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Master Thesis Masaryk University Faculty of Economics and Administration Study Programme: Finance THE USE OF TECHNICAL ANALYSIS IN TRADING ON FOREX MARKET Master Thesis Supervisor: Author: Ing. Peter Mokrička Bc. Marián Hockicko Brno, May 2014 Masaryk University Faculty of economics and administration Department of finance Academic year 2013/2014 ASSIGNEMENT Name: HOCKICKO Marián Department: Finance Topic: THE USE OF TECHNICAL ANALYSIS IN TRADING ON FOREX MARKET /Czech/ Vyuţití technické analýzy při obchodování na trhu FOREX P r i n c i p l e s : The aim: To propose an optimization of selected technical analysis indicators on the Forex market and formulate recommendations for intraday traders. Approach of work and the methods used: 1. Definition and characteristics of FOREX market 2. Characteristics of technical analysis and technical analysis indicators 3. Creating, testing and optimization of defined trading strategy 4. Formulation of conclusions and recommendations Methods: description, analysis, comparison, deduction, synthesis Graphic pictures: acoording to instructions Extent: 60 – 80 pages Bibliography: BACHRATÝ, Milan. Forex :dobrodružstvo vývoja stratégie. [Slovensko]: Fxmprofit, 2012. 190 s. ISBN 9788097092603. VESELÁ, Jitka. Investování na kapitálových trzích. Vyd. 1. Praha: ASPI, 2011. 789 s. ISBN 9788073576479. HARTMAN, Ondřej. Jak se stát forexovým obchodníkem :naučte se vydělávat na měnových trzích. Praha: FXstreet.cz, 2009. 230 s. ISBN 978-80-904418-0. O'KEEFE, Ryan. Making Money in Forex: Trade Like a Pro Without Giving Up Your Day Job. : John Wiley and Sons, 2010. ISBN 0-470-48728-3. HARTMAN, Ondřej a Ludvík TUREK. První kroky na FOREXu. Vyd. 1. Brno: Computer Press, 2009. 120 s. ISBN 978-80-251-2006. Trading and investing in the Forex market using chart techniques. Edited by Gareth Burgess. Hoboken: Wiley, 2009. xiii, 211. ISBN 9780470745274. Turning losing Forex trades into winners proven techniques to reverse your losses. Edited by Gerald E. Greene. Hoboken, N.J.: John Wiley & Sons, 2008. xi, 224 p. ISBN 0470187697. Supervisor: Ing. Peter Mokrička Thesis bulit in: 5. 3. 2013 The deadline for submitting the thesis into the IS is listed in schedule for the academic year …………………………………… ………………………………………… Head of department Dean In Brno, 5. 3. 2013 Name and Surname of the Author : Marián Hockicko Title of the Master Thesis: The use of technical analysis in trading on FOREX market Title in Czech: Vyuţití technické analýzy při obchodování na trhu FOREX Department: Finance Supervisor: Ing. Peter Mokrička Year of defense: 2014 Annotation The master thesis on topic ―The use of technical analysis in trading on FOREX market‖ detects, if there is possibility for improvement in trading using technical analysis indicators and their optimizing. The thesis defines Forex market as an integral part of financial market, introduces market participants and currency pairs. Followed by description of individual elements of technical analysis and subsuming of technical indicators at Forex market. In the last chapter, chosen technical strategies will be tested and optimized afterwards. Finally conclusion and recommendation for intraday traders will be drawn. Anotace Diplomová práce na téma "Vyuţití technické analýzy při obchodování na devizovém trhu" zjišťuje, jestli existuje moţnost zlepšit obchodování s vyuţitím indikátorů technické analýzy a jejich optimalizace. Práce definuje trh Forex jako neoddílnou součást finančního trhu, opisuje účastníky trhu a měnové páry, které lze na trhu Forex obchodovat. Následuje popis jednotlivých prvků technické analýzy a začlenění technických ukazatelů na Forexu. V poslední kapitole, budou vybrané technické strategie testovány a následně optimalizovány. Nakonec budou vypracovány závěry a doporučení pro intra-denní obchodníky. Keywords Back-test, Foreign exchange market (Forex), indicator, currency pair, optimization, trading strategy, technical analysis Klíčova slova Back-test, mezinárodní měnový trh, indikátor, měnový pár, optimalizace, obchodní strategie, technická analýza Declaration I hereby state, that I made my master thesis The use of technical analysis in trading on FOREX market on my own with the guidance of my university supervisor Ing. Peter Mokrička and external coordinator Prof. Giovanni Zambruno. I also stated all used literary and other scholarly sources are in accordance to law, internal regulations of the Masaryk University and internal acts of management of the Masaryk University and the Faculty of Economics and Administration of the Masaryk University. In Brno, May 2014 Author`s sign Acknowledgements I would like to express my gratitude to my supervisor Ing. Peter Mokrička, for willingness to supervise thesis in foreign language, for his all-rounded knowledge and the satisfactory amount of time I was granted his company. I would also like to thank Prof. Giovanni Zambruno (from Università degli Studi di Milano – Bicocca) for his help, advices and incredible willingness to cooperate with international student without any restrictions or any compulsion to do so. A special thanks to my