Jeffrey Macs - Guide to Indicators in Forex Trading: How Technical Indicators Help Improve your Trade Analysis

DESMOND LEONG

Guide to Indicators

Contents

1.1

1.2

1.3

1.4

2.1

2.2

2.3

3.1

3.2

3.3

4.1

4.2

4.3

5.1

5.2

5.3

InTroduCTIon To IndICaTors

Where is the market heading next?

Thats a question every trader will find themselves asking. And now that you should be equipped with the B asics of Forex Trading , well attempt to answer it by exploring the indicators most often used in Technical Analysis.

These indicators can be broadly categorised as follows:

Trend Indicators Momentum Indicators Volatility Indicators

Well start with a brief overview of what each category means, then well explore the indicators in detail in later chapters.

Trend Indicators are useful in determining whether a trend is present, or if the markets are just moving sideways with no clear direction. Theres a saying that the trend is your friend, so we want to be sure to get on the right side of the trend when were trading.

The most common trend indicators are:

Moving Averages Ichimoku Cloud

Average Directional Index

As the name suggests, Trend Indicators only work well in the presence of a trend. This means there must be a clear direction that prices are moving towards, either to the upside or downside. To determine if a trend is present, we can do so by looking at the highs and lows.

When prices consistently form higher highs and higher lows, we consider it an uptrend. Conversely, if prices consistently form lower highs and lower lows, we can consider it to be a downtrend.

Still unsure? Check out our Guide to Forex Trading where we explore the concept of trending and sideways market in detail.

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InTroduCTIon To IndICaTors

Momentum Indicators measure the strength of the movement in prices and are useful in identifying key reversal points. When the indicator reaches extreme levels, it could signal a potential change in trend. On top of that, divergence is another widely used concept in momentum indicators (you can explore this in more depth in ).

Here are the most widely used momentum indicators:

Stochastic Oscillator Relative Strength Index

Moving Average Convergence Divergence

Volatility Indicators help us to anticipate the range of movement in prices and are useful for placing our stop losses. When a currency pair swings wildly up and down, it has a high volatility. Meanwhile, a currency that does not fluctuate as much has a low volatility.

The most common volatility indicators are:

Bollinger Bands Average True Range

Parabolic Stop And Reverse

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Trend IndICaTors

Moving Averages can act as dynamic support and resistance levels and are calculated by taking an average of past closing prices over a specified period of time to obtain a single line on the chart.

So how do they help us? Its smoothing effect prevents short-term price fluctuations by filtering out the noise.

There are two common types of Moving Averages:

Simple Moving Average (SMA) Exponential Moving Average (EMA)

The main difference between the SMA and EMA is its sensitivity to price. This is because, in its calculation, the EMA gives more weight to the most recent price and less weight to older prices, hence it tracks prices closer as compared to the SMA, thereby making it more sensitive.

On the other hand, the SMA gives an equal weight to all prices that it calculates. Thus, it will produce a smoother line as compared to the EMA. The diagram below shows a comparison between the EMA (blue) and SMA (red) on EURUSD. We can see that the EMA (blue) tracks recent prices more closely as compared to the SMA (red).