Technical analysis is a trading strategy that simplifies Forex trading. It can be overwhelming to choose the right technical indicator from the many available.
We have narrowed your choices to five key indicators that Forex traders use, and you can learn and use them in your trading.
1. Bollinger Band
John Bollinger developed the Bollinger Band, a technical analysis indicator. It is named so because it is an indicator that John Bollinger created. It’s used to determine short-term price movements, and to assess how volatile the market might be.
The chart shows it as two trendlines that move on two standard deviations. These are positive and negative movement away from a simple moving median (SMA). Bollinger Bands can be used to identify overbought and oversold assets or to find opportunities to make higher profits.
How it works
These effective forex trading indicators uses two parameters: Standard Deviations and Period, with default values of 2 and 20 respectively. You can customize the combination to suit your needs.
Low market volatility is indicated by tightening or narrowing of the bands. This condition, known as the squeeze, signals sharp price movements and future volatility, which triggers trading opportunities.
Volatility will increase if the bands move away from or widen beyond the SMA. Any existing trend could end. This could be the right time to close a trade.
A trading breakout is when price action moves above or below the band.
Pros
It is useful in helping to apply momentum, trends, volatility, and other factors.
This is a strong indicator for market volatility, as the bands shrink or widen.
It helps to identify new trends and when they end.
Cons
It is not a stand-alone system
Can’t predict price pattern
Bollinger Bands are primarily used to provide information about price volatility. They cannot be used by themselves. These indicators must be used in conjunction with other non-correlated indicators. John Bollinger suggests using relative strength index (RSI), moving average divergence/convergence (MACD), and on-balance volume.
2. Moving Average (MA).
A moving average is a statistic which captures the average change over time in a data set. It is a technical indicator that represents market momentum and the average closing price for a particular period. MA in an upward trend could indicate a price or momentum upswing, while MA in a downward trend would be considered a decrease.
There are many moving averages available today. These range from simple measures to complicated formulas that require a computer program.
How it works
MA is calculated to show clear data about price movements over a period. This is achieved by creating an average price, which is continuously updated.
MA can be either simple or exponential. The simple moving average (SMA), is the arithmetic means of a set of prices spread over a specified number of days, such as 15, 100 or 20 days. SMA is preferred by traders who prefer to use longer timeframes.
The Exponential moving Average (EMA) weighted average focuses more on current price levels. It is popular with traders who trade intraday or on shorter time frames because it is more responsive.
We can set the SMA period to 5-20 days for trading with a shorter timeframe. We can also set the SMA period to 100-200 days for a longer timeframe.
To tell a trend, you can use moving averages (SMA and EMA) in two ways:
1. The slope of the moving average is important. The slope of the moving average should be moving upwards if it is moving continuously higher. This indicates an uptrend. If the slope of the line keeps moving higher, it indicates an uptrend. Conversely, if it’s constantly moving lower, the price is below the moving average.
2. Consider the intersection of two moving average lines. The shorter one is for a shorter time period and the longer one for a longer time period. We can combine the 5-day EMA and the 50-day EMA. If the 5-day EMA is higher than the 50-day EMA, it means that it’s an uptrend. If it moves in the other direction, it is a downtrend.
There are pros and cons to using Moving Average (MA).
Pros
SMA provides a smooth line that is less affected temporarily by price swings
The EMA reacts quickly to price changes
EMA is ideal for intraday swing highs or lows trading
It’s simple enough to be attractive for algorithmic and newer traders
It simplifies trading and assists in preventing or dealing with paralysis by analysis
Cons
SMA slows down when prices change rapidly
EMA is susceptible to false signals and back-and forth whipsawing
The average movement of the market can be affected by extreme volatility. This can make it difficult to determine the right time to enter the market. Noise may also be used to describe this phenomenon, as it is subject to rapid changes due the market’s ups and downs.
3. Relative Strength Index (RSI).
The Relative Strength Index is used to measure price momentum. This refers to the rate at which prices move and how much change occurs. J. Welles Wilder Jr. originally created it. It was included in his 1978 book New Concepts in Technical Trading Systems.
RSI is simply a measure of how fast traders move to increase or decrease the price of a security. This data is plotted on a chart using a scale of 0 to 100.
A stock that has a RSI below 30 means it is oversold
A stock that has a RSI above 70 means it is overbought
How it works
Technical traders can use the RSI to determine whether price momentum is bullish, bearish, or both.
What is an RSI Buy Sign?
