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Understanding is very important for our life. If, you can understand what your BOSS(monster) is thinking then you can always be prepared to tackle the bullets the BOSS throws at you. Similarly if you can understand your girl's mind(come on- whom I am kidding) then you can always get her birthday, the Anniversary and other important dates in advance and thus save your soul from torture. Understanding Forex Trading indicators would put you in a very unique situation. You would be able to grasp the Forex market in a much better way. You can see sense in the crazy movements Forex market unfolds everyday. And most importantly your would be able to take an informed decision before each trade. Thus, you would put your self at an advantage in trading.
There are over hundreds of indicators but we just need 2-3 indicators to devlope a good trading system. Let's look at some of the most popular and effective indicators for Forex trading.
MOVING AVERAGE
Benefit: Moving averages are very useful for trading because, (1) Reveal trends by smoothing out data by filtering out the market noises, (2) Identify points from which a new trend might start or existing trend might end, (3) Indicate shifts in market momentum based on the performance of price vs. a moving average or one moving average vs. another.
Reading signals: The simplest signal involves only price and one moving average. When the price is above the moving average, enter long(buy); when price is below the moving average, open short(sell) position.
Moving averages are often used in crossover trading systems. A buy signal occurs when a short-term or intermediate-term moving average crosses from below to above a longer-term moving average. Conversely, a sell signal is issued when the short-term or intermediate-term average crosses from above to below the longer-term average.
Because the moving average changes constantly with each new price data input, many traders test different time frames before they come up with a series of moving averages that are optimal for a particular market. The shorter a moving average, the more responsive it would be to short term price movements. Traders have to find the best combination of moving averages to make a system.
Pros/cons: Easy to understand and implement. There is already Moving Average lines in the trading platform. One just needs to decide the how many moving average lines needed, the period, and then put them on chart to test the results in previous trading days.
Bollinger Band
John Bollinger in the 1980s developed Bollinger Band. The Bollinger Bands are based on a moving average - usually 20 periods - with upper and lower bands two standard deviations above and below the moving average. These bands covers all the price points.
Purpose: Bollinger Bands indicate a market's volatility with just a glance at a chart and can provide significant clues for volatility-based trading strategies. These Bands help to see if the market would move up, down or go side ways.
During high volatility, the distance between the upper and lower bands get expanded; when volatility is low, the distance between the bands get squeezed. If the distance between the bands gets very wide like a big gap between the bands then it indicates the current trend is reaching its end. When bands get squeezed to look very narrow, it indicates the ranging market is about to end and a break out would happen to make a big move in the market.
Basic signals: The best way to trade with Bollinger Bands is when price is touching either the top or bottom band. When the price touches top band, it means end of up-trend so we enter sell deal, and when price touches bottom band it means end of down- trend so we enter buy deal.
Benefit: Bollinger Bands provide a good, quick visual reference of market volatility and can be used in many different ways.
MACD
The origination of MACD is generally associated with Gerald Appel in the 1970s.
Purpose: MACD finds overbought/oversold zones and identifies price trends, conditions measuring the strength or weakness of a trend and indicating the momentum of market movements.
Basic signals: The MACD indicator is used in several ways:
Pros and cons: MACD identifies trend direction and tells us if the trend is losing strength or not by using moving average. It provides us an early signal of trend reversal. At the same time, MACD is a lagging indicator like moving averages and requires rather strong price movement to generate a signal. It can work very well in a market that makes broad price moves but may get bogged down in choppy trading situations.
Stochastic:
The stochastics indicator is often associated with George Lane.
It works like this. When prices are moving up, closes will tend to be near the top of the price range for a given period. Then, as the market nears a top, closes will slip back from the top of the range, suggesting a loss of momentum. Similarly, when prices are moving lower, closes will tend to congregate near the lower end of the price range for a given period. Then the downward pressure diminishes, indicating a loss of momentum.
Stochastics is intended to be an indicator that reflects changes in momentum, either up or down. It does not give specific prices but only offers clues on price direction. Although the premise of stochastics seems plain enough, its computation is more complex and best left to analytical software.
