after the overbought zone and after some minutes is again in the overbought zone. I took my trade in the put arrow, I took a put. The reasons were the overbought condition, the price hit the resistance and there wasn’t enough movement in the market. I took my trades in the close of New York Session. And then, it happened. A big bullish breakout and my trade was OTM. Within the 5 minutes (my expiration) I was looking for a small pull back to cut the loose but it never came. So, the question is why we have this breakout. The answer is NEWS. Some minutes ago, there was news for the 30-year-Japanese Bond and this news had of course impact to the JPY currency.

So, if you are a technical analyst doesn’t mean that you can ignore the news. Most of the time news is unpredictable and you should follow a different strategy from technical analysis strats to trade them. A news calendar indicator is “a must” to your platform because you should know if there is some news, every time.

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How Volatility Can Sabotage Your Technical Analysis

Technical analysis is a blend of an art and a science. It cannot be one without the other.

While its inner-workings are somewhat of a mystery, one thing we do know is that it relies on market perception. A pattern or level that stands out as obvious to one experienced trader is likely obvious to many other experienced traders. Through this idea of perceived value, technical analysis just “works”.

But what happens when a level or pattern is only obvious to a handful of traders using the same broker?

Heavy volatility, which is common in the Forex market, can cause this to happen. So instead of seeing things from the same (or similar) perspective as the rest of the market, you see a fragmented view of it.

This fragmentation can be disastrous for the technical trader who relies on price action to determine areas of value. The good news is that there is a solution to this problem; a very easy one, in fact.

By the end of this lesson, you will not only understand how volatility can misdirect your technical analysis, you will know how to overcome it.

Don’t Blame Your Broker

Typically when I show someone what I’m about to show you, the immediate response is to blame their broker for not offering the “correct” price. But the disparity in pricing between the brokers you are about to see isn’t really about right versus wrong.

Get Instant Access to the Same “New York Close” Forex Charts Used by Justin Bennett!

Rather than focusing on the broker, it’s much more advantageous for you to focus on what you plan to do in the event this happens to you. Because once you are aware that heavy volatility can cause different Forex brokers to display widely different pricing for the same currency pair at the same time, you will be better able to account for it when you do your technical analysis.

That said, I have seen cases where the price action that is offered through a broker’s feed is absolutely abysmal. I’m not going to throw anyone under the bus here, but as long as you stick to one of the larger, more regulated brokers in the industry, you should be just fine.

Fibonacci and Volatility Don’t Get Along

For example purposes, we will be using one of the more popular tools when it comes to technical analysis – the Fibonacci retracement tool. Of course, anything that affects the use of this tool can just as easily affect other areas of your analysis, so be sure not to discount the following lesson in the event you don’t use this particular tool.

I was recently asked a question regarding a multi-year high on GBPNZD. The question pertained to using the Fibonacci tool to help determine where the pair might run into selling pressure on the way back up from a recent low.

It went like this – which of the two highs in the chart below should be used as the starting point to identify the key Fibonacci levels?

This was a valid question given the volatile spike in price (first high) that could throw off the Fibonacci sequence.

Under normal circumstances, you always want to use the swing high or low. In the case of the chart above, that starting point would be the high of the largest candle.

However, with the answer I gave, it wouldn’t matter which high this trader used because they would both technically be “incorrect”.

The three charts in the image above are from three different brokers (Pepperstone, FXCM and Forex.com). Notice that the actual multi-year high for GBPNZD varies widely depending on the broker.

To put things in perspective, the range from Pepperstone (highest high) to Forex.com (lowest high) is a massive 564 pips. This presents a huge problem – and a potentially costly one at that – for the trader who is trying to determine the “true” swing high in order to use the Fibonacci tool.

Just imagine if three traders, each using one of the three brokers above, attempted to draw out the Fibonacci sequence on a GBPNZD chart. It would end up looking like a plate of spaghetti.

