In this Lesson, we will review the most important technical indicators used to trade the Forex market.
Technical indicators are no more than a series of data points plotted in a chart that are derived from a mathematical formula applied to the price of any given instrument. In other words, indicators are just a different way in which price movements can be represented over specified periods of time (they offer us a different perspective).
Some technical indicators are used to confirm price action (lagging indicators), others are used to predict price action while some others are used as an alert or warning of a possible break on price action.
Lagging indicators – These indicators follow the price action, in other words they confirm what the price just did. The signals that come out of this type of technical indicators usually happen after the change in price begins. These types of indicators are also called trend-following indicators and work best during trending markets, where they allow traders to catch most of the move. During trendless conditions (sideways or ranging market) these types of indicators give many false signals.
Leading indicators – These indicators try to predict future price movements. They give signals before the actual price movement begins. These kinds of indicators work best during consolidation periods or trendless markets. During trending conditions, only signals in direction of the existing trend are advised to be taken. During up-trending conditions, leading indicators help us identify oversold conditions (price has falling enough and it is ready to continue its trend). During downtrending conditions, they help us identify overbought conditions (price has rallied enough, and now it is ready to continue its trend).
When using leading indicators it is also advisable to wait for the actual price movements before taking the indicator signal.
Most important lagging indicators: Moving Averages (MA) and Moving Average Convergence-Divergence (MACD).*
Most important leading indicators: Relative Strength Index (RSI), Stochastics, Commodity Channel Index (CCI) and Momentum.*
*Some of these indicators can be used both as a lagging indicator and as a leading indicator.
Sensitivity vs. Consistency
Before going through all the indicators it is important to understand the relationship between these two concepts. Every indicator represents price movements over a chosen period. Each indicator gives you the option to decide on how many periods you want to go back over to do the calculation. If we shorten the period, we will get more and earlier signals, but at the same time, the percentage of false signals will also increase. If we increase the number of periods, false signals will decrease, but the signal will get us in a trade later, giving up some profits.
It is up to the trader to select the approach that best suits his or her trading personality, trading style and objectives.
In this lesson we will cover the following topics:
Moving Averages – In this section, we will review moving averages, what they tell you, common uses, etc.
Moving Average Convergence-Divergence (MACD) – MACD is a popular indicator that can be used in several ways to our benefit.
Commodity Channel Index (CCI) – The CCI is an indicators that quickly reacts to the price action.
Stochastics (STC) – We will review the best overbought/oversold indicator.
Momentum (MOM) – Trying to measure the strength/momentum of the market can help us take better decision.
Bollinger Bands (BB) – This volatility indicator developed by Bollinger shows us how far the market could go during “normal conditions”.
Average Directional Index (ADX) – The ADX is an indicator that measures the strength of the trend in any market.
Fibonacci Retracements – Once the market has retraced, the Fibonacci retracements can help us determine where could the retracement could end.
Pivot Points (PP) – PP is a popular technique that shows us the sentiment of the market and other useful information.
Important Considerations about Technical Indicators – What’s inside indicators, how should we use them? Do they generate accurate signals?
Time-Frames – The combination of time-frames is critical to have good results.