Technical analysis consists of trading tools and theories used to forecast future prices. While technical indicators, like oscillators and trends, are built into the trading platform, things are a bit more complicated with trading theories. To use them, investors need to learn a bit more about the concepts and ideas behind them. Usually, the investors that use trading theories to trade financial markets have a longer time-horizon related to their trades. Scalpers (investors that keep trades open for a brief time to profit from the smallest market moves) aren’t fond of trading theories, as on their timeframe things change very quickly, therefore there’s no time to adjust the charts with the latest price developments.
Since technical analysis appeared over a hundred years ago, many investors have tried to understand the logic behind market moves. They used the U.S. stock market and the commodities markets at the start of the 1900s to document patterns and market behaviors. Even though the first trading theories appeared or were developed well before many of today’s financial markets even existed, the concepts still work today because they incorporate the main market sentiments: fear and greed. The principles are more or less, the same in 21st-century trading as they were over a hundred years ago.
Elliott Waves Theory
By far the most complex, sophisticated and intriguing trading theory, the Elliott Waves Theory, was created in the 1930s. Elliott, an accountant, fell ill and had the time to study the market movements. He documented impulsive and corrective waves of various cycles and dared to claim that the market expresses both pessimism and optimism in a predictable fashion. People that used the Elliott Waves Theory after Elliott’s death made quite an impression among other investors and by the end of the 1900s, the Elliott Theory became known as the “secret of the universe” among some investors.
Trading with harmonic patterns appeals to many retail Forex investors today due to multiple indicators that automatically spot harmonic patterns like crabs, bats, bullish and bearish Gartley’s, etc. Such indicators provide insight relating to entry, exit, and target; investors value such indicators as they can be used on all timeframes and all currency pairs. Few know that Gartley, known as the father of harmonic trading, was an investor who based his findings on Fibonacci ratios. In fact, together with Elliott, he was one of the pioneers in integrating Fibonacci with the market moves.
A fervent believer of price and time concepts when it comes to trade, Gann was famous for correctly predicting commodities and stock prices in the early 1900s. He firmly believed that each security (in the case of Forex – each currency pair) moves according to a rising or falling angle. As such, the 1×1 line became one of the most curious and emblematic lines in technical analysis, which gives the rising or falling angle of all financial products.
Andrew’s Pitchfork theory is based on three parallel lines, providing a rising and falling channel for a market with the middle line (ML or Median Line) attracting the price.
Over time, all these theories were refined by generations of investors. The Pitchfork was adapted to new market realities by Marechall and Schiff, Neely adapted some of Elliott concepts, and so on.
The three mentioned here are the most commonly used by retail investors, but many others exist (e.g. Drummond, Point-and-Figure). It is up to each individual investor to study the theories and apply them to the current markets. And, why not, if it takes them to the next level.
- Trading theories complement the trend indicators and oscillators as part of overall technical analysis.
- They originated in the early 1900s, documented on the stock market and commodities markets at the time.