The purpose of each technical indicator in forex is to help traders make better trading decisions.
The use of technical indicators can mark the difference between success and failure when running forex trades.
When you combine various technical indicators, you can be able to make even better trading decisions.
However, you need to know the best indicators to use and the best possible combinations for these indicators.
This will help you improve your chart reading skills.
Using the wrong indicators can lead to inaccurate price interpretation and bad trading decisions.
The impact of this will be high chances of running unsuccessful forex trades.
Always remember that each indicator is associated with a number of weaknesses.
So, if you use only one indicator to monitor the market movements, you will be missing out on some price movements.
When you combine many technical indicators into a single trading strategy, you will limit your risk of incurring losses and earn strong returns.
In this article, I will help you learn how to combine many technical indicators to come up with a multi-indicator trading strategy.
What is a Technical Indicator?
Technical indicators are statistics of the past market data obtained using different mathematical calculations.
They are used by traders in technical analysis to predict currency trends.
Different technical indicators are meant to perform different tasks.
That’s why they are grouped into different categories based on the tasks that they perform.
Each technical indicator analyzes the open price, high, low, closing price, and volume.
Once the technical indicators are calculated, they are plotted on graphs as chart patterns.
Some of the indicators are added on the price chart while others are added on a separate window.
Currently, there are thousands of technical indicators available for use by traders.
The good news is that you can create your own technical indicator if you are a programmer.
This will give you an opportunity to customize your technical indicator the way you want.
Types of Technical Indicators
As a trader, it is of great importance for you to learn the different types of indicators that are available for you.
You can then play around with different indicators and combine a few of them together to come up with a workable trading strategy that can help you identify trading opportunities.
Here are the different categories of technical indicators…
#1: Trend Indicators
It is easy for a trader to determine the price trend of a particular pair simply by looking at a price chart.
However, there are many indicators that were designed to show the current trend.
Traders use trend indicators to determine the strength and direction of market trends.
This makes it easy for traders to enter trades when the market is moving in their intended direction.
Trading in the same direction as the market will increase your chances of running successful trades.
Trend indicators also signal traders when a trend change occurs, making it possible for them to enter into new trades at the beginning of new trends.
The trend indicators can help determine the strength of a trend, which can in turn help you know whether the trend will continue for long or not.
Although some traders attempt to use trend indicators as separate trading systems, the main purpose of these indicators is to help traders determine whether they should enter long or short positions.
Examples of trend indicators include ADX (Average Directional Index), Aroon, Moving Averages, MACD, Parabolic SAR, and Bollinger Bands.
#2: Momentum Indicators
The price of a forex pair will always trade upwards or downwards.
However, it is challenging for any trader to know how long the trend will continue moving in that direction.
One of the ways to accomplish this is by determining the rate of acceleration or the speed at which the trend is moving in a particular direction.
This is what momentum indicators help you to achieve.
If the momentum is strong, it is an indication that the current trend is strong and that it may continue for some time.
However, if the momentum is weak, it’s an indication that the current trend is weak and that it may be coming to an end for a new trend to begin.
This is useful knowledge that can help you know whether it is time for you to enter or exit a trade.
It will prevent you from entering or exiting a trade when it is too early or too late.
Examples of momentum indicators include the RSI (Relative Strength Index), Stochastic Oscillator, CCI, Williams %, and MACD.
#3: Volatility Indicators
Other than the direction and the strength of a trend, you also need to know how dynamic a trend is.
There are times when the price of a forex pair is extremely volatile and whipsawing upwards and downwards.
There are also times when the price of a forex pair is quieter, barely moving at all, and being stuck in a narrow trading range.
In most cases, this is obvious, but it’s good for you to use one of the available volatility indicators to give you a good indication of volatility at any given moment.
Examples of volatility indicators are the ATR (Average True Range), Bollinger Bands, Standard deviation, Keltener Channel, Envelopes, and others.
#4: Volume Indicators
Volume indicators are common among stock traders because it’s hard to find volume data for an individual currency pair.
The reason is that Forex spot is traded over-the-counter (OTC), meaning that there is no single clearing location to recalculate the volumes.
The volume that you see on trading platforms is obtained from the data stream of the broker.
Those numbers do not even begin to report the total worldwide volume.
However, there are traders who have used volume indicators in their Forex trading, and some of them have succeeded in it.
Other than the actual volume indicator, there exist other volume-based indicators that traders can use to measure volume.
Examples of such indicators include the OBV (On Balance Volume) and Chaikin Money Flow indicators.
Indicator redundancy occurs when a trader uses different indicators which belong to a similar indicator class and then shows the same information on a trader’s charts.
Consider the chart given below…
The above graphic shows a chart of a forex pair with 3 momentum indicators, Stochastic, RSI, and MACD indicators.
All these are momentum indicators, hence, they essentially provide traders with the same information.
When you take a closer look at the indicators, you will realize that they rise and fall simultaneously, turn together, and they are all flat at times when the price action is in a sideways movement.
This is a typical case of indicator redundancy.
Instead of using all the three indicators, a trader can choose to use only one of them because they all give the same information.