On second thought, why imagine when we can draw it out?

Not very helpful, is it?

If this is what traders from those three brokers see, just imagine how the entire retail market is seeing these levels. I would bet that just about every single price from the swing high to the swing low would be accounted for if you did this exercise using every broker in existence.

This is obviously not ideal when your primary duty as a Forex trader is find and trade from the most obvious levels in the market.

All of that said, this does not mean that the Fibonacci tool is useless. I use it quite often and have found great success with it, especially when using it to identify potential major tops and bottoms.

What all of that does mean, is that the tool is only accurate when used in the right market conditions.

What are the “right” conditions, you ask?

Put simply, conditions where high levels of volatility are not an issue.

When used during periods of increased volatility, such as the one in the GBPNZD chart above, the tool is rendered quite useless. In fact under extremely volatile conditions, the Fibonacci tool can be downright dangerous to use as it can lead to false positives when drawing your key levels.

Lastly, the misdirection that volatility can cause doesn’t stop with something like the Fibonacci retracement tool. Any other tool or method of identifying key levels off of a volatile spike in price can be misleading, causing you to mark a level that may not be universally obvious.

So What’s the Solution?

There are two things you can do when faced with volatile conditions like the one we just discussed.

The first is the most obvious, which is to do nothing. That may sound like I’m being sarcastic, but I assure you that doing nothing is an extremely viable option as a trader. In fact, it’s the recommended option if you are ever unsure about what to do.

Remember, your number one job as a trader is to protect your capital, making money comes second. Also remember that you have dozens of currency pairs to choose from. So no matter how good a trade setup may look, it helps to know that it probably isn’t the only one out there.

The next option as it pertains to using the Fibonacci tool is something that I always do, regardless of the level of volatility in the market. That is to only give credit to a Fibonacci level if it lines up with a predetermined level on your chart.

This is something I have talked about before as a way to gauge whether or not these levels have any real significance, or if they are simply false positives that can throw you off.

Final Words

For many, the idea of an increase in volatility means a greater opportunity to capitalize on price movement. While this is true to some degree, a heavy increase in volatility can also misdirect your technical analysis, making it difficult to identify truly favorable trade setups.

Therefore it’s important to always take the current level of volatility into account when performing your analysis. While your broker may do its very best to offer reliable and accurate pricing, odds are that it will vary greatly from other retail brokers during periods of intense price swings.

Knowing this will allow you to discount the reliability of any false positives, putting you one step ahead of the retail crowd.

Your Turn

What do you think? What is your favorite method of dealing with high volatility in the Forex market?

Leave your feedback using the comments section below.

Leave a Comment:

4 comments

Adrian, glad to hear that. ��

high volatility , now i do nothing except if it is in the direction of fundamentals (long term ), like US NFP and Wages last friday , for the moment i am still looking to GBP/JPY retracement and will see if there is a south reversal when we will approach to the next Brexit issue …

Hello Justin, please I think a site like this is supposed to have search box. Yes it should! Please try to add it.

Yes I love this! I have once found myself trapped in a very volatile market,where I have had a very good trade setup, but, lo and behold, market suddenly turned against me that day, after I have read the news and discovered the direction of the market. The best thing to do is to abstain from the market, so till the proper time to trade comes: I mean the time the market is less volatile, when the market is steady. We new traders always put the blame on our broker that maybe they scam us, of course it’s what I had once done to my broker all because I have no knowledge of what’s is going on, how the currency market behaves.

This is a great lesson to learn from.

Thanks for sharing this, Justin.

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Problems Of Technical Analysis And How To Overcome Them

Problems Of Technical Analysis And How To Overcome Them

Let me put it out there: It doesn’t matter which strategy or system you use. Any trading method can make you money. And by trading method, in this context, I mean the way you define entries and signals. This is a bold statement, but I stand by it. They way you read charts and theВ way you define entries has usually nothing to do with the quality of the system and whether or not it is profitable. This is especially true when it comes to technical analysis.

