Academic journal article Federal Reserve Bank of New York Economic Policy Review

Support for Resistance: Technical Analysis and Intraday Exchange Rates

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Support for Resistance: Technical Analysis and Intraday Exchange Rates

Article excerpt

* Among the technical trading signals supplied to customers by foreign exchange trading firms are "support" and "resistance" levels. These levels indicate points at which an exchange rate trend is likely to be interrupted or reversed.

* A rigorous test of the levels specified by six trading firms during the 1996-98 period reveals that these signals were quite successful in predicting intraday trend interruptions.

* Although all six firms were able to identify turning points in exchange rate trends, some firms performed markedly better than others. As a group, the firms predicted turning points in the dollar-yen and dollar-pound exchange rates more accurately than turning points in the dollar-mark exchange rate.

* In addition, the predictive power of the support and resistance levels appeared to last at least five business days after they were first communicated to customers.

Early in the morning of each business day, the major foreign exchange trading firms send their customers lists of technical trading signals for that day. Timely technical signals are also supplied by major real-time information providers. These signals, which are based primarily on prior price and volume movements, are widely used by active foreign exchange market participants for speculation and for timing their nonspeculative currency transactions. In fact, 25 to 30 percent of foreign exchange traders base most of their trades on technical trading signals (Cheung and Chinn 1999; Cheung and Wong 1999). More broadly, technical analysis is used as either a primary or secondary source of trading information by more than 90 percent of foreign exchange market participants in London (Allen and Taylor 1992) and Hong Kong (Lui and Mole 1998).

The technical trading signals provided to customers vary over time and across technical analysts, but the vast majority of the daily technical reports include "support" and "resistance" levels. According to technical analysts, support and resistance levels are points at which an exchange rate trend is likely to stop and may be reversed. For example, a firm publishing a support level of $1.50/[pounds sterling] would claim that the dollar-pound exchange rate is likely to stop falling if it reaches $1.50/[pounds sterling]. If the firm also provided another support level of $1.45/[pounds sterling], the firm would claim that if the exchange rate passes through $1.50/[pounds sterling], it is likely to stop falling at $1.45/[pounds sterling].

Despite the almost universal use of support and resistance levels in short-term exchange rate forecasting, the ability of these trading signals to predict intraday trend interruptions has never been rigorously evaluated. This article undertakes such a test, using actual support and resistance levels published daily by six firms from January 1996 through March 1998. The firms include commercial banks, investment banks, and real-time information providers based in the United States and abroad. I examine the value of three currencies relative to the U.S. dollar: the German mark, the Japanese yen, and the British pound. Support and resistance levels for these exchange rates are tested against indicative exchange rate quotes sampled at one-minute intervals between 9 a.m. and 4 p.m. New York time.

These tests strongly support the claim that support and resistance levels help predict intraday trend interruptions for exchange rates. All six of the firms studied were able to identify points where intraday trends were likely to end. However, some firms were better than others at identifying such points.

For most firms, the predictive power of support and resistance levels lasted at least five business days beyond the levels' publication date. Despite their overall success at identifying points of trend interruptions, none of the firms correctly assessed the relative likelihood of trend interruptions at the different levels. …

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