Best Forex Technical Indicators
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This article will explore some of the best Forex technical indicators available, including trend indicators such as the Average Directional Movement Index (ADX) indicator, the Aroon indicator, the Moving Average Convergence/Divergence (MACD) indicator, and momentum indicators like the Relative Strength Index (RSI) indicator, the Stochastic Oscillator indicator, and many more!
When you begin to trade Forex, it's important to remember that looking for the best Forex technical indicator is futile - because there is no 'holy grail' in Forex. To succeed in Forex, you will have to follow the same route as every other trader, and learn how to trade. You will need to learn the logic behind the most popular Forex indicators, work out their strengths and weaknesses, and most importantly, learn how technical indicators can fit together organically and help you in your trading journey.
What are Technical Indicators?
Technical indicators are mathematical tools that analyse one of the five following figures: open price, high, low, closing price and volume. As a result of the calculation, technical indicators are plotted graphically as chart patterns. Sometimes they overlay the price chart, and sometimes they are drawn in a separate window. There are literally thousands of indicators out there, and anybody with coding skills can write their own, but keep in mind that there is only so much information that will actually be of use to you.
Another thing to keep in mind is that the majority of technical indicators were developed for the stock market and daily charts, because back in the day of their initial creation, 24 hours was about as often as trading charts were updated. This was about 30 years before the internet.
Average Directional Movement Index (ADX)
The ADX indicator is a Forex technical analysis indicator of trend strength, and it is built upon the EMAs (Exponential Moving Averages) of the two other indicators: +DI and -DI. The DI's (Directional Movements) are a calculation of how a current day's highs, lows and closing are related to the previous day's highs, lows and closing. The sum of these figures is then divided by the Average True Range (ATR), which we will cover later in this article..
In essence, the +DI tells us how strong the bull is today, compared to yesterday, while the -DI informs us as to how strong the bear is today, compared to yesterday. The ADX takes the values of +DI and -DI, and tells us who is stronger today, compared to yesterday - the bull or the bear.
Graphically speaking, the ADX with the +DI and the -Di looks like three lines entangled with each other, moving on the scale of 0 to 100. If the ADX is below 20, the trend (whether bullish or bearish) is weak. The threshold of 40 indicates a trend strength, and everything above 50 is a strong trend. If the +DI is above the -DI, the bull is overpowering the bear. The curvature of lines also has value, demonstrating how fast the rate of change is. The ADX is a lagging indicator, commonly used to evaluate the strength of a trend.
The Aroon is a Forex trading technical indicator that measures if there is a trend, how it's developing, and how strong is it. Aroon indicators play with the idea that the trend can be measured by evaluating how recent the previous highest highs and lowest lows were. The recentness of the highest high is reflected in the Aroon's bullish line, while the recentness of the lower lows is reflected in the Aroon's bearish line.
The lines are then further oscillated from 0 to 100. For example, when the bullish line is pressed to the top of the scale around the 100 mark, and the bearish line is barely above the bottom at 0, higher highs are often, while lower lows are seldom - and this all indicates that we have a strong bullish trend. Crossovers indicate trend direction change. The Aroon is also a lagging indicator, and is often used to confirm whether a trend has remained intact.
Moving Average Convergence/Divergence (MACD)
The MACD indicator is meant to reveal changes in the strength, direction, momentum, and the duration of a trend. It is built upon moving averages of 12 and 26 periods, but with some interesting alterations. There are two things you can conclude from this alone. Using moving averages is similar to using a lagging indicator; 12 and 26 sound a lot like a trading fortnight and a trading month, thus the indicator is meant to be used on daily charts.
Regardless of the alterations, the indicator consists of the MACD line - the difference between the 12 EMA and 26 EMA, the signal line - the same MACD line smoothed by a nine period SMA, and the histogram, which is the difference between the MACD and the signal. The bars along the 0 axis - the histogram - are often used to identify divergences. A divergence occurs when the price makes a higher high or a lower low that is not supported by the histogram, also making a higher high or a lower low, accordingly. A divergence hints at the change in the price direction.