family and my beloved Ivka for all of the sacrifices that you‘ve made on my behalf. Words cannot express how grateful I am to having you. Last but not the least, I would like to thank all my friends, in particular Michal and Silvester who have kept me afloat when times were hard or crazy. I am truly lucky to count you amongst my friends. CONTENT INTRODUCTION - 9 - TOTAL OBJECTIVE AND PROJECT STEPS - 10 - METHODOLOGY - 11 - 1 FOREX MARKET - 12 - 1.1 PARTICIPANTS - 12 - 1.2 TRADING HOURS - 13 - 1.3 CURRENCY PAIRS - 15 - 2 APPROACHES TO INVESTMENT INTO FINANCIAL ASSETS - 17 - 2.1 TECHNICAL ANALYSIS - 17 - 2.2 FUNDAMENTAL ANALYSIS - 17 - 2.3 PSYCHOLOGICAL ANALYSIS - 18 - 2.4 EFFICIENT MARKET HYPOTHESIS - 18 - 3 TECHNICAL ANALYSIS AND ITS INDICATORS - 19 - 3.1 ASSUMPTIONS - 19 - 3.2 THEORETICAL BACKGROUND - 20 - 3.2.1 DOW THEORY - 20 - 3.2.2 ELLIOTT WAVES - 21 - 3.3 CHART ANALYSIS - 22 - 3.3.1 TYPES OF CHARTS - 23 - 3.3.2 SUPPORT AND RESISTANCE - 27 - 3.3.3 TREND LINE AND TREND CHANNEL - 28 - 3.3.4 MARKET PATTERNS - 28 - 3.4 TECHNICAL INDICATORS - 29 - 3.4.1 TREND INDICATORS - 29 - 3.4.1.1 Moving average MA - 29 - 3.4.1.2 Moving Average Convergence Divergence - 32 - 3.4.1.3 Parabolic stop and reverse - 33 - 3.4.2 MOMENTUM INDICATORS - 34 - 3.4.2.1 Relative Strength Index RSI - 34 - 3.4.2.2 Commodity channel index - 35 - 3.4.2.3 Stochastic - 36 - 3.4.3 VOLATILITY INDICATORS - 38 - 3.4.3.1 Bollinger bands - 38 - 4 CREATING AND OPTIMIZATION OF STRATEGIES - 40 - 4.1 TECHNICAL DESCRIPTION - 40 - 4.1.1 DATA AND TIMEFRAME - 40 - 4.1.2 SOFTWARE - 41 - 4.1.3 BACKTESTING - 41 - 4.1.4 CHOICE OF CURRENCY PAIR AND INDICATORS TESTED - 42 - 4.2 MONEY MANAGEMENT AND RISK - 43 - 4.2.1 DRAWDOWN - 44 - 4.2.2 LEVERAGE EFFECT - 44 - 4.2.3 STOP-LOSS - 45 - 4.3 TRADING STRATEGY BASED ON MA - 46 - 4.3.1 SIMPLE MA STRATEGY - 46 - 4.3.2 MA CROSSOVER - 50 - 4.4 TRADING STRATEGY BASED ON RSI - 54 - 4.5 TRADING STRATEGY BASED ON MACD - 59 - 4.6 TRADING STRATEGY BASED ON BOLLINGER BANDS - 63 - 5 COMPARISON AND RECOMMENDATIONS - 67 - CONCLUSION - 69 - BIBLIOGRAPHY - 70 - LIST OF TABLES - 74 - LIST OF FIGURES - 74 - LIST OF ABBREVIATIONS - 76 - APPENDIX: GLOSSARY 77 INTRODUCTION The importance of Forex market wasn‘t always as strong as it is today. When the value of a currency was tied to physical commodity, e.g. silver or gold, it was impossible to benefit from the currency trading. Lately the abandoning of Bretton Woods system with fixed-rate led into floating exchange rate mode that allowed currency rates to be determined by trading on Forex market. Due to technical development, all financial data that were previously calculated manually and analysed using charts drawn on paper can now be calculated in seconds and drawn directly to computer software. All those advances led into developing more and more sophisticated trading platforms that make currency trading possible and easier even for retail traders. Nowadays, the exchange rates are incessantly changing as a result of interaction between supply and demand for currency within online trading. The question is: Is there possibility to benefit from this change? Exactly this question inspired me to find the answer. I was motivated by the authors LO, Mamaysky and Wang and by their scientific work Foundation of Technical Analysis. Those professionals claim that application of some indicators can results in a profit. The problem could be choice of indicators and setting their input values to make profitable strategies. In my master thesis I am trying to find answer even on this puzzle. Considering the size of issue relating to technical indicators, it is necessary to aim at concrete researched area. Therefore this thesis concerns into specific area of technical indicators and their optimization and use on Forex market using technical analysis. Moreover, for possibility to compare individual indicators, thesis is focusing only on EUR/USD currency pair. The meaning of this thesis is to point out that there is possibility to trade on profitable level using optimization of strategy and setting inputs correctly. This topic has been chosen due to growing popularity of Forex market. Decision to use technical analysis instead of fundamental or others came from my own long-time experiences and interest in given issue. - 9 - TOTAL OBJECTIVE AND PROJECT STEPS The principal goal of this master thesis is proposition an optimization of selected technical analysis indicators on the Forex market and formulation of recommendations for intraday traders. This thesis should provide the reader with view of possibility of using technical analysis indicators on Forex market and optimization of indicators for achieving profitability improvement. No less importance is put on recommendation for intraday traders. I aimed to point out profitable trading opportunities using optimization of technical indicators. I implemented an automated trading strategy (ATS) using a suitable programming language. Strategies will be tested on real market data. To achieve the primary objective, thesis is structured into chapters that represent different partial goals.
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