The clues are provided by the interaction of two lines. %K, the more sensitive line, determines where the current close is relative to the price range for a given time, typically 14 periods. %K is a percentage figure to show where the close is within the total price range for the selected period.
%D is a three-period moving average of %K in the fast stochastics version or another three-period moving average of %D arrive at a smoother, slow stochastics version favored by most traders who use this indicator.
Basic signals: Stochastics produces several different trading signals:
RSI
Relative Strength Index (RSI) is one of several innovative technical indicators introduced by J. Welles Wilder Jr. in his 1978 book, New Concepts in Technical Trading Systems.
There are really two different uses for the term "relative strength." The first suggests the strength of one market vs. another or how a market or market sector compares to some benchmark. The second usage refers to the strength of a price move for one period against the strength of a move for another period and in this usage serves as a measure of momentum.
One of the problems in analyzing prices is that they sometimes make sharp, erratic moves that can distort the overall picture of strength or weakness for a market, especially when one of the older erratic moves drops out of the calculation. Wilder's RSI provides a smoothing effect for these changes and places the current strength of a market within a 0 to 100 scale.
Relative Strength takes the average of the up closes for a given time period and divides that up average by the average of down closes during that period. Typically, 14 periods are used for RSI, but the number can be more or less, depending on the sensitivity of the index desired. That can vary to fit the time frame the user is trading.
By plotting RSI on an index scale of 0 to 100, a move to above 70 can suggest an overbought situation that might lead to a downturn or a move to below 30 can suggest an oversold condition that might lead to an upturn in prices. (Those thresholds can change to 80 in bullish markets or 20 in bearish markets.)
As with a number of other indicators, RSI is most effective when its readings are at the upper or lower extremes of the scale. When the RSI moves above 70 and then fails to move above a previous peak and falls through the downside of a previous dip, prices can be expected to move lower. On the other end of the spectrum, a bottom failure occurs when RSI drops below 30, then fails to set a new low and moves above a previous peak.
Several examples can be found on the chart below. The first is a buying situation on a bottom failure when the second low is not as low as the first low and RSI breaks out higher. The second is a signal for a selling opportunity when RSI tops 70, the second RSI high is below the first high and RSI drops below the RSI low. Of course, not every move above 70 or below 30 results in a great signal so any trading requires sound money management techniques.
As with other indicators, divergence between the direction of prices and the RSI line is also an important clue that RSI has detected an underlying change in market conditions and prices may be about to turn in the direction of the indicator, as the chart illustrates. These clues can be used in conjunction with traditional chart pattern or moving average analysis.
Pros/cons: RSI works great in giving us the over bought and over sold zones. So, we can make good profit by entering trades in trend reversals. But during strong trending markets RSI fails to show trend reversal correctly.
CCI
The Commodity Channel Index (CCI) was developed Donald Lambert and was designed to compare the current price with a moving average for a specified time period by using a constant divisor based on deviation to normalize the oscillator. The indicator is usually based on 20 periods, but some users have tied the time span to the length of price cycles for a given market to produce a channel within which most of the price activity is expected to take place.
CCI finds the value of the current price in the context of a series of prices over a range of time, which can be varied to make the reading more or less sensitive. The intent of the index calculation is to have the indicator reading fluctuate between +100 on the upside and -100 on the downside, with moves outside of those boundaries providing signals for trading positions.
Basic signals: To trade based on CCI, the basic parameter is to buy when CCI crosses 100+ and sell when CCI crosses below -100. But some traders trade it in the opposite way. That is - they consider +100 as overbought so they sell there and for them -100 is oversold so they enter buy.
Benefit: The CCI like Bollinger Bands is very easy to interpret to decide about market's directions.
The above indicators we discussed in details are the most popular and productive indicators. We have discussed the default parameters of those indicators as per the Developer's description. But one can easily research the above indicators with different parameters and find a more profitable trading system. The idea is to use 2 or maximum 3 indicators with the best parameters and enter buy or sell when all the used indicators are showing the same market direction. To reach into conclusion that we have a good trading system one needs to back test minimum 3 months trading results in at least one currency pair and see if the system has given minimum 8% average monthly profit without ever touching cumulative draw down of 20%. Once we find that elusive combination to get this result we are on our way to Forex trading glory and financial freedom.