If the RSI falls below 30, it is considered a buy sign. This means that the asset is likely to rebound after it has been oversold. The speed at which the rebound is possible will depend on whether or not an asset is in a significant downtrend. If the asset is in a significant downtrend, it’s best to wait until there is a confirmation signal before you buy.
There are pros and cons to using the Relative Strength Index (RSI).
Pros
Find key levels of reversal
Use in a non-trending area is more effective
It is easy to comprehend and put into practice
It can be used to determine momentum loss
Cons
Could be misleading signals in a trending area
Completely ignores volume during key reversals
It is not recommended to use RSI as a sole trading signal. There is a high possibility of error depending on the context. You must consider the formation of price trends and various candlestick patterns in order to make informed decisions.
4. Moving Average Convergence Divergence
Moving average convergence divergence is a momentum indicator that tracks trends and shows how one security price’s moving mean relates to another. MACD can be seen on a trading chart with multiple lines:
The MACD line results from subtracting the exponential moving mean (EMA) between 26- and 12-periods.
The MACD 9-day EMA results in the signal line.
The signal line, which can be plotted on the chart to trigger a buy signal or sell signal, can be triggered by a plot. The rule of thumb is to sell when the MACD crosses below it and buy when it crosses above.
MACD is a popular tool for interpreting crossovers, divergences and rapid rises/falls. It can also indicate if conditions are too hot or too cold for a trader.
How it works
MACD will not only provide technical signals for buying or selling, but also display:
The speed at which a crossover occurs determines whether the market is either overbought, or undersold.
If the price is moving strong or slow, it’s bullish/bearish.
A price’s trend or severity may change.
A price’s momentum could cause a shift in its underlying trend.
MACD is a tool that helps traders identify when they should enter, exit or add to their positions.
MACD is a lagging indicator because it uses historical data on stock price movements. It must “lag” the stock’s price. It’s also used by traders to predict the direction of a trend change.
A bullish divergence is when the price makes lower swing lows and the indicator makes higher lows. If the reverse happens, bearish divergence occurs.
There are pros and cons to using Moving Average Convergence Divergence
Pros
This signal is used to indicate when you should buy (crossover), and when to sell (divergence).
It can be used as both a momentum and trend indicator
Use of other technical indicators to enhance clarity during analysis
Cons
Can provide reversal signals, but not a significant one. They will only result in a temporary pause or sideways move.
This may not be a complete analysis of a trend.
MACDs often give trade signals at very close price ranges, before forming a strong sideways sign. This could lead to a small loss multiple times.
5. Average Directional Movement Index (ADX).
Average Directional Movement Index (ADX), a technical indicator, is used to assess a trend’s strength. To calculate the ADX indicator, the DX component is used.
ADX is a component in the Directional Movement System, which J. Welles Wilder Jr. also created. This system is designed to determine whether strong prices move in either positive or negative directions. It’s represented by a positive directional indicator (DMI+), and a negative directional indicator (DMI-).
How it works
DX can be used to determine the market’s trendiness. It ranges from 0 to 100. The more it is, the more directionally the market moves. If DX is higher, the trend will be strong. DMI+ and DMI+ spreads also increase.
An ADX higher than 25 signifies a strong trend
An ADX lower than 20 indicates that there is no trend
A trend may end if ADX drops below high values. Further research is required to confirm that there are still open positions.
ADX declines signify that the current trend has weakened and that the market is becoming less directional. It is recommended that you avoid trading trend systems as the trend is changing.
An ADX rise of 4 to 5 units after a long period of lows may indicate an opportunity for traders to trade current trends.
An ADX indicator that is rising means that there is a strengthening trend in the market.
When a trend is moving in a steady slope, the value of ADX tends towards flattening.
There are pros and cons to using Average Directional Movement (ADX).
Pros
Can you quantify the strength and impact of a trend?
Effectively filters trades during accumulation periods
Forex Trends: Can you identify them?
It is best to use for swing trading and day trading
Can give a clear indication about the strength of both bulls and bears simultaneously
Cons
Lagging indicator following price movement
When used for shorter periods, it can cause false signals
To properly analyse price action, must be used in conjunction with other indicators
The asset price may not move simultaneously if ADX moves down or up. Because both uptrend ADX and downtrend ADX can indicate strength in either a up or down direction, this is why it’s so confusing.
Forex trading will be easier if you use any combination of the above indicators. It is important to establish clear guidelines for how to use these indicators to your benefit.