Relative Strength Index (RSI)
The Relative strength index (RSI) indicator is the first in the group of momentum indicators next to the Williams % range and the Stochastic, that serves the same basic purpose, but through slightly varying methods. Momentum indicators are used to signal if an instrument is being overbought or oversold, by measuring the velocity and the magnitude of price movements.
Momentum is nothing more than the rate of price change. The RSI compares the closing prices of the current and previous candles for the up and down trends, and then turns the outcome into an EMA (or in some cases into a Simple Moving Average - SMA) and then calculates how the uptrend EMA relates to the downtrend EMA, when oscillated on a 1 to 100 scale. The bigger the difference between today and yesterday - the stronger the momentum.
Therefore, if every future close is higher than the previous one, the RSI will be oscillating upward, and as soon as it reaches the 80 threshold - the overbought area - it will constitute a sell signal. The RSI is no stranger to the concept of divergence. If the price makes a higher high, while the RSI only makes a lower high, a bearish signal is generated and vice versa.
Every technical indicator that jumps up and down in a set scale is oscillated. That's how even the trend indicators may be oscillators in terms of their characteristics. As mentioned above, the Stochastic Oscillator, much like other volume indicators, helps to identify overbought and oversold areas through measuring momentum. In the case of the Stochastic, it is done by evaluating how close the closing price was in relation to the price range.
In an uptrend, the price should be closing near the highs of the trading range, and during a downtrend, it should be near the lows. The Stochastic is similarly plotted in a 0 to 100 corridor, with basically the same 80/20 overbought/oversold thresholds. Just to mention briefly, the Williams % range compares today's closing price to the highest price in the past, and in relation to the average of the high and low in the past. In all other respects, it functions like the RSI and the Stochastic.
Average True Range (ATR)
Just like all the previously described Forex technical indicators, volatility-based indicators monitor changes in the market price, and compare them to historical values. The range is simply today's high, minus today's low. The true range extends it to yesterday's closing price, if it was outside of today's range. The Average True Range Indicator is then an EMA of the true range.
ATR is the greater of the following:
- Current high minus the current low
- The absolute value of the current high less than the previous close
- The absolute value of the current low less than the previous close
The bigger the price difference between one of the above, the higher the ATR goes, and the higher the volatility on the market. This can be helpful to know when adjusting your trading stops for example.
Bollinger Bands are another volatility indicator that uses an SMA or an EMA, and then envelopes it by two standard deviation lines. This creates a dynamic corridor for the price to bounce in. Following Mr. Bollinger's idea, prices are high when near the upper deviation line, and low when at the lower deviation line, which hints at a turnaround.
Measuring the total market volume of the Forex spot market is impossible at the rate and depth required by traders, unlike, say in stocks, commodities, or even Forex futures. The problem is that Forex spot is traded over-the-counter (OTC), which means that there is no single clearing location to recalculate volumes.
The volume that is available at your platform is derived from your broker's own data stream. Those numbers don't even remotely begin to report the total worldwide volume. Nonetheless, there are traders that involve volume indicators in their Forex trading, and some of them might even be successful at it.
On-Balance Volume (OBV)
The OBV indicator is used to measure increases or decreases in the volume of a traded instrument, relative to its price. This follows the idea that volume precedes price, and that it can be used to confirm price moves. Mechanically speaking, total daily volume is assigned a positive number if it increased, in comparison to the previous day. Similarly, a negative value is assigned if total volume has decreased since the previous day. When prices go strongly in one direction, so should OBV. A divergence between the price and the OBV would indicate a weakness in the market move.
Undoubtedly, there are many more technical indicators that will be of interest, but when researching them, you will inevitably see similarities between them and the Forex technical indicators explained in this article. This is a good thing, because it means that you are considering not only the mechanical execution of the trading signals they generate, but also understanding the logic they use, and how this applies to the market.
This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.