Free Trading Coach to guide you in your trading- Open Live Trading Account Below
Life is full of opportunities when one sees the potential more than the problems.
Disclaimer- Like any other business Forex Trading too comes with certain risk. One might lose money if not done properly. Never invest money you can’t afford to lose. That’s the first rule for any business. Forex Trading is not suitable for everyone
Understanding is very important for our life. If, you can understand what your BOSS(monster) is thinking then you can always be prepared to tackle the bullets the BOSS throws at you. Similarly if you can understand your girl's mind(come on- whom I am kidding) then you can always get her birthday, the Anniversary and other important dates in advance and thus save your soul from torture. Understanding Forex Trading indicators would put you in a very unique situation. You would be able to grasp the Forex market in a much better way. You can see sense in the crazy movements Forex market unfolds everyday. And most importantly your would be able to take an informed decision before each trade. Thus, you would put your self at an advantage in trading.
There are over hundreds of indicators but we just need 2-3 indicators to devlope a good trading system. Let's look at some of the most popular and effective indicators for Forex trading.
MOVING AVERAGE
Simple Moving Average (SMA) Here, the prices for a specified period of time is divided by the number
of prices in that period to get an average. Each price is given an equal
weight. As each new price becomes available, the oldest price is
dropped from the calculation.
Weighted Moving Average Here, the latest price is considered more
important than older prices. Example- While calculating a three-day weighted
moving average, the latest price is multiplied by 3,
yesterday's price by 2 and the oldest price three days ago by 1. The
sum of these figures is divided by the sum of the weighting factors 6
in this example. This makes the weighted moving average more responsive
to current price changes.
Exponential Moving Average (EMA) An
exponential moving average (EMA) is another form of a weighted moving
average that gives more importance to the most recent prices. It takes all past
prices into the current average. The current EMA is
calculated by subtracting yesterday's EMA from today's price,
multiplying the result by a constant and then adding this result to
yesterday's EMA to get today's EMA.
Benefit: Moving averages are very useful for trading because, (1) Reveal trends by smoothing out data by filtering out the market noises, (2) Identify points from which a new trend might start or existing trend might end, (3) Indicate shifts in market momentum based on the performance of price vs. a moving average or one moving average vs. another.
Reading signals: The simplest signal involves only price and one moving average. When the price is above the moving average, enter long(buy); when price is below the moving average, open short(sell) position.
Moving averages are often used in crossover trading systems. A buy signal occurs when a short-term or intermediate-term moving average crosses from below to above a longer-term moving average. Conversely, a sell signal is issued when the short-term or intermediate-term average crosses from above to below the longer-term average.
Because the moving average changes constantly with each new price data input, many traders test different time frames before they come up with a series of moving averages that are optimal for a particular market. The shorter a moving average, the more responsive it would be to short term price movements. Traders have to find the best combination of moving averages to make a system.
Pros/cons: Easy to understand and implement. There is already Moving Average lines in the trading platform. One just needs to decide the how many moving average lines needed, the period, and then put them on chart to test the results in previous trading days.
Bollinger Band
John Bollinger in the 1980s developed Bollinger Band. The Bollinger Bands are based on a moving average - usually 20 periods - with upper and lower bands two standard deviations above and below the moving average. These bands covers all the price points.
Purpose: Bollinger Bands indicate a market's volatility with just a glance at a chart and can provide significant clues for volatility-based trading strategies. These Bands help to see if the market would move up, down or go side ways.
During high volatility, the distance between the upper and lower bands get expanded; when volatility is low, the distance between the bands get squeezed. If the distance between the bands gets very wide like a big gap between the bands then it indicates the current trend is reaching its end. When bands get squeezed to look very narrow, it indicates the ranging market is about to end and a break out would happen to make a big move in the market.
Basic signals: The best way to trade with Bollinger Bands is when price is touching either the top or bottom band. When the price touches top band, it means end of up-trend so we enter sell deal, and when price touches bottom band it means end of down- trend so we enter buy deal.
