Trading indicators can be defined as mathematical computations. These indicators are represented by lines on a chart, and they can be used to help retail traders identify signals and trends in the financial market. Numerous investors and active traders employ technical trading indicators to assist them in determining high-probability trade entry and exit positions.
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Hundreds of indicators are accessible on most trading platforms; as a result, it is possible to utilize too many or inefficiently. Forex trading indicators may seem complex and hard to understand at the beginning.
However, it should be seen as learning a new language where traders will start getting familiar with the concepts and how the indicators work the more time they spend getting to know them.
In terms of their benefit in forex trading, Forex indicators are critical trading tools that all traders should be familiar with. However, the usefulness of a technical trading indicator is highly dependent on how it is used.
Technical indicators form part of a technical analysis, which is important in most trading strategies to track and speculate on price movements in financial markets. Using price charts, traders can effectively identify a strong trend on a currency pair or other security over a period.
Using trading indicators as part of a comprehensive technical analysis can open more trading opportunities in any given trading day to all types of traders in the forex market, amongst other markets.
Some traders try out just one indicator, while others like to use several different indicators. Trend indicators, momentum indicators, and volatility indicators are the three main types of technical indicators that forex traders use to make their trades.
Because there is a lack of comprehensive exchange trading volume data, volume cannot be seen as a reliable indicator in the decentralized currency market. Currency traders may instead use approximate volume numbers based on the movement of the exchange rate ticks.
However, a consideration towards trading indicators is that using more than one could make your strategy more difficult to follow. It is considered best practice to avoid using two indicators of the same type because they will just confirm each other's signals, so you should choose indicators that complement each other.
The most popular forex technical indicators in use by retail and professional traders today include:
1. Moving Averages
In terms of its definition, an MA, also known as the “simple moving average” (SMA), is an indicator that helps traders figure out the direction of a current price trend without having to deal with short-term price spikes that happen more quickly.
In terms of its use, the MA indicator looks at the prices of a financial instrument over a certain amount of time and divides them by the number of data points to show a single trend line for the whole time.
In terms of its usefulness, a short-term MA crossing over a long-term MA is often used as the foundation for a trading strategy in the Forex market.
In terms of its structure, a MA can be identified by the following unique structure on a price chart.
A moving average is calculated as follows:
This can be explained as “A” referring to every data point while “n” refers to the number of periods.
Moving averages can be classified either as Simple Moving Averages (SMA) or Exponential Moving Averages (EMA).
Moving Average Convergence Divergence (MACD) is a technical indicator that is used to find moving averages that show a new trend, whether it is bullish or bearish. It is used to locate moving averages that indicate the onset of a new trend.
MACD is used to measure momentum or the trend strength by considering the MACD line and zero line as a guide on the price chart.
- Whenever the MACD line crosses above the zero line, the market is going up.
- Trends go down when the MACD line goes below the zero line.
The MACD is calculated as follows:
- MACD Line is the 12-Period EMA – 26-Period EMA
- Single Line is the 9-period EMA
- Histogram refers to the difference between the MACD line and the signal line
In terms of its structure, a MACD can be identified by the following unique structure on a price chart.
3. Bollinger Bands
Bollinger Bands® are a technical indicator used by technical traders in all financial markets, including forex, to assist them in determining what to do.
Bollinger Bands® are a popular technical analysis technique used by many traders. This indicator was established by John Bollinger to assist traders in identifying relative highs and lows in tumultuous markets.
The indicator is constructed entirely of moving average lines. It consists of upper and lower bands in addition to a moving average line.
Traders can use bands of two standard deviations above and below the moving average to execute trades (usually 20 periods). It is expected that 95% of pricing data will fall inside the two bands using two standard deviations.
As a basic rule of thumb, prices are overbought when they reach the upper band and undersold when they reach the lower band.
As price fluctuates between the indicator's upper and lower bounds, Bollinger Bands® become an excellent tool for determining market volatility. Individuals who trade a range-bound approach should keep a watch on how tight the bands get during periods of lower volatility since this is a useful indicator to employ.
Bollinger Bands® will expand in size when the market becomes more volatile. At these periods, traders may employ a breakout strategy, or a plan based on the market's direction.