Consider the next chart given below…
The above graphic shows a chart of a forex pair with 2 trend indicators, the ADX and Bollinger Bands indicators.
These two indicators serve the same purpose, which is to help traders identify the strength of a trend.
From the chart, you can tell that during a trend, the Bollinger bands move down and the price moves close to the outer Bands.
During the same time, the ADX indicator is high and rising, confirming that there is a trend in the market.
When the price action is ranging or making a sideways movement, the Bollinger Bands become tightened, and the price hovers around the center of the Bollinger Bands.
At the same time, the ADX is flat or going down, sending the same signal as the Bollinger Bands.
So, this is another case of indicator redundancy.
It will be prudent for a trader to choose only one of the indicators, either the ADX or the Bollinger Bands.
There is a great problem when a trader uses multiple indicators that give similar information.
The trader gives too much weight to the information that is provided by each technical indicator, which may make him miss out on other things.
When a trader uses more than 2 indicators, he might end up believing that the trend is strong than it actually is.
The reason is that the indicators will give him a green light and he may end up missing out on other important information provided by the chart.
This way, the trader risks entering a trade without full knowledge of the market, which may increase chances of the trader having a failed trade.
So, always avoid using many indicators that give the same information.
The best approach to avoid this is by knowing the category to which each technical indicator belongs.
This will make it easy for you to avoid using multiple indicators that belong to the same category.
In the next sections, I will be showing you how to combine the various technical indicators to come up with a winning trading strategy…
MACD is a very popular trading indicator among forex traders.
It can be used together with other trading indicators to identify trading opportunities.
It is commonly combined with RSI, Stochastic, supports, and resistances.
Let’s give examples of how you can combine the MACD with other trading indicators.
MACD + Stochastic
The Stochastic indicator helps traders determine when a security is overbought as well as when it is oversold.
The MACD is a trend following indicator that helps traders know the relationship between 26 and 12 days EMA that are used to calculate the MACD and the Signal lines.
The Stochastic indicator oscillates between 0 and 100, with positions below 100 being considered oversold and positions above 80 being considered overbought.
The MACD indicator on the other hand gives traders buy and sell signals through crossovers between its MACD line and Signal line.
When the MACD line goes above the Signal line, the indicator sends a buy signal.
When the MACD line goes below the Signal line, it gives a sell signal.
Here is how you can combine these two indicators…
- MACD gives a buy/sell signal through a crossover of its MACD and Signal lines.
- Stochastic levels rise above 80 (overbought -> sell signal) or below 20 (oversold -> buy signal).
- The two indicators give the same type of signal (buy or sell).
- Open a position.
Consider the chart given below…
The above chart shows how you can use the MACD and Stochastic indicators to run a trade on a forex pair.
You should sell the currency pair or enter a short trade at the position marked as “Sell” on the chart.
But, what is happening with the indicators at that time?
This has been shown using two red circles on the indicators section of the chart.
During that time, the MACD lines make a bearish crossover, that is, the MACD line begins to move below the Signal line.
The Stochastic indicator was at an overbought position (above 80) at that point.
A combination of those two indicator signals sends a sell signal.
Note that the price action started a strong bearish move from that position and it continued for some time.
This means that it was prudent for a trader to enter a sale trade at that position.
After entering a sell trade, you should close it at the position marked “Close Sell” on the chart.
At that position, the MACD indicator makes a bullish crossover.
The MACD line begins to move above the Signal line.
At the same time, the Stochastic indicator is in an oversold position, that is below 20.
This is a nice opportunity for you to exit your short position and enter a long position.
The price action shows that the market begun to make a bullish move immediately after that.
So, it’s possible for a trader to combine the stochastic and the MACD indicators to run a successful forex trade.
If you have observed keenly, there was no redundancy of indicators on the chart.
The two indicators, that is, the MACD and the Stochastic, don’t give the same information.
One tells us when the forex pair is overbought or oversold, while the other one tells us whether the price action is starting a bullish or a bearish move.
This prevents you as a trader from missing out on the important information on your chart, increasing your chances of running a successful trade.
MACD + RSI
The RSI technical indicator is a momentum indicator that measures the recent price changes so as to determine if the current price is oversold or overbought.
It oscillates within a range of 0 and 100 and sets the overbought and oversold positions.
The overbought level is set at 70, while the oversold position is set at 30.
So, all positions above 70 are considered overbought and all positions below 30 are considered oversold.
They work similarly as the previous case:
- MACD sends a buy/sell signal after a crossover of both of its lines, the MACD and Signal lines.
- All RSI levels move above 70 (overbought) or below 30 (oversold).
- The two indicators give the same type of signal.
- Open the position
Consider the chart given below….
The above graphic shows the RSI and the MACD indicators added to a single chart.
You should enter a sell trade at the position marked as “Sell” on the chart.
If you look at the RSI indicator, it is above 70, meaning that it’s in an overbought position.
This has been shown by the red circles on the indicator.
At the same time, the MACD indicator makes a bearish crossover.
The MACD line of the indicator crosses the Signal line and begins to move below it.
