A crucial aspect of forex trading is predicting where and when market and currency values will change. These educated predictions are the basis on which most investments are made, as they provide you with the best ways to benefit from these changes and realize your profits.
Since it is such an essential part of forex trading, technical indicators are therefore considered an indispensable tool for every trader. These indicators allow traders to have an edge in their investment strategies, as they allow for more accurate predictions of market movements.
Keep reading to learn more about technical indicators; including what they are and how they work in forex trading.
What are technical indicators?
Technical indicators are forms of data – specifically mathematical calculations – that provide insight into trading patterns, trends, and signals within a market. These indicators play a central role in technical analysis, as they take into account the price, volume, and interest of current assets. With this information, traders can then assess the patterns indicated by these indicators and adapt their strategies accordingly.
These indicators can also be used in conjunction with any type of trade, be it stocks, currencies or indices. When it comes to forex trading, however, these indicators are particularly useful in ensuring the highest probability of profit. Currency values are constantly changing, so having a detailed prediction method can help you stay ahead of these moves – and potentially profit from them.
The use of indicators can, for example, reveal a pattern of United States dollar (USD) falling against the Hong Kong dollar (HKD). This will allow you to adapt your investments to take advantage of what is happening in the current market. This can be done via a range of methods, including potentially opening a Contract for Difference (CFD) position on one of the currencies.
Different types of technical indicators in forex trading
Forex technical indicators can be categorized into four main types:
Trend indicators are used not only to identify if a currency pair trend exists, but also to establish its strength and direction of movement. This is often done by creating a baseline, using the price average. Currency price movements above and below this line will establish the nature of the trend.
Here are some examples of trend indicators:
This tool can average the price of a currency pair over a period of time. This identifies the direction in which the price is moving.
- Average Directional Index (ADX)
The ADX does not identify the trend direction of a currency pair, but rather shows the strength of the trend. Higher values on the ADX reveal a larger trend, giving the opportunity to perform something like trend or range trading.
Momentum indicators (also called oscillator indicators) are used to establish the speed of price movements from a currency pair. By analyzing closing prices over a period of time, traders can see if prices have reached an extreme high/low, and possibly predict future moves.
Here are examples of momentum indicators:
This indicator compares the current closing prices to the price ranges (from the lowest price to the highest price) over a certain time period. This can give an idea of where future closing prices might 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 number of time periods (usually 14), to reveal likely changes. For example, a currency pair may show a continuous upward trend, but also regular declines in value, which is beneficial to consider before trading.
Volatility indicators measure the rate of price movement as a whole, in both directions. This shows the volatility of a currency pair, revealing the likelihood of the value changing suddenly. This can make traders more aware of the risks associated with volatile pairs.
Here are some examples of volatility indicators:
This indicator establishes a moving average, with an upper band and a lower band. Bands are often placed two standard deviations above and below, to contain 95% of the data. This reveals when the pair’s prices are overbought (reaching the upper band) and oversold (reaching the lower band), to help establish volatility.
- Average True Range (ATR)
This tool shows the average price ranges (distance between highs and lows) over a certain period. The higher the ATR value, the more volatile the currency pair.
Volume indicators measure the current volume in a forex market, which can relate volume to movement in value. Trends often increase in strength when there is also an increase in market volume.
Here are examples of volume indicators:
- On balance volume (OBV)
This tool measures the total volume buildup for a currency pair (how much money is moving in and out), to help predict future price movements.
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 (up or down) and therefore help predict future movements in volume relative to price.