In terms of its structure, a Bollinger Bands® can be identified by the following unique structure on a price chart.
4. Ichimoku Kinko Hyo
Ichimoku Kinko Hyo, or Ichimoku Cloud, is a forex indicator that contains components for developing a full trading strategy. There are several unique components in this indicator that assist traders in identifying all facets of the market.
The Kumo Cloud is the indicator's initial component that assists in comprehending the market situation. When the price falls below the Kumo Cloud, the trend is bearish; when the price rises above the Kumo Cloud, the trend is bullish.
In terms of its structure, the Ichimoku Kinko Hyo can be identified by the following unique structure on a price chart.
5. Relative Strength Index
Technical analysts use the relative strength index (RSI) to figure out if a stock or other asset is too high or too low in terms of momentum. The RSI is shown on a graph as an oscillator (a line graph that moves between two extremes). It has a range of 0 to 100.
An asset near 70 is often thought to be overbought, and an asset near 30 is often thought to be oversold, but this is not always the case.
Some traders think that an oversold currency pair means that the falling trend is likely to stop, which means it is a good time to buy. Some traders think that an overbought currency pair means that the rising trend is likely to stop, which means it is a good time to sell.
If the RSI first shows that the market is overbought or oversold, it is not unusual for the price to keep going even after that point. There are many different technical indicators you can use in addition to the RSI to make sure you do not get into a trade too early.
The following calculation is used to determine an upward or downward change, with Upward periods identified by a higher close than the previous close as follows:
U = Close (now) – Close (previous)
D = 0
A Downward period is subsequently identified when the close is lower than the previous close as follows:
U = 0
D = Close (previous) – Close (now)
In terms of its structure, the Relative Strength Index (RSI) can be identified by the following unique structure on a price chart.
Fibonacci retracement is an indicator that can help you determine how far a market will move against its current trend. A retracement is when the market drops for a short time. This is also called a pullback.
Fibonacci retracements show important points of support and resistance. This happens when a market has jumped very high or very low and seems to be levelling out at a certain price point. Fibonacci levels are often used to figure out where the market should go next.
1.618 is the most important part of the Fibonacci tool. In the forex market, traders use this ratio to figure out when the market is going to turn and where to take their profits.
In terms of its structure, Fibonacci can be identified by the following unique structure on a price chart.
7. Parabolic SAR
People often use the parabolic SAR, also known as the parabolic stop and reverse, to figure out how quickly an asset will move in the short term. The indicator shows a curved pattern on a price chart that shows where to stop and when to move.
Because of the shape of this pattern, Wilder thought it reminded him of the parabolic curve in classical geometry and mechanics, which is the reason behind its name. The indicator shows where to stop and how to go back on the chart. These are according to the following Parabolic SAR formula:
SARNEW = SARCURRENT + AF x (EPCURRENT – SARCURRENT)
AF or Acceleration Factor refers to a changing value that will increase in increments for every period where there is a new high reached. EP, or Extreme Point, refers to the highest or the lowest price which can be observed while the current trend continues.
In terms of its structure, Parabolic SAR can be identified by the following unique structure on a price chart.
8. Pivot Point
A pivot point can simply be defined as a technical indicator that commodities retail traders use to detect potential turning points. Pivot points are used by day traders in currency markets to identify predicted levels of support and resistance, and hence prospective turning points from bullish to bearish or vice versa.
The Pivot point formula is as follows:
- Pivot point (PP) = (High + Low + Close) / 3
- First resistance (R1) = (2 x PP) – Low
- First support (S1) = (2 x PP) – High
- Second resistance (R2) = PP + (High – Low)
- Second support (S2) = PP – (High – Low)
- Third resistance (R3) = High + 2 (PP – Low)
- Third support (S3) = Low – 2 (High – PP)
Forex traders employ pivot points in conjunction with classic support and resistance trading tactics. Price, like support and resistance, tends to obey these levels. The price levels of pivot points are evaluated regularly, which further validates these levels.
To make trading decisions in the forex market, traders often combine the pivot with other validation tools such as indicators, candlestick patterns, oscillators, fundamentals, and price movement.
The types of pivot points that are employed by forex traders include the following:
- Camarilla pivot point
- Woodie’s pivot points
- DeMark Pivot Points
In terms of its structure, Pivot Points can be identified by the following unique structure on a price chart.
