The foreign exchange market is a highly volatile market that requires traders to be watching positions carefully. Within a few seconds time, currencies can move in either direction and drive investors out of their positions. The most popular method to trade these types of markets is through the use of technical analysis. Technical analysis revolves around the study of the supply and demand that is happening within the market place. The demand will have an impact on the price and the investor can use the analysis of the price movement to gauge what direction the market might be headed. Technical indicators are not a sure bet and do not provide the trader with the one magic equation to make money. These indicators are simply showing you what the price has done in the past, be it hours or minutes, so the trader can develop a plan for a future trade. There are a few technical indicators that are used to trade Forex more than others. Some of the best forex indicators include: simple, exponential, and weighted moving averages, stochastic, and ADX momentum study.
Moving averages are a simple indicator that is used to trade in any market including foreign exchange. The moving averages measure the average move in price during a given time period. When using charting software, the moving averages will smooth out the price over the period making it easier to see trends. The Simple Moving Average (SMA) just calculates the average price over a given period of time, which you enter into the software. The exponential moving average will calculate the average giving priority to the most recent data. This will cause the average to react to price changes faster than the SMA. The weighted moving average also weights the recent price data and gives older data less weight. Traders will use different time periods to create signals by which they enter or exit trades. A buy signal would be created if a shorter time framed moving average, like 10 days, crosses against a longer, 20 day term average. A sell signal would be created if the shorter then moved back below the longer moving average.
The stochastic indicator is a momentum indicator that consists of two lines: a fast line and a slow line. The main theory behind the indicator is that rising prices tend to close near previous highs and falling price tends to close near its previous lows. It is used to identify overbought or oversold levels in the market. The indicator is plotted at the bottom of the chart, unlike the moving averages which are plotted on the chart. The stochastic indicator has values between 0-100 and when the indicator moves above 80 the market is said to be overbought. When the indicator moves below 20, it is said that the market is oversold. Traders can use this indicator as a place to enter trades. When the market is either overbought or sold, it could be subject to a reversal. This particular indicator gives the trader an idea when the reversal might take place. If the indicator crosses below 20, stays there for a period of time, and then starts to move upward, this could signal a bullish uptrend. If the market has been overbought and the indicator is over 80, traders will look for it to cross back below 80 and then sell the market. Markets cannot stay going in one direction forever, the stochastic indicator helps traders find when their might be a short or long term correction.
The average directional index (ADX) indicator will give traders who use it insight into the strength of the current trend. The calculation of the indicator is based on a moving average of price range expansion over a given period of time. The range of the ADX is from 0.0-100.00; zero being no trend has formed and 100 being a strong trend. When the ADX starts to break above 25.00, the indicator is telling you that a possible strong trend is starting and perhaps traders should initiate a long position. The ADX will not tell the trader what direction the price is headed, just how strong the trend is becoming. This indicator helps the Forex trader find the currencies that are trending. This will allow them to make informed decisions on whether or not they would like to buy or sell the particular currency.
These are only a few of the many technical indicators that have been developed to analyze the price movement in the financial markets. The Forex market is one of the financial markets that many use indicators to create buy and sell orders. Reading about the other various indicators would also be educational and provide the trader with more knowledge that they can use to trade.
Article contributed by guest blogger Jennifer Gorton.