An Overview of Forex Trading Indicators

An Overview of Forex Trading Indicators

Forex trading has come a long way in the past few decades and technology has made it easier to conduct technical analysis of markets. There are a variety of technical indicators available to use on platforms such as MT4. These indicators are not magic bullets, but they can give some indications of finding ideal entry and exit points for a trade. There are many indicators to choose from and as a beginner, it can be hard to know which ones to go with. In this article, we will take a look at some of the most popular forex trading indicators and look at what they show.

There are two main types of indicators; Oscillators and Support/Resistance Levels.

Oscillators provide information on when an asset is “oversold” or “overbought”. This can measure price momentum and help to provide a clearer picture of the current state of the market. Traders looking for trend momentum or potential reversals can find oscillators useful to spot opportunities. They can also help traders to frame their entry and exit points in a trade.

Support and resistance levels are based on price action. Support is a level where the price tends to rebound and resistance is a level where the price tends to go downwards. The levels can have different types of strength and traders lookout for when important levels are broken through since it may signal a new trend. You may come across the term ‘trading in a range’ and this is related to support and resistance levels.

Let’s look into some of the most popular Forex indicators that are used on MT4 and other platforms.

Moving Averages

One of the most popular Forex trading indicators is moving averages. They can indicate momentum by showing the average closing price over a specific period of time. The main purpose of moving averages is to show longer-term trends rather than short-term price action. They are considered simple and easy to understand indicators that give a general picture of the market.

There is a variety of moving average types such as simple moving average (SMA) and exponential moving average (EMA). The SMA is a simple calculation of data points divided by the number of data points. However, this calculation gives an equal weighting to all sets of data which could provide outdated pictures of the market. The SMA gives more weighting to recent price points to give a more current indication of current price trends. Moving averages can be used by traders to help see resistance/support levels and to determine the general direction of a trend.

Moving Average Convergence Divergence (MACD)

Traders can make use of multiple moving average lines to spot trends. The MACD is an indicator that measures the relationship of EMAs. A MACD line is usually made up of the difference between two exponentially levelled averages. The indicator measures trend strength. Therefore, it may be more useful in trending and volatile markets while being less useful in range markets. There are many variations that can be applied to the MACD indicator, and therefore a trader can experiment with the points that make sense for their individual trading strategy.

Relative Strength Index (RSI)

Another momentum indicator that is used by many traders is RSI. It is displayed as a line graph that has figures between 0 and 100 based on the magnitude of recent price changes. In general, assets can be considered overbought when RSI is above 70% and oversold when RSI is below 30%. However, these are only traditional metrics and traders often use their own figures for particular market situations. An RSI line is often plotted below the asset price. Overall, RSI can inform traders about the general trend of an asset while also providing clues on swing rejections.

Bollinger Bands

This indicator was introduced by John Bollinger in 1983. Bollinger Bands can be used to provide an indication of volatility on an asset. The ‘bands’ have three different parts which are an upper band, a midpoint, and a low-point. The middle band is a simple moving average point whereas the other two 2 lines are usually 2 standard deviations away, but can be customised.

Typically a 20 day moving SMA is used and the closing price plotted. The deviations measure how spread out the numbers are which can give some information on the recent volatility of an asset. In general, more volatile markets lead to wider bands and less volatile markets result in a contraction of the bands. In some cases, the bands can come together and this is known as a ‘squeeze’. Bollinger Bands are not typically used for entry/exit points but rather used in combination with other indicators to provide context on a market.

Pivot Points

When it comes to establishing levels of support and resistance, pivot points are commonly used. Pivot points are usually the highs, lows and closing prices of a security and they can be used over various timeframes. The levels can be used by traders to spot potential reversal points. Day traders can use these indicators to help them make informed decisions on entry levels, stop-losses and profit-taking.

One key difference between pivot points and other indicators is that they remain fixed throughout the day. The pivot point is already set when the day of trading begins which means traders can plan some moves in advance. Traders may combine pivot points with other indicators. In particular, a pivot point overlapping with a moving average can potentially be an indication of a stronger support or resistance level. Overall, pivot points are a fairly basic calculation and therefore they have limitations as to what they can show. Furthermore, there are no guarantees that the levels will be respected by price.