TechnicalВ analysis and price action analysis seemsВ so easy and simple. The patterns lookВ very clear and obvious to an inexperienced trader butВ the truth is, that technical analysis and price action trading is maybe one of the most subjective andВ difficult to master trading styles out there.В You don’t believe me? Other ‘trading experts’В usually say theВ complete opposite but keep on reading and you will see how technical analysis is not what you think it is and why it is harder to master than traders believe

I can reassure you that this article isn’t going to badmouth technical analysis – in the end, I am a huge fan of technical analysis myself – but to serve as an eye opener and provide you with a whole new perspective on the way technical analysis and trading works. We have talked about system hopping frequently before andВ one of my main goals over the past years on Tradeciety has been to make sure thatВ traders stop system hopping as much as possible.В Your trading shouldn’t be about hunting new and ‘better’ entry methods, but building a robust trading approach that looks and combines allВ concepts of trading and here are a few thoughts of mine…

Technical Analysis Is Subjective And Any Method Can Work

This is a statement no technical trader wants to hear. Traders choose to become technicians because they don’t want to deal with the uncertainty and the subjectivity fundamental traders have to face, right? Isn’t the advantage of being a technical trader that you can easily draw some horizontal lines, channels or identify pre-defined price action patterns?

To start off, let’s observe the following charts. They all show the same instrument with the same timeframe over the same time horizon, but with different price action patterns and tools. The point is, as I mentioned before, it does not matter which system or method you choose. A profitable trader is not characterizedВ through his way of choosing entries, but it goes much deeper.

We start byВ just looking at trendlines and trendline breaks. The signals look good and very clean for the most part.

But not all traders like trendlines and so another trade might choose to look forВ head and shoulders patterns which could have given the same trade signals basically.

Moving averages are also very popular and they are used to identify cross-overs and then get into longer term trend-following trades. The signals look very good as well and a trader could probably improve the quality of the signals by adding another moving average to create a moving average crossover system.

The StochasticВ indicator analyses momentum and momentum shifts. In its purest form, the trader looks for a cross of the two Stochastic lines between 80/70 and 30/20. Looking at the screenshot below, we can see that the Stochastic indicator could also have been used toВ identify good trading opportunities and catch some longer term trends as well asВ trade some of the shorter term ranges in between.

Of course, we cannot go without horizontal support and resistance and local swing highs and lows. You can see that we can nicely explain the same chart using those classic technical analysis concepts as well. We look for bounces at the levels or breakouts of levels.

And finally, we can even spot a ‘puking camel‘ pattern 😉

The Takeaway Message For Technical Traders – What really matters

The message is clear: you can take any chart, pull up a random timeframe and apply any price action pattern or indicator to it and find (potentially) great entry spots and ways to ride trends for hundreds of pips. This called the hindsight error andВ a trader needs to be aware of that to make theВ right decisions.

If you look closely at each individual chart above, you can see that, although the entry signals look very clear and the trades seem profitable, in real-time trading, this would have been much harder because we haven’t looked at what is really important: emotions, execution, orders risk management and trade management.

Again, I want to highlight the point that a trading method cannot be reduced to how you pick your entries alone. Only amateurs think this way. Let’s go over each point and see how it impacts a trading system.

Emotions

Obviously, emotions are a big deal in trading and they impact all our trading decisions. From FOMO when we enter a trade, to risk management, trade management, dealing with drawdowns during a trade and exiting trades. Thus, the first thing you need toВ do is to make sure that emotions are influencing your trading decisions as little as possible. This is far more important than the question which pattern or indicator to use.

Execution and orders

How do you really define an entry and where do you place stop loss and take profit orders? Even the best entry is totally worthless if your stop and profit placement are off because you will run into stop runs, take profits too early or too late and give back money.

Trade management

Micro-management is a big deal and we have talked about it before. Many traders mismanage theirВ trades when they let their emotions take over, or when they don’t have a real trading plan and know what to expect.

