Crucial to both flow and technical analysis is the idea that financial markets are not in fact inherently efficient and that the past can in fact impact the future. With flow analysis, one is dealing with trends in order flow. With technical analysis, one is analysing past pricing to make predictions about the future. At its most basic, technical analysis uses such concepts as “support” and “resistance” to denote points of dynamic market tension between supply and demand for an exchange rate, equity, bond or commodity. At a more sophisticated level, technical analysis relies on patterns in mathematics to suggest they may be reproduced in market pricing. Fibonacci, Elliott Wave and Gann analysis are examples of these.
“Charting” remains a controversial subject for some within the financial and academic communities who appear to regard it as little more than voodoo. In the real world of trading, hedging and investing however, nothing counts except results. Unlike in the economic world where the quality of the story is seen as important, almost irrespective of its accuracy, for traders, investors and corporations the bottom line is the bottom line. To that end, while classical economics has failed to explain short-term exchange rate moves on a sustained basis, flow and technical analysis have stepped into the void. Just as in economics, there are “good” and “bad” chartists or technical analysts. The profession of technical analysis however has consistently outperformed the returns generated by random walk theory and frequently also those by economists. In analysing exchange rates, currency market practitioners who do not use technical analysis in addition to fundamental analysis are hampering their own ability to produce consistently high returns.