Benefit: Bollinger Bands provide a good, quick visual reference of market volatility and can be used in many different ways.
MACD
The origination of MACD is generally associated with Gerald Appel in the 1970s.
Purpose: MACD finds overbought/oversold zones and identifies price trends, conditions measuring the strength or weakness of a trend and indicating the momentum of market movements.
Basic signals: The MACD indicator is used in several ways:
Crossover signals When
the MACD line - the difference between the two EMAs - crosses below the
signal line - the 9-period EMA of the MACD line - it is a bearish
signal; when the MACD line crosses above the signal line, it is a
bullish signal. Another crossover signal occurs when MACD crosses above
or below the zero line.
Overbought-oversold If
the 12-period EMA pulls away from the 26-period EMA or diverges
dramatically, it indicates the market may be getting overextended and is
due for a correction to bring the averages back together (convergence).
Divergence As
with other indicators, MACD can provide early clues about the
divergences between prices and the indicator. If the MACD turns positive
and makes higher lows while prices are making lower lows, as
illustrated by the black lines on the chart below, this could be a
strong buy signal. Conversely, if the MACD makes lower highs while
prices are making new highs, this could be a strong bearish divergence
and a sell signal. Frequently, the indicator will be a better indicator of the direction of a trend than price itself.
Histogram alerts MACD
can also be shown as a histogram with each bar showing the difference
between the 12/26 MACD line and the 9-period signal line. A reading of
zero means no difference between the two lines. When the size of the
histogram bars grows or shrink, it could be the first alert that the
underlying strength or weakness of the market is changing. Note in the
red box on the chart below that the histogram bars began to shorten
several periods before the MACD line and signal line and before the
crossover signal. This might be an early entry/exit clue for an
aggressive trader. A more patient trader might wait for the histogram to
move above the zero line to buy or below the zero line to sell.
Pros and cons: MACD identifies trend direction and tells us if the trend is losing strength or not by using moving average. It provides us an early signal of trend reversal. At the same time, MACD is a lagging indicator like moving averages and requires rather strong price movement to generate a signal. It can work very well in a market that makes broad price moves but may get bogged down in choppy trading situations.
Stochastic:
The stochastics indicator is often associated with George Lane.
It works like this. When prices are moving up, closes will tend to be near the top of the price range for a given period. Then, as the market nears a top, closes will slip back from the top of the range, suggesting a loss of momentum. Similarly, when prices are moving lower, closes will tend to congregate near the lower end of the price range for a given period. Then the downward pressure diminishes, indicating a loss of momentum.
Stochastics is intended to be an indicator that reflects changes in momentum, either up or down. It does not give specific prices but only offers clues on price direction. Although the premise of stochastics seems plain enough, its computation is more complex and best left to analytical software.
The clues are provided by the interaction of two lines. %K, the more sensitive line, determines where the current close is relative to the price range for a given time, typically 14 periods. %K is a percentage figure to show where the close is within the total price range for the selected period.
%D is a three-period moving average of %K in the fast stochastics version or another three-period moving average of %D arrive at a smoother, slow stochastics version favored by most traders who use this indicator.
Basic signals: Stochastics produces several different trading signals:
- Extreme readings in %K and %D. In general, a reading above 80, the dashed green line on the chart below, indicates an overbought situation and a potential turn down. A reading below 20, the dashed red line on the chart, indicates an oversold condition and a potential turn to the upside. A reading of 0 does not mean a price bottom but extreme weakness in prices
- Crossovers of %K and %D when the two readings are in the overbought (80-plus) or oversold (20 and below) zones. Sometimes the turn may not occur until after a second crossover. The arrows on the chart below show several situations where the crossovers led to timely buy or sell signals as a new trend was beginning.
- Divergence between the indicator and price action - that is, prices make a higher high but the indicator makes a lower high or prices make a lower low but the stochastics lines make a higher low. The solid black lines on the chart are examples of divergence at a low and at a high. Divergence is one of the most useful signals for a number of indicators, not just stochastics.
RSI
Relative Strength Index (RSI) is one of several innovative technical indicators introduced by J. Welles Wilder Jr. in his 1978 book, New Concepts in Technical Trading Systems.
