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6 Types of Technical Analysis Every Forex Trader Should Learn

   

technical-analysis-forex

Forex indicators are useful in a variety of ways. They operate as tools that are embedded in trading platforms and connected throughout in order to offer traders a different—and often more concise—perspective on the market. They can offer long- or short-term forecasts, a view into the current state of a currency pair, or a look back at historical data. There are actually quite a few different forex indicators that are of use, several of which are detailed below.

What Indicators Are Best?

Many traders out there have their favorite technical indicators, and these indicators become part of those traders’ standard strategy. Regardless of what you might hear, there is no real best indicator, because every trader’s style, personality, and psychology are different; thus, the indicators that each trader uses will be different. That being said, there are a few must-know indicators when it comes to technical analysis.

Moving Averages

Moving averages are leading technical indicators specifically designed to identify breaks in price actions, as well as the general direction of the market. They take the form of a line drawn on a chart, which is used to gauge the average—or mean—value of a forex pair over a set amount of time, such as 14 days or 200 days. 

This offers the trader a glimpse at the general trend of the currency pair, but it should be noted that moving averages over a smaller period of time will have a faster reaction to price changes that happen in the market.

Pros:

  • Moving averages—especially simple moving averages—tend to be a more stable indicator than other analysis tools.
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  • In general, moving averages are more beneficial to traders working with longer-term time frames, such as position traders.

Cons:

  • Moving averages are based on historical data, which means they are slower to respond to fast-evolving market conditions.
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  • Traders working with shorter time frames may struggle to gain meaningful insights from a simple moving average. An exponential moving average may be preferable.

moving-averages

Oscillators

Forex oscillators indicate the moment when the market reaches a limit and an opposite correction of the current trend becomes the likely outcome. For example, when a price goes too high, analysts say that it is overbought, which means that the price will stay stable or slide down a bit as traders work to improve their profits. When a negative correction happens, new traders enter the market, raising the price. An oversold market, on the other hand, causes the other direction’s reaction, or a positive correction. Typically, it’s better to buy oversold and sell overbought forex pairs.

Oscillators can also be used to forecast a breaking point in the price movement of the market. On a graph, it will seem like the lines are moving in the same direction as the price, but when the lines begin to move apart, analysts will consider the trend to be losing momentum.

Pros:

  • Oscillators are leading indicators, helping traders identify trends and opportunities before a price movement takes place and maximize their profits.
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  • Oscillators offer valuable insight into the speed and momentum of the market—independent of currency price or trading volume.

Cons:

  • Like any leading indicator, oscillators aren’t foolproof. False signals do occur.

oscillators

Stochastics

Stochastic oscillators are designed to indicate zones of overbought and oversold conditions, but stochastics also point out possible price reversals. There are multiple versions of stochastics, but the slow stochastic stands as the one that’s most commonly implemented. Located at the bottom of a chart, it’s made up of two moving averages bound between 0 and 100.

Stochastics are a favorite indicator of many traders because of the accuracy of their findings. Implemented by both seasoned traders and novices, stochastics have the power to help investors of all skill levels determine good entry and exit points.

Pros:

  • Stochastics are easy to understand and offer clear trading signals, making them a beneficial indicator for inexperienced traders.
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  • Signals develop often on a single forex chart, creating numerous opportunities for traders to consider.

Cons:

  • Stochastics have a tendency to produce false signals.
  • The timelines for using the stochastic oscillator sometimes extend too long for day traders and scalpers, which can limit the value of the indicator for shorter trading time frames.

stochastics

Fibonacci Retracement Lines

Part of an entire set of tools based on the Fibonacci sequence, Fibonacci retracement lines are a method of technical analysis that looks to find support and resistance levels on a trading instrument. The concept is simple: Markets react or retrace by smaller portions of a larger move, and these portions are predictable. So Fibonacci retracement is a series of patterns that are continuous. Traders who use this method use the Fibonacci ratios of 23.6 percent, 38.2 percent, 50 percent, 61.8 percent, and 100 percent to place stop-losses or determine target prices.

Pros:

  • Because Fibonacci retracement is such an integral part of forex trade evaluations, prices do have an inclination to experience extensions and retracements that generally align with this theory.
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  • Fibonacci retracement has a long history in forex trading, and many successful traders over the decades vouch for its value as a trade analysis tool.

Cons:

  • Unlike other technical indicators, Fibonacci retracement involves subjective evaluation. Critics argue that these retracement levels are so universally used that they become a self-fulfilling prophecy, with price movements being dictated by traders who anticipate the influence of Fibonacci levels.
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  • Although it’s widely regarded as a useful tool among many traders, Fibonacci retracement is not grounded in mathematical logic or economic theory; rather, it’s developed based on common ratios observed in the natural world.

fibonacci-retracements

Relative Strength Index

Just like stochastics, the relative strength index—commonly listed as RSI—is an oscillator that is used to find conditions in the market that are oversold or overbought. This is particularly useful for traders who like to buy low and sell high, because values are plotted between zero and 100. Zero is considered oversold, whereas 100 is considered overbought.

Pros:

  • The RSI is an easy indicator to use, and traders can set RSI alerts that notify them when a currency pair’s value hits a certain threshold.

Cons:

  • The RSI is known to give false signals, so it is best used as a starting point for trade evaluations: When traders receive an RSI notification, they can then begin a more thorough evaluation of trade potential.
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  • The RSI is less reliable when used to evaluate currency pairs involving volatile markets.

relative-strength-index-1

Bollinger Band

A volatility channel that is usually featured on lists detailing forex indicators, Bollinger Bands are a simple idea and, thus, are widely used. If the price of a currency pair surpasses a moving average, plus a certain amount, it indicates the start of a trend. Usually, values of the Bollinger Bands are two or 2.5 standard deviations from a simple moving average.

Pros:

  • The width of Bollinger Bands offers an easy visual representation of volatility in the market: A wider distance between the two outer bands reflects increased market volatility, whereas a narrowed distance reflects consolidation that could lead to a price breakout.

Cons:

  • Bollinger Bands are a reflection of past performance, which can make them difficult to use for identifying trade opportunities early. This makes Bollinger Bands most useful when they’re paired with other technical indicators.

bollinger-bands

Conclusion

Indicators can do a lot for a trader: simplifying information about prices, providing trend signals, warning about reversals, and more. There’s an indicator for every time frame, and there are variables that can be changed and adjusted according to the preference of the trader. Every trader is unique, and every indicator can be used in a variety of ways. A single indicator will rarely be a perfect signal, but taking into account a range of indicators can often put you on the right side of the forex markets.

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Disclaimer:

The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.

This post was written by Graeme Watkins

CEO Valutrades Limited, Graeme Watkins is an FX and CFD market veteran with more than 10 years experience. Key roles include management, senior systems and controls, sales, project management and operations. Graeme has help significant roles for both brokerages and technology platforms.

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