Risk management

A trader with inconsistent money and risk management can easily destroy the best entry method. Being clear how much you risk, what your minimum reward : risk ratio is and how to apply leverage are fundamental concepts and a trader has to master them before looking at entries.

The role of entries and spotting patterns isВ totally overrated in today’s world of trading and entries should have a very small role in your trading. I say it again: it does not matter which system you follow, В any method can make money and any method can lose money. Entries are not relevant to the profitability of the system. Instead, focus on the other things to build a robust trading method. Once a trader is aware of the other components of hisВ trading method, he will be able to look at his way of trading in a completely different way.

The ImperfectionВ Of Price Patterns

Let’s come back to the hindsight error and something most traders miss when it comes to technical analysis. MostВ traders look for those textbook patterns and very clear moves but those same traders are usually always the ones who are left behind, wondering how they could have lost money on seemingly profitable patterns.

Price action patterns andВ price moves are ‘imperfect’ which means that they don’t follow your textbook rules. Price is a very dynamic concept and it’s important to understand how other traders are out to get you. At the same time, it’s important toВ internalize the imperfection and get a feeling for volatility and natural price movements to be able to manage stops and trades in general.

On the left site, you can see the textbook patterns which tradersВ expect and try to trade. However, what really happens is that you see stop runs, squeezes, back and forth and lots of volatility.

Again, entries and finding patterns is overrated and it’s not about how you time your entry, but everything that follows: stop placement, reward:risk ratios, trade management, exit taking, risk management, etc.В

Why Technical Analysis Can Be Unprofitable

One of the main reasons why traders are unable to make money by following technical analysis is the lack of knowledge about the importance of discretion in trading. Especially patterns such as Head and Shoulders, support and resistance, trendlines, Cup and Handle, Elliot Wave, Triangles, Wedges, Flags and Pennants are very discretionary when it comes to entries, stop loss and take profit placement.

Technical traders face dozens of difficult and very subjective questions each and every day: where do I draw my second shoulder?В Is this the neckline? Do I connect the wicks or the bodies? Is this the candle where my triangle starts? Is it an actual wedge? Which candle do I use to connect the tops for my trendline? Should the handle of the cup be a little higher? Is the divergence from my MACD already confirmed? Did price successfully re-test my moving average, or do I wait another candle? Is this a strong enough breakout or do I need to wait more? How likely is a retest of my neckline and what does it mean for my stop loss? Is this a retest or a failed breakout? etc.

I urge you to stop putting all your time and energy into finding better ways to enter a trade or exploring different ways to time entries and instead focus on the other parameters of your trading system. I have never seen a profitable and successful trader who spendsВ the majority of his time looking at entries. The best traders obsess about developing a robust systemВ and spend most of their time looking at risk management, order placement, trade management, profit taking, managing reward:risk scenarios, etc.

Tips On How To Use Technical Analysis

The single most important point about this article is: stop obsessing about entries,В stop hunting for better ways to time trades. Pick ONE method and make it work instead of jumping from one thing to the next. If you are losing money right now, it’s not because your entries suck. We have seen it with hundreds of traders when working with Edgework: what keeps traders from reaching profitability is not because they pick the wrong entries, but because they neglect everything else.В

The following tips will help you structure your trading approach and add some objectivity to the subjective world of technical analysis.

  • Create fixed rules for how to draw price action patterns and even better, write them down and print out an example chart so that you can refer to it when you are trading
  • Be clear which patterns you trade and whatВ differences you see between a good and a bad pattern
  • Know which tools and indicators you use and don’t jump around
  • Avoid the hindsight error and look objectively at past setups
  • Entries are not as important as most think. It’s what happens around the entries that make or break a system
  • Understand the imperfection of trading patterns
  • Technical analysis is very discretionary. You really need to know every part of your system to avoid subjectivity
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