There are really two different uses for the term "relative strength." The first suggests the strength of one market vs. another or how a market or market sector compares to some benchmark. The second usage refers to the strength of a price move for one period against the strength of a move for another period and in this usage serves as a measure of momentum.
One of the problems in analyzing prices is that they sometimes make sharp, erratic moves that can distort the overall picture of strength or weakness for a market, especially when one of the older erratic moves drops out of the calculation. Wilder's RSI provides a smoothing effect for these changes and places the current strength of a market within a 0 to 100 scale.
Relative Strength takes the average of the up closes for a given time period and divides that up average by the average of down closes during that period. Typically, 14 periods are used for RSI, but the number can be more or less, depending on the sensitivity of the index desired. That can vary to fit the time frame the user is trading.
By plotting RSI on an index scale of 0 to 100, a move to above 70 can suggest an overbought situation that might lead to a downturn or a move to below 30 can suggest an oversold condition that might lead to an upturn in prices. (Those thresholds can change to 80 in bullish markets or 20 in bearish markets.)
As with a number of other indicators, RSI is most effective when its readings are at the upper or lower extremes of the scale. When the RSI moves above 70 and then fails to move above a previous peak and falls through the downside of a previous dip, prices can be expected to move lower. On the other end of the spectrum, a bottom failure occurs when RSI drops below 30, then fails to set a new low and moves above a previous peak.
Several examples can be found on the chart below. The first is a buying situation on a bottom failure when the second low is not as low as the first low and RSI breaks out higher. The second is a signal for a selling opportunity when RSI tops 70, the second RSI high is below the first high and RSI drops below the RSI low. Of course, not every move above 70 or below 30 results in a great signal so any trading requires sound money management techniques.
As with other indicators, divergence between the direction of prices and the RSI line is also an important clue that RSI has detected an underlying change in market conditions and prices may be about to turn in the direction of the indicator, as the chart illustrates. These clues can be used in conjunction with traditional chart pattern or moving average analysis.
Pros/cons: RSI works great in giving us the over bought and over sold zones. So, we can make good profit by entering trades in trend reversals. But during strong trending markets RSI fails to show trend reversal correctly.
CCI
The Commodity Channel Index (CCI) was developed Donald Lambert and was designed to compare the current price with a moving average for a specified time period by using a constant divisor based on deviation to normalize the oscillator. The indicator is usually based on 20 periods, but some users have tied the time span to the length of price cycles for a given market to produce a channel within which most of the price activity is expected to take place.
CCI finds the value of the current price in the context of a series of prices over a range of time, which can be varied to make the reading more or less sensitive. The intent of the index calculation is to have the indicator reading fluctuate between +100 on the upside and -100 on the downside, with moves outside of those boundaries providing signals for trading positions.
Basic signals: To trade based on CCI, the basic parameter is to buy when CCI crosses 100+ and sell when CCI crosses below -100. But some traders trade it in the opposite way. That is - they consider +100 as overbought so they sell there and for them -100 is oversold so they enter buy.
Benefit: The CCI like Bollinger Bands is very easy to interpret to decide about market's directions.
The above indicators we discussed in details are the most popular and productive indicators. We have discussed the default parameters of those indicators as per the Developer's description. But one can easily research the above indicators with different parameters and find a more profitable trading system. The idea is to use 2 or maximum 3 indicators with the best parameters and enter buy or sell when all the used indicators are showing the same market direction. To reach into conclusion that we have a good trading system one needs to back test minimum 3 months trading results in at least one currency pair and see if the system has given minimum 8% average monthly profit without ever touching cumulative draw down of 20%. Once we find that elusive combination to get this result we are on our way to Forex trading glory and financial freedom.
Free Trading Coach to guide you in your trading- Open Live Trading Account Below
Life is full of opportunities when one sees the potential more than the problems.
Disclaimer- Like any other business Forex Trading too comes with certain risk. One might lose money if not done properly. Never invest money you can’t afford to lose. That’s the first rule for any business. Forex Trading is not suitable for everyone
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