Over the years, technical analysis has become popular with most of the traders. Many of them like to call themselves technicians. But does the traditional forms of technical analysis work now like comparing the current prices with the moving averages and their standard deviations. Trading technology is improving rapidly. In the early 1950s, technology was not that advanced. Information didn’t get transmitted quickly this lowered the number of shares that got traded on that information. So, the new information got incorporated into prices gradually. Newspapers carried previous days trading prices. This helped technical analysts a lot in inferring the future price movements. Thus technical analysis became a self fulfilling prophecy.
What this meant is that if enough people in the market believed in the fibonacci levels, markets would react at those levels or if enough traders thought that the head and shoulder pattern would results in a trend reversal, the prediction would come out to be true. But soon computers got developed.
In the early part of 70s, big institutions started using computers extensively. Institutional investors began modelling technical patterns using computers. Over the years, sophisticated algorithms have been developed to model the different markets. Most of them are econometric models that incorporate both technical as well as fundamental analysis. Fundamental analysis originated in the stock market and was popularized by people by Benjamin Graham in his book, “The Intelligent Investor” when he said that a stock price was linked with the performance of the company. Warren Buffet is known to be a firm believer in Ben Graham Intelligent Investor.
Soon, Wall Street firms started hiring mathematicians and physicists to use advanced mathematics to model the markets giving birth to Quant Trading Models. The idea was to identify market inefficiencies well before your competitors and use it for arbitrage opportunities. This required speed in trading. To increase speed in trading, more and more fast computers were used.
Thus high frequency trading developed at a rapid pace with the advances in computer technology. Soon, exchanges also followed suit when they switched over to electronic trading platforms. As high frequency trading became more and more popular amongst the big boys like the banks, institutional investors and the hedge funds, technical analysis used by the retail investors needed overhauling. Does traditional technical analysis work now? Especially in the forex market, we hear a lot about automated trading systems. More on that in the next few articles.