Handbook of Exchange Rates

12.1 Introduction

Technical analysis is the use of past price behavior and/or other market data, such as volume, to guide trading decisions in asset markets. These decisions are often generated by applying simple rules to historical price data. A technical trading rule (TTR), for example, might suggest buying a currency if its price has risen more than 1% from its value 5 days earlier. Traders in stock, commodity, and foreign exchange markets use such rules widely. Technical methods date back at least to 1700, but the “Dow Theory,” proposed by Wall Street Journal editors Charles Dow and William Peter Hamilton, popularized them in the late nineteenth and early twentieth centuries.¹ Technical analysts—who often refer to themselves as “technicians”—argue that their approach allows them to profit from changes in the psychology of the market. The following statement expresses this view:

The technical approach to investment is essentially a reflection of the idea that prices move in trends which are determined by the changing attitudes of investors toward a variety of economic, monetary, political and psychological forces…Since the technical approach is based on the theory that the price is a reflection of mass psychology (“the crowd”) in action, it attempts to forecast future price movements on the assumption that crowd psychology moves between panic, fear, and pessimism on one hand and confidence, excessive optimism, and greed on the other.

(Pring, 1991, pp. 2–3)

Although modern technical ...