Traders & Investors Club

 I had a conversation this week with a colleague (thank you Shyam!) about Technical Analysis versus fundamentals. We debated whether Technical Analysis is more appropriate for short-term trades whereas fundamentals trump the longer term view.

My view is this: I believe Technical Analysis is equally as effective in long-term analysis as it is in the short-term.

That said, Technical Analysis is a tool. It can be successful, but has to be applied with skill and discipline (just like fundamental analysis).

To illustrate how very accurate technical analysis is in the long-term, let’s do a step-by-step analysis of a long-term chart. We’ll look at the US Dollar versus the Swiss Franc, USD/CHF, on a current weekly chart.

Next step: I’ve labelled the last three major points on the chart.

Point 1: 1.19670; 12 March 2009

Point 2: 0.99090; 26 November 2009

Point 3: 1.17302; 1 June 2010

Now let’s look to see if there are any basic relationships between the three points on the chart. From Point 1, the price moved down to Point 2, retraced to Point 3 and then continued its moved down (in line with the longer term downtrend). Did the retracement from Point 2 to Point 3 match any key Fibonacci levels?

The above chart shows that as the price retraced to Point 3, it stopped within 2 pips of the 88.6% Fibonacci level.

So the price retraced 1,821 pips over 27 weeks, and it still managed to hit a key Fibonacci level within 2 pips!

It’s worth looking at how this would have looked with all the other Fibonacci levels in real-time:

As the price moved up past the Fib levels, the price never hit any of them cleanly and reversed. It did come quite near the 50% level, made a bounce before moving back up. However, it hovered around the level for 3 weeks before moving down. When the price pinned the 88.6% precisely (a sign that that particular level is going to be respected), the price quickly and decisively moved down. A trader could then plan trades using Point 2 as a downside target. If the trader waited two bars (or two weeks) after the Fib level was hit to confirm the reversal, there was still over 1,000 pips available up to the Point 2 target.

Note: The 0.886 Fibonacci level is derived by taking the 0.618 Fibonacci golden ratio, square rooting it, and square rooting it again.

More basic than Fibonacci, are trendlines. Let’s look at a simple trendline using the last two major higher lows on the chart:

Shortly after the trendline is broken, the price moves back up and retests it again within a couple of pips.

The first low marking the beginning of the trendline is on 17 March 2008. The subsequent retest after the trendline is broken is on 1 December 2010. So a trendline that took more than two and a half years’ to form was retested again within 2 pips. Since the retest, the price has moved more than 800 pips: very precise technicals especially given the hundreds of pips the price moved to meet the levels.

So what’s my point?

1. Technical Analysis can be as precise on long-term charts as on short-term charts.

2. You can use long-term Technical Analysis independently of other analysis.

3. You can use long-term Technical Analysis to plan trades.

H. Hamid

hamid@simplyprofit.net