The importance of technical analysis in forex markets

The widespread use of technical analysis by forex traders was first took into consideration at the end of the 1980s. At that time the technical analysis did not receive much support among economists. The scepticism with which academic economists initially viewed (and to some extent continue to view) technical analysis came largely from the true belief in the efficient markets hypothesis developed by Eugene Fama, which states that all relevant information are always embodied in prices, making it impossible for traders to earn excess returns on forecasts based on historical price movements.
In the 1990s some empirical studies were made to test the use of technical analysis among traders. The first one was by Allen and Taylor and was carried out among chief forex dealers at financial institutions located in London in 1988. Others have covered traders based in London, Frankfurt, Hong Kong, Singapore, Tokyo, New York and Zurich. In 1995 the BIS ranked the seven locations covered by the survey studies as first to seventh in terms of daily turnover in forex dealing, making up about 78% of the total global turnover; the combined market share of these centres was virtually unchanged until 2004.
These empirical studies documented systematically that technical analysis was (and still is), indeed, an important tool in decision making in the forex market. They further discovered complementarity in the use of technical and fundamental analysis by traders , and showed that reliance on technical analysis was skewed towards shorter trading or forecast horizons. Three stylised facts emerged: 1) almost all forex traders use technical analysis as a tool in decision making at least to some degree; 2) most forex traders use some combination of technical and fundamental analysis; 3) the relative weight given to technical analysis as opposed to fundamental analysis rises as the trading or forecast horizon declines.
Those surveys which asked traders whether or not they used technical analysis at some horizon found that around 90% or more did so. The fact that traders use technical analysis does not by itself, however, mean that they regard it as of major importance—they may attach some weight to it, but only a low weight. Although not identical in design, most of the surveys also asked traders to quantify the weight given to technical analysis relative to fundamental analysis at various horizons; the average relative weight assigned to technical analysis ranges from around 30% to a little over 50%.
A further aspect of the importance of technical analysis concerns its use among various groups of traders, since a high average score could mask its concentration in small subgroups. Technical analysis is perceived as important relative to fundamentals across a range of practitioner groups such as chief forex dealers, international portfolio managers and others, whatever their specific role in forex trading may be. Early analytical studies that allocated a role to technical analysts or chartists tended to view chartists and fundamentalists as competing groups. Some studies, however, challenges this adversarial view of chartism and fundamentalism. Other studies have basically reproduced this finding of perceived complementarity (i.e. a reliance on fundamental and technical analysis). In particular, the weight given to strong mutual exclusiveness of chartism and fundamentalism, i.e. a reliance on either fundamental or technical analysis, is at most 10% of respondents in all studies.
Finally, technical analysis tends to be perceived as less important at longer horizons in comparison with fundamental analysis. Some studies relate the perceived relative importance of technical and fundamental analysis with forecast or trading horizon. Other studies, instead, show the result remains unchanged for the medium and longer horizons but becomes less clear for the very short horizon. There is, however, an obvious reason for this apparent difference in perceived relative importance at the very short horizon, in terms of their coverage of analytical tools or price-determining factors. In particular, some studies take into account other factors such as the perceived importance attached by traders to information on order flow (i.e. on information relating to the value of forex transactions signed according to the originator of the trade). The inclusion of factors other than technical and fundamental analysis in the menu of choices offered to survey participants thus dilutes the relative score given to technical analysis in the shorter-term domain.