Using Indicators in Forex Trading

The use of technical and fundamental indicators is of extreme importance when trading Forex. There are hundreds of different indicators in the marketplace and one can get confused as to which one to use before placing a trade. Among the many free indicators available online today, there are a few ‘premium’ ones that must be purchased before use but these are not any better at foretelling the direction or price of a currency pair than the free ones. In fact, many online Forex brokers provide a wide choice of indicators to its account holders.

When discussing premium indicators, it should be noted that indicators can only be successful when they are actually used by traders. For that reason, it is important to understand the ones most commonly used since the market needs to be moving in the same direction in order for it to be beneficial for a trader’s position. Learn forex here. In fact, the best way to move the market is to have a large group of traders view the same thing. This is why certain indicators such as a 50% Fibonacci retracement will attract a tremendous amount of attention. In this regard, there should be no reason to search for some sort of “secret” indicator as the other market participants will not know what this indicator is showing.

Moving Averages

While not necessarily the most exciting or exotic of indicators, the moving average is certainly one of the most common ones. There seems to be an unlimited amount of moving average combinations but there are three specific values that appear over and over. The 50 day, the 100 day, and the 200 day moving averages tend to appear on most charts. This is because traders tend to like large round numbers. In addition, it should be noted that on a daily chart, the 200 day moving average represents a full year’s worth of trading. (There are 200 trading days in the stock markets, and although it doesn’t match up perfectly with the Forex markets, this figure continues to be used throughout the financial sector.)

MACD

MACD, or Moving Average Convergence Divergence, is probably one of the more popular indicators used in Forex trading. This particular indicator is an oscillator and is composed of three signals which are calculated from historical price data which is usually the last closing price. The three signal lines are the MACD line, the signal line, and the difference. MACD is used in a variety of ways but it is essentially used to track momentum. Ironically, this indicator is combination of moving averages and works very much the same way. Because it is somewhat of a lagging indicator, it is the preferred indicator for longer time frames. There are a plethora of systems based upon this particular indicator and is often cited by traders as being one of their more trusted indicators.

RSI

RSI, or the Relative Strength Index, is an indicator that measures historical strength or weakness and is based upon the closing prices of recent trading periods. This too is a momentum oscillator, and measures velocity and magnitude of price movement. The RSI computes momentum as a ratio of higher closes to lower closes, tends to be used on a 14 day time frame and is measured from 0 to 100 for strength. You will often see a dashed line at 30 and 70 which is the range for which RSI should typically be hovering over. Above those ranges, the indicator will show extreme strength or extreme weakness depending on whether we are in the higher or lower part of the indicator.

RSI is often used in a very similar manner to MACD, and as such many of the systems that use MACD and RSI are relatively interchangeable. Nonetheless, RSI is a very popular indicator and you will find it being  used over and over again.

ADX

ADX or Average Directional Movement Index is like the RSI and measures strength in a series of movements over the course of time. This indicator is often used to differentiate between true momentum and low liquidity spikes in price. By using the ADX, the trader can compare the recent movement to average movements over the course of a longer time period. The ADX doesn’t show the direction of a trend, only its strength. The trend must be an established one in order for this indicator to be effective. Strong trends that measure over 70 are often thought to be more reliable as they show real momentum building in the currency pair.

Bollinger Bands

Bollinger Bands are one of the most commons indicators in the market. Essentially they use a moving average as the centerline surrounded by two other lines that measure standard deviations from the moving average. In other words, a standard deviation is the average price movement away from the moving average. Many Bollinger Band traders use a deviation of two in order to see when a market is either overbought or oversold. The idea is that price will eventually come back to the moving average.