For many newer traders, foreign exchange
(FX) can seem a bit overwhelming at first glance. Given the complexity of the
data or charts, it is not always clear what the best tools or patterns are to
use in your trading.
Indeed, figuring out the optimal indicators
for your strategy and trading goals can take years of trial and error, as well
as fine tuning and endless small adjustments. However, there are generally four
very powerful and reliable patterns that FX traders can harness that are amongst the most popular for traders of all experience
levels. This article will highlight four such indicators.
1. Relative Strength Index (RSI)
Relative Strength Index (RSI) constitutes a
gauge of a trend’s momentum that can indicate whether the asset being analyzed
is in the overbought or oversold region. This
distinction is extremely relevant for future price action and relies on a
For the purpose of calculation, the RS in the
equation below is the Average gains during upswings/Averages Loss during
downturns within the timeframe being looked at. As such, we can represent this via a simple
RSI = 100 – 100/(1+RS)
Broadly speaking, RSI oscillates between the
range of 0-100 if the price moves below 30 – this means that is in the oversold
region, and if the price moves above 70 that means it is in the overbought
region. However, it’s crucial to understand why this is important.
For example, if a given asset is oversold or
overbought, there is a high probability the current trend will undergo a price
reversal. By extension, traders can use RSI (cross-referencing it against other
indicators to avoid false signals), by using a drop below 30 as a
“buy” signal and a cross above the 70 level as a “sell”
signal and anything in between a sign to hold the position.
2. Simple Moving
A tried and true indicator, the Simple Moving
Average (SMA) represents the sum of all the closing prices of a specific time
period divided by the time intervals. This can sound like a lot of data that is
more complex than it actually is.
As its name suggests, the indicator is a simplified
display of prices over a given interval of time. For example, if you want the
SMA of the last 10 days, you would add the closing prices of the last ten days
and then divide them by 10.
Expanding this to other intervals, depending
on the time frame that is used to calculate the SMA it can show price changes
rapidly. If the SMA is calculated on a short timeline or slower to react (but
better at revealing long term trends) then the timeline is longer.
Longer-term SMA can visually normalize a given
price movement whereby affording you a better gauge of emerging longer-term
trends. Conversely, the first shorter term SMA shows smaller fluctuations in
the price, which is a better analytical tool for traders using shorter-term
strategies such as intraday.
3. Bollinger Bands
Bollinger Bands have evolved into one of the
most popular indicators in recent years, given its versatility and utility. The
indicator excels in helping traders identify periods of volatility, as the
upper and lower bands will converge when volatility is lower as they diverge
when volatility increases
The reason many traders swear by the Bollinger
Bands indicator is due to it giving more specific short and long signals
(comparable to other indicators).For
example, when a high price crosses an upper band, a short signal is given and
where the low price crosses the lower band, a long signal is given (as
indicated in the circles in the image below).
Bollinger bands also occasionally act like
support and resistance, like other indicators do as well.
4. Moving Average Convergence Divergence
Finally, one of the other more common and
helpful indicators used by traders is
the Moving Average Convergence
Divergence MACD. While MACD is a touch more complex in terms of
calculation and analysis, the indicator has a variety of uses for traders.
MACD is a
trend-following momentum indicator, which highlights a relationship between two
moving averages of an asset. MACD is calculated by subtracting the 26-period
Exponential Moving Average (EMA) from the 12-period EMA.
result of this calculation is the MACD line. A 9-day EMA of the MACD, known as
the “signal line,” is then plotted on top of the MACD line, which can
function as a trigger for buy and sell signals.
Traders may be
incentivized to buy when the MACD crosses above its signal line and sell – or
short – when the MACD crosses below the signal line. MACD indicators can also
be interpreted in several ways, but the more common methods are crossovers,
divergences, and rapid rises/falls.
Generally speaking, MACD can help traders
identify the speed of crossovers taken as a signal of a market being overbought
or oversold. Moreover, MACD also assists investors in understanding whether
bullish or bearish movement in the price is strengthening or weakening.
This article was submitted by InstaForex.