You can make your life easier as a forex trader by understanding how to read and interpret the main technical indicators. Forex markets are not rocket science. There are behaviours, movements and patterns that are repeated, and when recognised, they can be used to make better trades of currency pairs.
Making sense of these forex charts should be one of the first things on which to focus. Here are several of the most important indicators and what they mean.
Simple Moving Average
A Simple Moving Average (SMA) helps traders to identify trends by visualising how the average price of a currency pair has changed over a given period. SMAs are based on the closing prices. The moving average is arguably the most used technical indicator due to its ability to confirm a trend and identify support and resistance levels. This makes it a great entry point for new traders. Moving averages cover a range of different periods with 10, 50, 100 and 200 days being the most common.
Computing an SMA is as simple as adding up the exchange rates for a set period, such as 20 days, and then dividing the total sum by this period. If the moving average is located on the chart above the exchange rate, then that is not a good sign for a trader. In contrast, an exchange rate above the moving average is classed as ‘bullish.’
Exponential Moving Average
There are four main moving averages. The second is an Exponential Moving Average (EMA) that is similar to an SMA. It is, however, more rooted in recent prices and thus is a better indicator for micro-movements. EMA responds quickly to changes in currency prices. Using a dual moving average with short and long periods is a simple strategy that can support your decision making when trading. When the two moving averages intersect, you can enter the market.
The two other fundamental MAs are weighted moving averages and smoothed moving averages. The former involves a unique calculation that multiplies each bar by a predetermined weighting factor. At the same time, the latter balances historical and recent prices and takes a range of data into account rather than focusing on a fixed period. Getting to grips with different moving averages will help you to determine the underlying direction of any given market.
Relative Strength Index
The Relative Strength Index (RSI) has been used regularly by traders since it was created by J. Welles Wilder, a technical analyst, more than 50 years ago. The RSI indicator looks at both peaks and troughs and small rises and decreases to offer a well-rounded view of a currency pair’s traction. The default period for the RSI is 14 days.
An RSI is viewed by traders as a “bounced oscillator” as the values on the chart fluctuate between a value of 0 and 100. These values compare the most recent rises and falls for the exchange rate of a currency pair. A reading of 30 or lower points to the possibility of the price of a pair going up while a reading above 70 signals the opposite. Traders often use the latter as a reverse signal which means it may be best to sell a currency.
Forex is inherently a volatile market, so having an indicator that tracks this volatility is very important for a trader. This is where the Bollinger Band created by analyst John Bollinger comes in. Bollinger Bands are based around the simple moving average of a currency. There will be an upper and lower band plotted at a standard deviation away from the SMA. The values of these standard deviations can change but are typically two or 2.5.
Bollinger Bands track volatility and are a window into potential trends. If a currency pair is trading below the lower line, then a viable strategy is to enter the market and buy currency at that point. Meanwhile, trades above an upper line are a signal for a potential sell position. These bands will widen when the market is particularly volatile and narrow when the opposite is true. John Bollinger recommended using this indicator with others to inform trading strategies.
Moving Average Convergence Divergence
The Moving Average Convergence Divergence (MACD) indicator is another useful tool as it gauges the momentum or strength of a trend rather than merely just identifying that trend. A MACD charts the divergence between two of the exponentially weighted moving averages (EMAs) outlined earlier. Typically, this covers a faster and slower period along with an additional SMA line. This line can be used as a signal for traders. When the MACD crosses beneath it, traders usually opt for a sell position.
A couple of other popular indicators are the Fibonacci Retracement and the Stochastic Oscillator. All of these tools are unlikely to work well in isolation and are best used alongside each other to get a better overview of trends and movements. Armed with this knowledge, you will be able to execute trades at precisely the right time.