Technical analysis has proven to be a highly effective method of analysing the Forex market. It uses many tools which include charts, technical indicators, and patterns. The use of technical indicators, especially, is a very important skill that you will have to master as you strive to enhance your trading performance.
But what are technical indicators? Well, technical indicators are sets of mathematical formulas that analyse past price trends in order to predict price behaviour. There are many of them but here, we discuss the 10 most effective and widely used.
Simple Moving Average
The Simple Moving Average, usually called MA for short, is so popularly used because it arguably provides the best and most consistent trend information. This owes to the fact that it does not pay attention to the interference of short-term movements in price in its course.
Because it identifies key support and resistance levels in the market, the MA reveals past price action. It builds on that information to also indicate possible future patterns. There are different types of MA depending on the required number of days of data, but the 200-MA is the most used.
Exponential Moving Average (EMA)
The Exponential Moving Average (EMA) is another form of moving average. However, unlike other moving averages, it places a huge emphasis on recent market information. As a result, it tends to be more responsive than others.
Exponential moving averages (EMAs) can be either short-term or long-term. The 12 and 26-period EMAs are the most commonly used short-term EMAs while the 50 and 200-period EMAs are the most commonly used ones.
If there is an indicator you need to make trading decisions based on momentum and trend strength, it is stochastic. Being an oscillator indicator, it uses a scale of 0 to 100 whereby a reading of below 20 signals an oversold market and a reading of over 80 an overbought one.
The Stochastic is easy to use. All you need to do is to watch out for the 0-100 range. When it gives a reading below 20, you can buy. And when it gives one above 80, that can be a good time to sell. However, always confirm with other tools before you trade.
Moving Average Convergence Divergence (MACD)
The popular “moving average of other moving averages”, the MACD, is a technical indicator that can also help you easily recognise overbought and oversold regions in the market. It does that through its revelation of key support and resistance levels which you can use to know when to buy or sell.
Through its points of convergence and divergence, it points out when momentum is either increasing or decreasing. The momentum increases during convergence (when the moving averages are coming together) and decreases during divergence (when they are going apart).
Developed by the foremost technical analyst, John Bollinger, and named after him, the Bollinger Band is a highly useful technical indicator that can tell you the price range within which a particular asset is trading at a particular time. There are two lines, hence a band.
When an asset is trading beyond the upper band, it might be overbought and a correction can be in sight. But when it is trading below the lower band, it might be oversold, and a correction can be in sight too. Also, the closer the bands are for any asset, the lower the volatility of the asset is.
Relative Strength Index (RSI)
The Relative Strength Index is easy to use. It is similar to the stochastic in that it is also expressed as a scale of 0 to 100. It is often used to identify when the market may be trading beyond limits and to forecast possible dangerous moves in price.
When the indicator has a reading below 20, it is suggestive of oversold conditions in the market. And when it gives above 80, the market could be overbought. For the former, a buy is advised. For the later, a time to sell can be presenting itself.
A retracement, also known as a pullback, is a time of temporary dip in the market. The Fibonacci is an indicator that seeks to identify the degree to which the market will move either against or for its current trend by analysing those dips.
Hence, you can use it to identify support and resistance. The knowledge of those key levels will help you to enter and exit the market at the right times, and also set optimal stops.
Ichimoku Kinko Hyo is a technical indicator of Japanese origins. Literally translating to “one look equilibrium chart”, it is most effective for traders who are seeking adequate market information by just taking a glance at the charts.
By identifying multiple support and resistance levels on charts, it reveals any prevailing trend and gauges its momentum, thereby helping to forecast price levels.
If you are looking for a technical indicator that relates price to volatility, the Standard Deviation is. By helping traders size price moves, the indicator can be used to detect how the price will be affected by the market volatility.
Based on that, the general belief that large price moves follow small price moves and that small price moves follow large price moves has become widely established among its numerous users.
Average Directional Index
The Average Directional Index, the ADX for short, is an indicator that measures the directional strength of trends. Consequently, it is used to signal whether a trend is likely to continue or not.
It works on a scale of 10-100. A reading above 25 indicates that the trend will most likely be sustained. However, any reading below that forex signals that a reversal can be initiated anytime soon.