How to use Technical Indicators in Forex Trading?

When someone is new to Forex trading, technical analysis can often seem overwhelming. When trading the financial markets, there are hundreds of different technical indicators to use on your charts. It's important to select the ones that best fit your trading approach and style. In this article, we look at how to use technical indicators in forex trading.

What are the technical indicators in forex trading?

Mathematical methods known as technical indicators examine one of five figures: opening price, high, low, closing price, and volume. The calculation produces chart patterns, which are graphical representations of technical indicators.

You can superimpose them on top of the price chart or display them in a separate window. Anyone with basic computer knowledge may create their own forex technical indicator.

Remember, most technical indicators existed long before the internet. These indicators were initially intended for use in the stock or commodities markets and were built to be used over very long periods of time, as trading charts were only updated every 24 hours.

The four types of technical indicators

Technical indicators fall into four main categories: trend, momentum, volatility and volume.

1. Trend indicators

Following the trend is the best way to make money. Embracing a trend, instead of resisting it, is likely to produce superior outcomes.

That is not to deny the efficiency of counter-trend tactics. They can, under certain conditions. In probability, outcomes. Nevertheless, it makes sense to spot a trend and trade in its direction rather than against it.

According to common trading knowledge, markets fluctuate 70% of the time and trend 30% of the time. Assuming that claim is true, trend trading is only possible for 30% of market open times. Therefore, trend traders should capitalise on trend phenomena while they are happening.

Average directional movement index (ADX)

The ADX Indicator, a lagging technical indicator for forex, takes its cues from two directional indicators, the +DI and the -DI, to reveal the size of a trend.

Directional movements (DI's) are a way to measure the relationship between the highs, lows, and closing prices of one day and those of the previous day. Next, we divide the total by the ATR, which stands for Average True Range.

The +DI essentially tells us how much stronger the bull is now than yesterday, while the -DI tells us how much stronger the bear is today than yesterday. Using the readings +DI and -DI, the ADX indicates whether the bull or the bear is more powerful today compared to yesterday.

Moving average convergence/divergence (MACD)

Using the MACD indicator, one can see how a trend's strength, direction, momentum, and length have changed over time. When comparing two exponential moving averages (EMAs), this indicator shows the link between an EMA with 12 periods and an EMA with 26 periods.

Typically, the indicator consists of:

• The above-mentioned calculation yields the MACD line.
• One way to determine when to purchase or sell is with the use of the MACD line's 9-period exponential moving average (also known as the signal line).
• A histogram displays the gap between the MACD and signal lines.

Regardless of the differences, people commonly use the MACD indicator to detect divergences. A divergence occurs when the price of a security makes a high or low that the histogram does not support. A divergence can infer the price's future trajectory.

2. Momentum indicators

Momentum indicators, commonly called oscillators, are useful tools for identifying overbought and oversold situations. They show the speed and size of price changes for a given security. They can assist in determining the start and finish of a trend when used in conjunction with trend indicators.

Relative strength index (RSI)

The RSI is a widely used momentum indicator that indicates the remaining relative strength of a market move even after the momentum may have peaked.

We create an EMA by comparing the closing prices of the current and prior candles for up-and down trends. The RSI calculates the relationship between the uptrend and downtrend EMAs when oscillated on a scale from 1 to 100. The bigger the momentum, the greater the difference between today and yesterday.

Therefore, if each closing exceeds the previous one, we expect an upward oscillation in the RSI. On the other hand, if each close is less than the prior, the RSI will oscillate downward. Generally, when the RSI hits 70, we consider the security overbought and may be approaching a trend reversal. In contrast, a rating of 30 signifies that the security has been overpriced.

Stochastic oscillator

By calculating momentum, the stochastic oscillator assists in identifying overbought and oversold signs. Stochastics accomplish this by contrasting a specific closing price with a range of prices across time.

In an uptrend, the price should be close to the trading range's highs, and in a downtrend, it should be around its lows. Plotted between a 0 to 100 corridor, the stochastic is similar to the RSI. People often regard values above 80 as overbought, and values below 20 as oversold.

3. Volatility

When identifying ranges, volatility indicators show the volume behind the movement. Traders can use them to forecast future price changes and understand the current trend of the market. An abrupt shift in market sentiment frequently generates an entrance signal.

Similar to every other forex technical indicator that was previously discussed, volatility-based indicators track changes in market price and contrast them with past values.

Average true range (ATR)

The true range average takes into account the previous closing price as well as the current high and low; the indicator calculates the market's volatility. The greatest of the following is then used to establish the "true range":

• Current low less current high.
• The current high's absolute value is lower than its prior close.
• The new low's absolute value is lower than its prior closure.

The ATR is a helpful tool for determining how much a market may change, but it is not very good for creating trading signals.

Bollinger bands

An SMA encircled by two extra trend lines, computed as follows, make up the Bollinger Bands:

• Minus two standard deviations from SMA is the lower band.
• Two standard deviations plus SMA equals the upper band.

The end effect is a fluctuating price corridor for the security. Any of the values can be changed to suit the trader's tastes.

Prices at or close to the upper deviation line indicate an overbought market; prices at or close to the lower deviation line indicate an oversold market.

4. Volume Indicators

Volume indicators display the volume of trades underlying a price movement. More traders entering the market must be doing so out of group motivations.

Unlike, say, equities, commodities, or even forex futures, it is difficult to measure the entire market volume of the forex spot market at the rate and depth necessary for traders. Spot Forex trading takes place over-the-counter, preventing volume recalculation at a single clearinghouse.

Your broker owns the data stream from which the volume accessible on your platform originates. Those figures are by no means representative of the entire global volume. However, some traders use volume indicators in their Forex trading, and some of them may even be profitable at it.

On-balance volume (OBV)

We use the OBV indicator to calculate changes in an instrument's volume in relation to its price. This aligns with the theory that volume, moving before price, can corroborate price movements.

We assign a positive value to the total daily volume if it increases from the previous day. Similarly, we assign a negative value if the overall volume decreases from the previous day. The OBV should rise sharply in tandem with a strong price trend. A divergence between the price and the OBV would suggest that the market move was not strong enough.

What is the best forex indicator?

Selecting the best technical indicator is a personal decision. A lot of things will influence the technical indicators you select, such as your approach, style, and trading plan.

Trend and momentum indicators can be quite helpful if you're a swing trader trying to determine when a swing or trend will begin and conclude. A scalper that runs on a one-minute timescale, however, won't be very useful for either.

Day traders are the most reliant on technical indicators. When they are on their platforms, they are actively searching for opportunities. Combinations are often used by day traders to create signals, which can happen when events and data from the economic calendar are released or sent.

Pros and cons of technical indicators

Conclusion

Technical indicators are a popular strategy in contemporary trading that has a number of advantages and disadvantages. Its accessibility and value for many traders, especially in trending markets, stem from its impartiality, simplicity, and timing focus.

But because of its drawbacks—such as subjectivity, a lack of fundamental analysis, and a vulnerability to misleading signals—it might not be appropriate for every trading scenario.

In order to develop a well-rounded trading strategy, traders frequently find success by fusing technical analysis with other types of analysis and risk management strategies. The trader's ability, discipline, and the specific market circumstances ultimately determine the efficacy of technical indicators.