Abstract
Technical analysis in the foreign exchange (Forex) market has yielded mixed results, particularly regarding its effectiveness over different holding periods in swing trading. This study addresses this gap by evaluating 497 technical trading rules across 10 currencies over 22 years (January 2000 to December 2022). Focusing on swing trading windows of 1-7 days, the research introduces the concept of an ‘optimal holding period,’ examining how price movements align with trading signals at varying time lags post-signal. The results demonstrate that technical trading rules significantly predict price movements in both developed and emerging market currencies, with emerging markets showing higher levels of predictability. Notably, simpel moving average (SMA) indicators perform most effectively for emerging market currencies, while oscillator-based strategies prove more successful for developed markets. These findings have practical implications for Forex traders employing short-term strategies, providing actionable insights for optimizing trade timing. Additionally, the study opens new avenues for future research on the role of technical analysis in enhancing trading performance in global currency markets.
- Introduction
The predictability of currency returns is a critical topic due to its potential implications for market efficiency and its practical value for investors. Historically, most asset pricing research has focused on understanding the equity market, where empirical studies have identified various anomalies that prompt investors to apply technical analysis techniques to outperform the market. Technical analysis, often called ‘Chartist analysis,’ involves generating trading recommendations based on time series properties of financial assets (Hsu et al., Citation2016). These recommendations can be either qualitative, relying on visual patterns, or quantitative, driven by mathematical models. Numerous studies have examined the predictability and profitability of technical trading rules across financial markets to identify successful trading strategies and test market efficiency. While technical analysis has been thoroughly explored in equity markets, its application to the foreign exchange (FX) market has received comparatively less attention (Park & Irwin, Citation2007).
The FX market is the world’s largest and most liquid financial market, with an average daily trading volume of $7.5 trillion in 2022, a significant increase from around $2 trillion in 2004 (Bank For International Settlements, Citation2022). Unlike the relatively more stable stock market, the FX market is characterized by high volatility, nonlinearity, and irregular price movements, making it one of the most complex financial environments (Ahmed et al., Citation2020). These unique features provide FX traders with a wide range of trading opportunities, particularly for short-term strategies, where technical analysis has proven popular. Surveys show that 30–40% of FX traders globally believe exchange rates are primarily driven by technical analysis, particularly over short-term horizons of up to six months (Menkhoff & Taylor, Citation2007). The strong reliance on technical analysis in FX trading reflects a deep-rooted behavior among professional traders, who often find it more effective in navigating the market’s intricacies.