TRADING SYSTEMS by Dr. Daniel Fernández PhD
FX
Support and Resistance of Random vs. Real FX Prices
Support and resistance (S&R) levels are touted as a fundamental pillar of price action based technical analysis. The theory suggests that traders see where price has reached high and low levels in the past and decide to execute their actions according to these past high/low levels. Levels where price bounces after an upward movement are called “resistance levels” while levels where price bounces aſter a downward movement are called “support
levels”.
Supposedly if a given price level has acted in the past as support or resistance then it is more likely to act as S&R again in the future compared to other price levels. Te more it has acted as support or resistance, the more it is likely to continue this behavior.
However a big problem with this theory is that the apparent phenomena of support/resistance can also happen as a consequence of pure random chance. Figure 1 shows some apparent support and resistance levels in a completely random time series, created by shuffling the distribution of returns of the GBP/JPY 1986-2016 data with replacement. Although this series has the same distribution of returns as the GBP/JPY real data the data has been shuffled such that this data contains no possible real causal relationships.
In effect any support
and resistance we see within this data is a pure consequence of random chance since there is no relationship between a candle and the ones that preceded
it. Given that S&R levels can happen randomly it is important to ask how what we observe in real data differs from what we observe in randomly generated data, if there is a difference at all.
For this analysis I used daily data for the EUR/USD, USD/JPY, GBP/ USD and GBP/JPY from 1986 to 2017. To test S&R in real data Vs random data I used neighbor counts as a proxy for whether a level resembles support or resistance. For both real and random data series I took the minimum and maximum price levels in the data and then explored the entire range of levels in 10 pip steps. For each level I then looked into the
FX TRADER MAGAZINE October - December 2017 59
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