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Essential Indicators

The list below highlights some key indicators that can be woven into your Forex trading style, It is important to acknowledge the probability that no indicator on its own is a good enough reason for entering or exiting a trade, it is crucial to get a combination factor when considering a trade.

Moving Averages

A “Moving Average” is a technical indicator that shows the average value of a particular currency pair over a previously determined period of time. This means, for example, that prices may be averaged over 20 or 50 days, or 10 and 50 min depending on the time frame that is more convenient for you at the moment of your trading activity.

Moving Averages are an averaged quantity and can bee seen as a smoothed representation of the market activity at the moment and it’s an indicator of the major trend influencing the market behavior.

This smoothing effect of the Moving Average is very helpful when the trader is looking for getting rid of the “noise” in the price fluctuations of the currency pair he is trading at the moment and a more precise emphasis in the trend direction is required.

The mechanics of how Moving Averages can tell a Forex trader where the Forex market is moving (up or down) is by considering two different time frame Moving Averages and then plotting them on a Forex chart. It is very important that one of these MA is over a shorter time period than the other one; let’s say one will be over a 15 days period and the other over a 50 days period.

Once you have plotted the two Moving Averages with your charting software you will notice points of crossover where the shorter time period MA will cross above the longer time period MA indicating an upward trend in the market, or if the crossing is below the longer period MA that will be an indication of a down trend in the Forex market.

So by using this simple concept of the Moving Averages you can start understanding the basics of confirming trends when checking your Forex charts during your particular trading hours.

Bollinger Bands

Bollinger bands are simply volatility bands drawn either side of a moving average.

You calculate Bollinger bands using the standard deviation of price over the same period as moving averages the mean price, then the volatility bands are plotted above and below the moving average.

Moving averages are used to identify the underlying trend of currencies and Bollinger bands take this one step further by:

Combining the moving average of the currency with the volatility of the individual market (or the standard deviation) – this then creates a trading envelope – with a middle mean price (moving average and 2 x bands (expanding or contracting) either side that reflect volatility or standard deviation.

As prices move away from the longer-term average, the standard deviation rises - and thus the bands will fluctuate in varying amounts, away from the average.

Relative Strength Index (RSI)

The RSI (Relative Strength Index) is a popular technical analysis oscillator. There are numerous uses of the RSI, including objective buy and sell signals and bullish and bearish divergences. The RSI, as its name implies measures the relative strength of price currently compared to the past: the formula usually uses a 14-period input. As an oscillator, above 70 is considered overbought and below 30 is considered oversold.

Some traders use the RSI for objective buy and sell signals. They usually interpret a buy signal as occurring when the RSI crosses back above 30 after spending time in the oversold area. A sell signal is declared when the RSI moves back below 70 after spending a period of time in the overbought region. The RSI as well as buy and sell signals is visually depicted in the link to the chart Relative Strength Index

Another popular use of the Relative Strength Index for stock, futures, or currency traders is bullish and bearish divergences. At times when price is increasing, but the RSI is falling or not moving, this can signal trouble. This bearish divergence can suggest that a trader exit his/her position.

In contrast, when price is falling, but the RSI is failing to go lower, but is maintaining steady or rising, a bullish divergence has occurred. A trader might exit any short positions.

Moving Average Convergence Divergence (MACD)

MACD (Moving Average Convergence Divergence) comes as a standard Forex signal on all the main charting packages. Some show MACD by itself with two lines, one a combination of a 12 and 26 Exponential Moving Average, and the other line based on a 9 Exponential Moving Average.

Some charting packages also include what is called a Histogram in the same charting area as MACD. The histogram merely represents in a different way what is happening between the two MACD lines as to market momentum. The wider the gap between the MACD lines, the higher or lower the height of the histogram bars.

To identify MACD divergence, simply draw a line across the highs if MACD is above the zero line, or draw a line across the lows if MACD is below the zero line.

Now go to the price action section of the chart, the candlesticks, and draw a line across the highs directly above where the line is drawn on the MACD highs, or draw a line across price lows directly above where the line is drawn on MACD lows.

If they are going in opposite directions you have MACD divergence. In other words, when MACD is making lower highs and lower lows but price is making higher highs and higher lows, this negative MACD divergence forms a Forex signal indicating price could well start to drop.

If MACD is making higher highs and higher lows but price is making lower highs and lower lows, this positive MACD divergence forms a Forex signal indicating price could well start to rise.

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