This generates a sell signal, hence, it is a good time for you to sell the forex pair.
The price action entered a bearish move from that time, and this bearish move continued for some time.
You should exit your short position at the point marked “Close Sell” on the chart.
At this point, the RSI indicator is in an oversold position, that is, below 30.
The MACD indicator also makes a bullish crossover, that is, the MACD line begins to move above the Signal line.
This has been shown by the two black circles on the two indicators.
This was followed by a rise in the price of the forex pair.
If you enter a long position immediately after exiting your position, you will benefit from this rise in the price of the forex pair.
MACD + DMI
DMI (Directional Movement Indicator) is a momentum indicator with 2 lines, the negative directional index (-DI) and the positive directional index (+DI).
The DMI indicator is used to measure the strength of positive and negative trends.
The indicator sends sell and buy signals after a crossover happens between the +DI and the –DI lines.
When the +DI crosses the –DI in an upwards direction, it’s an indication that the price of the forex pair is increasing.
This generates a buy signal, meaning that it’s a good opportunity for you to enter a long position.
When the +DI crosses the –DI in a downwards direction, it’s an indication that the price of the forex pair is decreasing, hence, it’s a good opportunity for you to enter a short position.
You can combine the DMI and the MACD indicators to come up with a trading strategy that works as follows…
- MACD generates a buy/sell signal after a crossover of both of its lines, that is, the MACD and the Signal lines.
- DMI generates a buy/sell signal after a DMI crossover.
- The signals are generated at the same time or at the time of the “Keep signal for x candles”.
- Open the position.
Consider the chart given below…
The above graphic shows the DMI and MACD indicators added to a chart.
You should sell the forex pair at the position marked as “Sell” on the chart.
During this time, the +DI line of the DMI indicator crosses the –DI line of the same indicator in a bearish direction.
This is an indication that the price of the currency pair is decreasing, hence, it’s a good time for you to enter a short position.
The MACD indicator also gives a similar signal.
The MACD line crosses the Signal line in a bearish direction, which means that the market is in a downtrend.
You should exit your short position at the point marked “Close Sell” on the chart.
At this point, the +DI line of the MDI indicator crosses the –DI line in a bullish direction.
This is an indication that the price of the forex pair is increasing.
This is a good time for you to exit your short position and enter a long position.
At the same time, the MACD indicator generates a buy signal.
The MACD line of the indicator crosses the Signal line of the indicator in a bullish direction.
This is an indication that the market is in a bullish trend, hence, it’s a good opportunity for you to exit your short position and enter a long position.
This was followed by a significant rise in the price of the forex pair.
So, a trader who had bought the pair will benefit from the increase in the price of the pair.
RSI + OBV
The RSI (Relative Strength Index) is a momentum and leading indicator at the same time.
It is loved by most traders because it is easy to use.
The RSI technical indicator shows the possible overbought and oversold positions in the market.
The OBV (On-Balance Volume) indicator on the other hand works based on the idea that both the volume and the price activity are equally important.
It combines both the price and the volume so as to show you the total amount of funds that go in and out of the market.
These two indicators can be combined to come up with a great trading strategy.
Consider the chart given below…
The above graphic shows the RSI and OBV indicators combined on a single forex pair chart.
You should enter a short position at the point marked as “Sell” on the chart.
The RSI indicator is above 70 at this point, which is a signal that the forex pair is overbought.
At the same time, the OBV indicator begins to make a bearish move.
This has been shown by the two red circles on the chart.
These two signals are an indication that the price action is about to begin a bearish move, meaning that it is time for you to enter a short position.
The price begun to make a bearish move from that position.
This is also the same trend shown by both indicators.
You should exit your short position at the position marked as “Close Sell” on the chart.
At this point, the RSI indicator is below 30, which is a signal that the forex pair is oversold.
At the same time, the OBV indicator is beginning to move upwards, which is an indication that a bullish trend is beginning in the market.
At this point, you should exit your short position and enter a long position.
This way, you will benefit from the bullish move that results from the price action.
So, it’s possible and easy to combine technical forex indicators when running forex trade!
This is what you’ve learned in this article…
- Technical indicators are statistics of past market data obtained using different mathematical calculations.
- Technical indicators help forex traders make better trading decisions, in terms of when to enter buy or sell positions.
- Due to this, a correct use of technical indicators can improve your chances of running successful trades.
- Trend indicators help traders determine the strength and direction of the current market trend.
- Momentum indicators help traders determine the speed at which a trend is moving in a particular direction.
- This way, a trader can tell whether the trend will continue for long or it’s about to end.
- If the trend is accelerating at a high speed, this is an indication that it is strong and that it may continue for some time.
- If the trend is accelerating at a slow speed, it is an indication that it is weak and that it can end anytime for a new trend to begin.
- Volatility indicators help traders determine how dynamic or volatile a trend is.
- Sometimes, the market is more dynamic and in other times, the market is quieter.
- This can help traders know the price range within which the price action varies.
- Volume indicators are not common in forex because it’s not easy to find volume data for an individual currency.
- Combining different indicators can help you make even better trading decisions.