(Image Source: https://www.investopedia.com/terms/p/pivotpoint.asp)
9. Average True Range
The simplest definition of the Average True Range indicator is that it shows the volatility of currency pairs. The ability to measure volatility in the forex market can be a great advantage to traders because it is related to direct market movements.
The average true range (ATR) is calculated using three basic formulas. Traders can calculate the ATR by subtracting the current day's low from the current day's high. Traders can then deduct the previous day's close from today's high. Finally, traders can subtract the current day's low from the prior day's close to get three distinct numbers.
The advantage of using this indicator is that beginners can quickly learn how to use it, helping them set stops and price targets according to the strength of market volatility.
In terms of its structure, the Average True Range can be identified by the following unique structure on a price chart.
Stochastic oscillators are meant to highlight overbought and oversold levels, but they also signal potential price reversals. Because of the accuracy of its conclusions, stochastics are a favoured indicator of many traders.
Stochastics, when used by both seasoned traders and beginners, have the potential to assist investors of all skill levels in determining suitable entry and exit opportunities.
Stochastic oscillators use a scale that ranges from 0 up to 100, where a reading below 20 indicates oversold markets while a reading above 80 indicates an overbought market. If there is a strong trend present it may not mean that a correction or a rally will start in the market.
In terms of its structure, Stochastic Oscillators can be identified by the following unique structure on a price chart.
11. Commodity Channel Index (CCI)
Donald Lambert, a technical analyst, created the CCI, or Commodity Channel Index, which was first published in Commodities magazine (now Futures) in 1980.
The Commodity Channel Index Technical Indicator (CCI) evaluates the commodity price's departure from its average statistical price. High index values indicate that the price is extremely high when compared to the average, while low values indicate that the price is excessively cheap.
Despite its name, the Commodity Channel Index may be used for any financial asset, not only commodities. CCI can be used either to find the divergence or to identify overbuying or overselling conditions in the market.
The formula used to calculate CCI is as follows:
- Typical Price – Simple Moving Average) / (0.015 x Mean Deviation)
The structure of the CCI Indicator is as follows:
- The CCI indicator is an oscillator, which means it evaluates the market's strength or weakness and whether a trend is dependable.
- The indicator has a ‘zero level' centre line that displays a neutral reading. The indicator appears in its own window beneath the price chart and is confined by 100 points on both sides of the zero line.
- A move of the indicator line above the 100 level indicates a possible overbought position in a currency pair, while a move below the -100 level indicates a potential oversold condition.
- It implies that the market is moving in one direction or the other between those two levels, but it does not provide an actionable signal in and of itself.
12. Donchian Channels
The Donchian Channel can simply be defined as a trading indicator and tool that helps traders see through the market volatility. When traders consider a normal chart, it can become overwhelming to read. By using Donchian Channels, traders can see whether an instrument has reached its full potential, and how long it took for this to be achieved.
Donchian Channels are three lines that are made by moving average calculations. They make up an indicator that has upper and lower bands around a middle or middle band.
People use the upper and lower bands to show how much security has changed in price over time. It is called the Donchian Channel because it is in the middle of the upper and lower bands.
The Donchian Channel highlights the following:
- The true growth of a financial instrument
- The volatility of the instrument
- The highest and the lowest points in the timeframe that traders must avoid
To use the Donchian Channel, traders must do the following:
- Avoid using it with other tools
- Choose wider timeframes
- Do not solely rely on the Donchian channel because it does not provide an analysis
The structure of the Donchian Channel is as follows.
(Image Source: https://www.investopedia.com/articles/forex/06/bandschannels.asp)
How to Use Forex Trading Indicators
Forex trading indicators can be added directly to price charts on trading platforms and trading dashboards.
Indicators are mathematical calculations that consider how a trading instrument has changed in price or volume in the past and now. They use this information to look at how well things have worked in the past and predict what prices will be in the future.
Indicators do not provide specific buy and sell signals. A trader must interpret the signals to find trade entry and exit points that fit their unique trading style. There are a lot of different types of indicators, like those that look at trends, momentum, volatility, and volume.
