Why You Should Know If Prices in Forex Are Random

The Efficient Market Hypothesis is a variation of the work done in 1900 by Louis Bachelier. It states that prices hold all the relevant information there is to know therefore the price at any given time is efficient. This work was done by Eugene Fama at The University of Chicago and is important to traders regardless of the financial market they trade.

Why? Because if the EMH is true, then the trader must conclude that market movement and behavior is random. Traders would also have to conclude that they have no better opportunity to make money than a gambler. And they would have to question why they were trading?

If markets are random then traders only have a 50% chance of being right and the long term result of trading would be zero. This is the same result you would get counting the flips of a coin.

According to Benoit Mandelbrot a Noble Prize winner, "the theory (of EMH) is elegant but flawed."

He says that prices are not independent of each other like the flip of a coin. He points out that his research shows that "financial price series have a memory of sorts." In short, prices are not random and professional traders are those who have strategies that allow them to make decisions about the future of prices. This is what gives the professional trader the ability to consistently trade in such a way to create substantial returns for themselves and their clients.

Retail traders can do the same thing if they develop resources that will give them insight as to the direction a specific trade is most likely to go. How often have you seen one moving average cross another creating the expectation of a substantial trend move only to see it turn back? Or knew with certainty that price would retrace to the 38.2% Fib level only to see it test that level and move hundreds of pips to the 50% level and perhaps further. This is when have resources at your fingertips could save you money.

There are different types of resources, keys or helps that professional traders use to increase the chances of doing better than a coin flip. Some examples would be economic statistics that can be known and studied, there is the policy of the Fed that can be considered, and traders should never trade without knowing statistical data on the particular Forex trading system they are using. It would be like managing a baseball team without the statistical data; but traders do it every day.

When a trade signal is given it may not mean that price will immediately move in the direction expected by the trader. Regardless, the trader should know which direction it should go based on economic statistics and what the current Fed policy is. There are many books that discuss this.

Last it is important to be aware of statistical data of past successes and failures of the trading system used to improve entries, exits and profits. Without this information, traders might just as well be flipping a coin to decide their entry; both when and in which direction.