Stochastics

The next indicator on our list has been around since 1950. Stochastics are a way of measuring the relationship between the closing price and price range of an asset over a selected period of time. The indicator remains popular because it is fairly simple to understand and can give some clues to traders on the optimal time to buy or sell. Stochastics are used to indicate whether an asset is an ‘overbought’ or ‘oversold’ position. The indicator can be used for a long term or shorter-term views and is usually combined with other indicators such as RSI.

Fibonacci retracements

The Fibonacci sequence is a mathematical formula that is present in nature. Simply put, after 1 and 0 every number is the sum of the previous two numbers. 1.618 is the golden ratio that you get when you divide a number by the previous number. But enough with the maths. How does this sequence help in forming trading strategies?

Well, Fibonacci retracement levels can be useful for plotting resistance and support. They can indicate potential reversal and are usually used to determine entry levels. These levels are based on market moves that have already happened and therefore cannot be used to predict future moves. When a big rise or fall happens in the market, traders may use these levels to see where price may retrace before continuing with the general trend.

Ichimoku Cloud

One of the newer trading tools that is gaining popularity in Forex trading is the Ichimoku Cloud. It uses three indicators to show various data points and to give clues on price action. As you may have guessed from the name, this charting tool originated in Japan. It can seem complicated to new traders because of the many lines that are drawn. The Ichimoku Cloud is made up of 4 major components.

The first is the ‘Tenkan Sen’ which is a simple calculation of the total highest high and lowest low which is then divided by two. It takes into account the last 9 time periods. The second part is the ‘Kijun Sen’ which is similar but accounts for the last 26 time periods. With both of these lines, traders will look for a crossover that could indicate a changing trend in the market.

The next two parts are the ‘cloud’ which helps to represent levels of support and resistance. The first cloud is ‘Senkou Span A’ which is the total of the Tenkan Sen and Kijun Sen divided by 2. This point is usually plotted in 26 time points ahead. ‘Senkou B’ is the highest high and lowest low divided by two and it is plotted in the same time points. The space between these 2 lines is known as the ‘cloud’.

Using this indicator may seem complex for new traders, but once each part is broken down it begins to make sense. Some traders use it to spot potential high probability trades and look for lines crossing. The chart puts together multiple indicators into one and provides an insight into the price action of an asset.

How to Use Forex Trading Indicators

Every trader will have their own approach on how to make the best use of trading indicators. It is important to understand that they are only a guide and a way of representing data that has already occurred. If indicators were always 100% accurate, then trading would be easy. But, this is not the case.

Indicators are merely a way of analysing the markets and they can help to provide guidance on potential entry and exit points. Sometimes traders can overcomplicate their strategies by trying to fit in too many indicators. There is no recommended amount to use. Some traders may use none whereas others will use a few at the same time. In some instances, there can be specific indicators that traders prefer for specific market conditions or types of assets. For example, some indicators may be more useful in trending markets whereas others can be more helpful in ranging market conditions.

When testing a trading strategy, some traders will stick to specific rules. For example, they may enter a trade if entry and exit points are defined by indicators. Backtesting is helpful for testing strategies. There is not a specific correct way to trade the markets or one way to use indicators. Every trader can utilise their own strategies and indicators can be a helpful tool. But, they should be regarded as tools rather than reliable predictors of future market movements or conditions. Getting more experience and practice with indicators on a trading platform can be a good way for new traders to become more familiar with them.

Conclusion

You may now have a better idea on how forex trading indicators can help traders get a clearer overview on price action. They do not show what will happen, but they can provide a context into market movements. Some traders use one or two indicators for most of their trades, whereas others rely on more. In certain markets and times of volatility, certain indicators may be more useful than others. It can take trial and error to find an indicator setup that suits your individual trading style.

The article contains market commentary information, it should not be regarded as investment research or investment advice. Past performance is not a reliable indicator for the future.

CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 78.77% of retail investor accounts lose money when trading CFD. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

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Dildeep Singh

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