How Are You Predicting Prices in Forex?



Predicting the future in Forex is difficult if not impossible. If you read most economists and mathematicians over the last 110 years you would have to come to the conclusion that prices are efficient and therefore it is most difficult to make a profit.

Most trading Forex trading books and systems ignore this however, offering systems that actually play into the strengths of the Efficient Market Theory. This theory has governed most trading on Wall Street and other Global markets since 1900. My contention is that one of the reasons that most Forex traders trading today's markets fail (95%) is because they fail to appreciate this information.

Chart patterns are over-rated

Many trading systems use chart patterns to determine a trading position. While chart patterns do appear on charts it was shown years ago that chart patterns similar to what are being traded today (ascending and descending triangles, head and shoulders, etc), can and have been produced by flipping a coin and recording a +1 for heads and -1 for tails. Unless there is statistical data for these patterns and their odds of a trade direction based on the pattern, they do nothing to provide predictability.

Auto trading systems

Many traders just getting into Forex, or those who have been unsuccessful on their own, opt for an automated system. Automated systems are wonderful ideas but in the absence of knowing exactly how the system is picking trades, they should not be used. No system is good in all conditions and regardless of the programming cannot outperform the Efficient Market.

Other trading methods

I could go on as to the weaknesses of Fibonacci, Gann, Elliott Wave, moving averages and other technical methods that attempt to predict the future.

Where are the markets vulnerable?

My thinking on this after exploring the literature for a number of years, is that a trading method must have a way to determine when momentum is changing. This is when new or unexpected or uncontrollable news comes into the market place.

The signal in Forex trading is simply an alert the trader uses to determine if there is a "possibility" to trade. The possibility of the trade is like a window of opportunity. In fact, the signal could occur at the right time but the window of opportunity may not present itself.

Here are two partial solutions to this problem.

Algorithmic signals that can be tested statistically

There must be a trading signal that signals an alert based on an algorithm. All this means is the signal should alert you to the trade opportunity. Of course, the signal should tell you something; for example, a moving average cross tells you little. Your signal should place you in position to take advantage of a window of opportunity, if it is there and if it is open. It should give you market direction and it should have statistical data that tells you the odds of your being right.

Market order flow (momentum)

At the moment of the window of opportunity, the market must provide momentum or "force" in the direction you are trading. One of the ways this can be seen is using the Open Positions and Open Orders Chart at Oanda. This can give you an idea for example of when the traders are in significant areas of profit. If you then understand when those traders will or most likely will take profit you will find a window of opportunity that you can combine with your trading signal.