Things that traders must consider when they use technical and trading indicators include:
- Chart indicators should enhance and not hinder the trader’s market analysis.
- Prevent information overload by interpreting portions of data one at a time instead of causing analysis paralysis by trying to process too much information.
- Create a well-organized workspace and only use the necessary analysis tools.
How to use trading indicators effectively:
- Use colours – All the data may be viewed if the colours are bright and simple to discern.
- Layout – Use more than one monitor if possible.
- Sizing and fonts – consider using bold and crisp fonts to read numbers and words easily.
How can you read the trading indicators relating to Forex Trading?
Traders can start learning to read trading indicators by learning about forex charts and how to read these charts. Next, traders can learn about different types of indicators and learn their unique patterns, allowing them to identify certain trends in the market according to the indicator.
Traders can start using demo accounts to read trading indicators in different markets, this will allow traders to build their trading skills before they enter the real market.
Which Forex Indicator is Easy to Learn?
The following forex indicators are easy to learn for beginners:
- Simple Moving Average (SMA)
- Relative Strength Index (RSI)
- Stochastic Oscillator
- Moving average convergence divergence (MACD)
Beginner traders can start learning these indicators by using a demo account that is funded with virtual money. Traders can consult guides and YouTube videos on how to apply indicators to price charts to identify certain trends in the market.
What are the best platforms to learn Forex Trading Indicators?
The following platforms are the best options to learn how to use Forex trading indicators:
- MetaTrader 4
- MetaTrader 5
These platforms not only offer guidance but also provide demo accounts that can be used as practice accounts, allowing traders to apply trading indicators onto their charts where they can identify certain trends in live markets without risking real money.
Do Forex Indicators work in Forex trading?
Forex indicators work but they should not be considered a quick fix to learning how to trade. Adding forex indicators will not guarantee profitability in forex trading. They can help beginner traders start trading, but professional traders do not consider them a useful long-term tool.
Many forex traders rely on these technical indicators to determine when it is best to buy or sell in the foreign exchange market. Every technical and fundamental analyst must be familiar with these forex indicators since they are an essential aspect of technical analysis.
Indicators are used by professional traders that utilize technical analysis. Indicators are rarely used by professional traders who do not rely on technical patterns.
There are drawbacks to using technical indicators that traders must know before they use them, these are:
- They cause information overload
- They can be extremely distracting
Professional traders use technical indicators in the following ways:
- Retail Traders rely on indicators because they use technical analysis as part of their overall trading strategy.
- Intraday traders, active traders, and scalpers trade using short timeframes which means that they heavily rely on technical indicators to provide their entry and exit points in the live market.
- Multiple timeframe trading makes it possible to trade a single item or a group of assets using several periods.
- Trend Trading involves using the momentum of a trading asset to determine the specific trading strategy.
- Institutional Traders have access to forward contracts, Initial Public Offerings, swaps, and more. They have larger capitalization and thus large trading volumes, giving them trading opportunities that are not available to retail traders.
When should Forex Trading Indicators be used?
Each forex trading indicator has its unique timeframe when it must be applied.
The following popular forex trading indicators have the following timeframes:
- Moving Averages – 5 to 20 periods over short-term trends
- MACD – between 12 and 26 periods
- Bollinger Bands 5 or 15 minutes
- Fibonacci – 30- or 60-minute candlesticks
What is the connection Between Chart Patterns and Chart Indicators?
Technical indicators are mathematical formulas that are derived from the evaluation of prices and/or volume to profit from market conditions. Traders must understand how they work to optimize their settings and create efficient indications.
A Chart Pattern is a characteristic pattern/formation on a stock chart that indicates a trading signal or an indication of future price movement. Traders employ these chart patterns to denote current market trends or any indication of a trend reversal, as well as to generate buy and sell signals.
One of the advantages of chart analysis is that it enables traders to make more educated and timely trading decisions in response to market fluctuations. Pattern assessment forecasts prospective possibilities using previous data and broad patterns that tend to reoccur over time.
Technical indicators, in comparison to chart patterns, use a more empirical approach, depending on data points commonly regarded to be indicative of a market's future performance.
The trustworthiness of this data has also been shown repeatedly when used to evaluate deals in the past, providing novice traders with some sense of confidence.