Phase 6: Learn Basic Indicators
Here are four different market indicators that most successful Forex traders rely upon:
- A Trend Following Tool
- A Trend Confirmation Tool
- An Overbought / Oversold Tool
- A Profit Taking Tool
1) A Trend Following Tool
The real purpose of a trend-following tool is to suggest whether you should be looking to enter a long position or a short position. Most simplest and famous trend following method is the moving average crossover.
A simple moving average represents the average closing price over the number of days in question. The point on a stock chart when a security and an indicator intersect. Crossovers are used by technical analysts to aid in forecasting the future movements in the price of a stock. In most technical analysis models, a crossover is a signal to either buy or sell.
2) A Trend Confirmation Tool
A trend-confirmation tool may or may not be intended to generate specific buy and sell signals. The most popular and useful trend confirmation tool is known as the moving average convergence divergence (MACD).
This indicator first measures the difference between two exponentially smoothed moving averages. This difference is then smoothed and compared to a moving average of its own. When the current smoothed average is above its own moving average, then the uptrend is confirmed. When the current smoothed average is below its moving average, then the downtrend is confirmed.
3) An Overbought / Oversold Tool
If the trend is determined to be bullish, the choice becomes whether to buy into strength or buy into weakness. If you decide to get in as quickly as possible, you can consider entering a trade as soon as an uptrend or downtrend is confirmed. On the other hand, you could wait for a pullback within the larger overall primary trend in the hope that this offers a lower risk opportunity. For this, a trader will rely on an overbought/oversold indicator. Tool that is useful from a trading standpoint is the three-day relative strength index (RSI).
This indicator calculates the cumulative sum of up days and down days over the window period and calculates a value that can range from zero to 100. If all of the price action is to the upside, the indicator will approach 100; if all of the price action is to the downside, then the indicator will approach zero. A reading of 50 is considered neutral.
RSI is a technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset. It is calculated using the following formula:
RSI = 100 100/(1 + RS*)
*Where RS = Average of x days up closes / Average of x days down closes
4) A Profit Taking Tool
A useful profit taking tool is a popular indicator known as Bollinger Bands. This tool adds and subtracts the standard deviation of price data changes over a period from the average closing price over that same time frame to create trading bands. It is one of the most popular technical analysis technique. The closer the prices move to the upper band, the more overbought the market, and the closer the prices move to the lower band, the more oversold the market.
Another profit taking tool would be a Trailing Stop. Trailing Stops are typically used as a method to give a trade the potential to let profits run, while also attempting to avoid losing any accumulated profit. A Trailing Stop for a long position would be set below the security’s current market price and for a short position, it would be set above the current price.
