Types of Technical Analysis Indicators: Technical traders often compute and plot mathematical quantities based on market observable like price and volume in order to indicate the past or present state of the market. They can often also use certain specific recognizable behaviors of the so-called technical indicators to predict the future behavior of the market and to generate buy and sell signals.
As useful as technical indicators can be to the Forex trader, their effective use often requires keeping the number of indicators consulted down to a manageable level in order to facilitate quick trading decisions.
Types of Technical Analysis Indicators
The following sections will cover some of the more popular technical indicators that many forex traders have found efficient and effective to use in practice when trading.
- Trend Indicators
- Moving Averages
- Momentum Indicators
- Relative Strength Index (RSI)
- Volatility Indicators
- Bollinger Bands
Trend-following indicators are the most popular type of indicators. They are good in identifying trends and giving you simple buy and sell signals.
One of the common charges against trend-following indicators is that that they lag significantly after price and generate signals too late. But you don’t want an indicator to get you into trend changes too fast either, as you can then be lead into too many false signals in a noisy, vacillating market. It is encouraged that you play with the length and calculation methods of different trend indicators to find the right balance between speed/responsiveness and smoothness/reliability.
Traders might compute an average of the exchange rate for a certain period of time. This average is then superimposed on the price action so that it moves along as time progresses. The effect is to help smooth out the price data so that trends can better be identified.
Moving averages might be computed as simple, exponential or weighted averages, and they tend to be a lagging indicator of future price action with relatively little predictive power.
Nevertheless, some traders use crossovers between a short moving average and a longer term moving average as a trading signal, with the short term average crossing above the longer term average being a bullish signal and a crossover below being a bearish signal.
Learn more about the Moving averages indicator here.
The Moving Average Convergence Divergence or MACD indicator is also based on this general idea which it enhances considerably.
Learn more about the MACD indicator here.
Momentum indicators / Oscillators
Momentum indicators in Forex are great for measuring the speed of prices over a specific period of time in order to get in and out of the trade at the right moment. You want to be able to get in when momentum is accelerating, indicating that traders have great confidence in the current trend. You want to be able to get out when momentum is decelerating, indicating uncertainty for traders as they re-evaluate the odds of chasing the price.
Trend indicators can identify the up or down trend and can tell you of a pending trend reversal, but they cannot tell you the moment of entry/exit as well as momentum. Momentum indicators can show you the best moment to make the trade, to buy or sell with the higher odds that the market will move in your favor. They can can also tell you when the momentum of the trend is weakening, and you can use this information to take profits or re-adjust your trailing stops.
The Relative Strength Index or RSI
The RSI is a very popular and useful indicator of overbought or oversold market conditions, and since it fluctuates in value between 0 and 100, it is considered a banded momentum oscillator. If the index is showing a number higher than 70, then the market is thought to be overbought, but if the number is below 30, then the market is oversold.
Forex traders can also use the RSI to watch for regular and hidden divergence versus the price action that might indicate pending market reversals.
Learn more about the RSI indicator here.
The Stochastics Oscillator
The Stochastics are a popular example of a momentum indicator. Its basic premise is that in an uptrend, prices tend to close in the higher part of the day’s range to signal upward momentum. Conversely, while in a downtrend, closing prices tend to close in the lower part of the day’s range, indicating downward momentum.
Learn more about the stochastics indicator here.
Volatility indicators reveal the size and magnitude of price fluctuations, providing insight into the level of market activity. Markets fluctuate between periods of high volatility and low volatility, with a period of low volatility gradually increasing in intensity, and a period of high volatility gradually diminishing in intensity to become low volatility.
For instance, one of the most popular of volatility indicators, the Bollinger Band, measures volatility via the bands (2 standard deviations of the 20 SMA): the bands expand when volatility is rising, and contract when it is falling. Over the years traders have figured out different ways of trading off the indicator. Some choose to trade the breakout: buying (selling) the breakout (breakdown) of pricing crossing over (under) the upperband (lowerband). Others choose to trade the reversal bounce: buying (selling) the bounce of prices crossing under (over) the upperband (lowerband).
Another useful technical indicator related to market volatility is the Bollinger Bands that are typically depicted superimposed over the price action on a chart.
The central line of the indicator is a simple moving average, while the upper and lower lines of the indicators represent a certain number of standard deviations around the central line.
Forex traders tend to use this indicator to generate a signal to initiate a short position when the market exceeds the upper line or a long position when the market falls below the lower line.
Learn more about the Bollinger Bands indicator here.
Keeping it Simple: Types of Technical Analysis Indicators
One of the keys to using technical indicators effectively is to keep the number of indicators you watch to generate trading signals down to a minimum that will still show consistent profitability.
Basically, the risk of falling into the trading trap of “analysis paralysis” increases the more technical indicators you need to consult before making a trading decision.
Remember, the Forex market often moves quickly, especially when key technical indicators or chart patterns forecast important exchange rate movements. As a result, any unnecessary delay in entering the market can be quite costly and may even turn what would initially have been a winning position into a losing one.
Please note that: Successful Technical Analysis largely depends on the functionalities of the MT4 Platform provided by your broker. If you are new in forex trading, you might consider reading the article on what is the best trading platform, Introduction to MT4 Platform and MT4 Platform functions. We have used a fully functional MT4 platform provided by HYCM Broker. Read why their MT4 platform has better trading conditions from the HYCM Broker review.
|Chapter 5||Technical Analysis in Forex Trading|
|Lesson 1||Types of Technical Analysis Indicators|
|Lesson 2||Forex Trading Trendline Analysis|
|Lesson 3||Forex trading Chart Patterns|
|Lesson 3.2||Double Tops and Double Bottoms|
|Lesson 3.3||Head and Shoulders Pattern|
|Lesson 3.4||Rectangle Chart Patterns|
|Lesson 3.5||Triangle Chart Patterns|
|Lesson 4||Japanese candlestick Trading Strategy|
|Lesson 4.2||Japanese candlestick Trading Strategy Part 2|
|Lesson 5||Support and Resistance Levels|
|Lesson 6||Types of Technical Analysis Indicators|
|Lesson 6.2||moving averages Technical Analysis|
|Lesson 6.3||MACD Indicator Technical Analysis|
|Lesson 6.4||RSI Indicator Technical Analysis|
|Lesson 6.5||Stochastics Indicator Technical Analysis|
|Lesson 6.6||Technical Analysis with Bollinger bands Indicator|
|Lesson 7||Fibonacci Retracement Forex Strategy|
|Lesson 8||Forex Trading Pivot Strategies|