The Problem of False Trading Signals in Forex

False trading signals are a significant problem. Moreover, it's a frequent issue, even for experienced and seasoned traders. However, it's a problem that can be at least partially circumvented or contained. You just need to know how. The five tips we'll illustrate in this article represent an excellent starting point.

What Are False Signals?

The definition of false trading signals is fairly simple to understand. A false signal is defined as any evidence gathered through technical analysis about the current state of the market and the near future that, despite (apparently) good premises, proves to be untrue and consequently is contradicted by reality. Relying on a false signal is a negative occurrence, fraught with bad consequences. If you plan a trade based on a false signal, you do so by hypothesizing a price movement that has no correspondence with reality. The result is easily predictable: the trade proves to be a failure, and you lose capital. False signals are a frequent occurrence. It's not surprising: the market is a complex entity that can lead to misunderstandings despite the trader's good intentions and a - at least theoretically - correct practice of technical analysis. However, it's essential to try to avoid them. How to do it? Here are some common-sense tips.

Tips to Avoid False Signals

Before providing the tips, it's important to make a clarification. In fact, below we have also considered fundamental analysis. From a purely formal and taxonomic point of view, it's improper to talk about trading signals when dealing with fundamental analysis, since it pertains to technical analysis. However, it's good to consider fundamental analysis, provided that the occurrences and estimates produced by this practice are associated with the term "signals".

Beware of Automatic Services

Some services provide periodic supply of signals. In some cases, such services should not be taken seriously, especially when they are inexpensive and delivered in a short time, perhaps several times a day. The reason is simple: the signals, in this case, are not derived from study or even from a well-calibrated and designed software, but from inefficient bots. Therefore, more often than not, such signals prove to be fallacious, false. This, of course, doesn't mean that automatic trading, especially that which intervenes in the analysis phase, should not be taken into consideration... On the contrary. Simply do not consider services that by their very nature cannot guarantee a sufficiently narrow margin of error.

Integrate Technical Analysis and Fundamental Analysis

Most false signals are derived through the use of a single tool. Therefore, it's always necessary to perform a double-check, that is, to use one tool as a means of verification. The best approach, certainly not the only one, is to integrate technical analysis and fundamental analysis, i.e., to practice them together in an organic way, so that one acts as a double-check for the other. In this context, a trading signal deserves trust when it is detected by both technical analysis and fundamental analysis. Obviously, this lengthens the analysis time, but it's a side effect that should be considered as such and accepted.

Combine Indicators

Unfortunately, it's not enough to simultaneously practice technical analysis and fundamental analysis. More is needed, especially on the "technical analysis side". The reference is to the use that is generally made and that should be made of indicators. Inexperienced traders often use one indicator at a time. From these, they extract signals and based on these, they plan trades. Well, this approach, although theoretically acceptable, does not protect against false signals. The reason? Simple, it lacks the double-check element that we presented in the previous paragraph. Therefore, integrate multiple indicators (the ideal number is two or three). The ideal setup involves the simultaneous use of a price indicator, such as those based on moving averages, and a volume indicator (such as RSI).

Contextualize Market Movers

This is obviously a tip that exclusively concerns fundamental analysis. Most false signals from technical analysis arise from a misinterpretation of market movers, or rather of the values arising from market movers. Very simply, the effects are misunderstood. The reason is simple: a value may seem high or low in an absolute sense, but it may lose importance if contextualized with previous values. In simple terms, it's absolutely necessary to analyze the history, in order to identify the context through which to judge a value. Only in this way is it possible to estimate the effects with reasonable certainty, or at least with an acceptable margin of error.

Ensure They Have Not Already Been Discounted

This is an occurrence that happens more often than one might think. Obviously, we are still in the field of fundamental analysis. It may happen that the value expressed by a market mover is significant, and that it is also significant following contextualization. At this point, the trader expects a reaction from the market and trades accordingly, only to find out that there is no reaction. What happened? Simple: investors had already discounted that value. This happens when the market mover is preceded by heavy indications about its outcome, perhaps purposely provided by policymakers. It happens especially with market movers related to monetary policy. Therefore, verify that the data has not already been discounted. To do so, always stay updated and follow what happens outside the market realm.

A Fatalistic Indication

Following these tips, which are absolute common sense, will help you avoid false trading signals. However, it's important to present a bitter truth: avoiding false signals altogether is really difficult. In some cases, it's practically impossible, as in the case of particularly hectic, chaotic phases, characterized by demanding volatility, that is, caused by external factors. The most important advice, therefore, is another: accept the occurrence of false signals. Therefore, accept that the trade may prove to be a failure. As strange as it may sound, defeat is part of trading. The corollary of this dynamic is the absolute and mandatory necessity to practice good money management and equally effective risk management. Only if these two activities are put into practice is it possible to protect your capital and, in fact, continue trading, even in the event of defeat or repeated defeats over time. So defend yourself from false signals, do everything to avoid them, but cover your back thinking about the worst-case scenario, i.e., unknowingly relying on false signals and consequently failing the trade.