A crucial aspect of forex trading is predicting where and when, market and currency values will change. These informed predictions are the foundation on which most investments are made, as it provides you with the best means to benefit from these changes and make your profits.
Since this is such an essential part of forex trading, technical indicators are therefore considered to be a vital tool for every trader. These indicators allow traders to have an edge in their investment strategies, since they allow for more accurate predictions of market movements.
Keep reading to learn more about technical indicators; including what they are and how they operate within forex trading.
What are technical indicators?
Technical indicators are forms of data – more specifically, mathematical calculations – that provide insight into trading patterns, trends, and signals within a market. These indicators form a pivotal role in technical analysis, as they take into account the price, volume, and interest of current assets. With this information, traders can then evaluate the patterns shown by these indicators, and adapt their strategies accordingly.
These indicators can also be used in conjunction with any type of trade, whether it be stock, forex, or index. When it comes to forex trading, however, these indicators are particularly useful in ensuring the highest probability of profit. Currency values are ever-changing, so, having a detailed method of prediction can help you stay ahead of these movements – and potentially profit in the process.
The use of indicators may, for instance, reveal a pattern of the US Dollar (USD) decreasing in value against the Hong Kong Dollar (HKD). This will allow you to tailor your investments to take advantage of what’s happening in the current market. This can be done via a range of methods, including potentially opening up a Contract for Difference (CFD) position on one of the currencies.
Different types of technical indicators in forex trading
Forex technical indicators can be categorised into four main types:
- Trend indicators
Trend indicators are used to not only identify whether a currency pair trend exists, but also to establish its strength and direction of movement. This is often done by creating a baseline, using price averaging. Currency price movements above and below this line will establish the nature of the trend.
Examples of trend indicators are:
- Moving Average (MA)
This tool can average the price of a currency pair over a certain period of time. This identifies which direction the price is moving.
- Average Directional Index (ADX)
ADX doesn’t identify the direction of a currency pair trend, but instead, it shows how strong the trend is. The higher values on the ADX reveal a greater trend, giving opportunity for something such as trend or range trading.
- Momentum indicators
Momentum indicators (also known as oscillator indicators) are used to establish the speed of price movements from a currency pair. By analysing the closing prices over a period of time, traders can see whether prices have reached an extreme high/low, and possibly predict future movements.
Examples of momentum indicators are:
- Stochastic Oscillator
This indicator compares current closing prices to the price ranges (lowest to highest price) over a certain period. This can give an idea of where future closing prices may be.
- Relative Strength Index (RSI)
This calculates the strength of currency pair trends and can help predict momentum. It measures momentum in stages over a certain number of periods (usually 14), to reveal likely changes. For instance, a currency pair might show a continuous upward trend, but also regular dips in value, which are beneficial to take into account before trading.
- Volatility indicators
Volatility indicators measure the rate of price movement as a whole, in either direction. This shows the volatility of a currency pair, revealing how likely the value is to suddenly change. This can make traders more aware of the risks involved in volatile pairs.
Examples of volatility indicators are:
- Bollinger Bands
This indicator establishes a moving average, with an upper band and lower band. The bands are often placed at two standard deviations above and below, to contain 95% of the data. This reveals when the pair prices are overbought (reaches upper band) and oversold (reaches lower band), to help establish the volatility.
- Average True Range (ATR)
This tool shows the average price ranges (distance between high and lows) over a certain period. The higher the ATR value, the more volatile the currency pair.
- Volume indicators
Volume indicators measure the current volume in a forex market, which can establish a connection between volume and value movement. Trends often increase in strength when there’s also an increase in market volume.
Examples of volume indicators are:
- On Balance Volume (OBV)
This tool measures the total accumulation of volume for a currency pair (how much money is flowing in and out), to help predict future price movements.
- Chaikin Oscillator
This indicator measures the moving average of the Accumulation-Distribution Line (ADL). This is done by calculating the Estimated Moving Average (EMA) of the ADL over a 3-day and 10-day period. It then subtracts the latter from the former. This will reveal ADL trends (rising or falling), and therefore help predict future movements of volume against price.