“Out of the many forex technical indicators, which is the best technical indicator on its own?”
This is a common question among many forex traders.
Forex traders don’t include indicators to their charts to make them look nicer.
Traders want to make money.
If any indicator generates signals that don’t translate into profits over time, then the indicator is not good for you.
When trading forex, you must know that there is no perfect indicator.
This means that you will have to follow the same path that is followed by other traders and learn how to trade.
You should learn the logic behind most Forex indicators, learn their strengths and weaknesses, and work out on them.
You also need to know how the forex indicators can fit together organically and help you become a better trader.
In this article, I will help you know the best technical indicators for you as a forex trader.
Let’s start…
What is a Technical Indicator?
A technical indicator is a mathematical tool that analyzes the open price, high, low, closing price, and volume of a security.
The technical indicators are plotted on graphs as chart patterns.
In some cases, they overlay the price chart, and in other cases, they are drawn in a separate window.
Currently, there are thousands of technical indicators, and anyone with programming knowledge can create their own indicators.
When creating indicators, the past market data is used, hence, we can say that technical indicators are statistics of past market data.
Traders then use them in technical analysis to predict currency trends.
Most forex traders spend their time watching for a perfect time to enter a “buy” or “sell” trade.
This search can be fascinating, but the truth is that traders end up getting the same results.
However, you can use forex technical indicators to know the best time to buy or sell a forex cross rate.
Best Technical Trading Indicators in Forex
The forex technical indicators are classified into different categories based on their purpose.
Now, let me give you the list of the best forex technical indicators that you should consider using as a trader.
Trend Indicators
Trend indicators show the strength and direction of the current trend.
Of course, most traders trade by recognizing the direction of a major trend and try to profit by trading in the direction of the trend.
A trend indicator can help you accomplish this easily and increase your chances of becoming a successful trader.
Some traders attempt to use trend indicators as a separate trading system, but the major purpose of trend indicators is to help traders determine whether they should enter a long or short position.
Here is the list of some of the best trend indicators that you should use in forex…
#1: Average Directional Movement Index (ADX)
The ADX indicator shows the strength of a trend and it was developed upon the Exponential Moving Averages (EMAs) of two other indicators, +DI and –DI.
The DI’s (Directional Movements) help traders determine how the highs, the lows, and the closing of the current day are related to the highs, the lows, and the closing of the previous day.
The sum of the figures is then divided by the ATR value (Average True Range).
The +DI indicator gives the strength of the bull on that day compared to the previous day, while the –DI indicator gives the strength of the bear for the day compared to the previous day.
The ADX indicator takes the values of +DI and –DI and tells the trader who is strong for the day compared to the previous day, the bull or the bear.
When you add the ADX indicator to your chart with +DI and –DI, it looks like three lines entangled with each other and moving within a scale of 0 and 100.
Consider the chart given below…
The above chart shows the ADX chart with DI’s added on the chart of a forex pair.
The ADX line is the black line pointed by an arrow marked as ADX.
The +DI line is the line pointed by an arrow marked as +DI.
The -DI line is the line pointed by an arrow marked as -DI.
Just as we stated previously, the indicator looks like three lines entangled with each other.
Whenever the ADX line is below 20, it is an indication of a weak trend in the market, whether bullish or bearish.
A threshold of 40 is an indication of trend strength and everything above 50 indicates a strong trend.
If the +DI line is above the –DI line, it indicates that the bulls have overpowered the bears, and they are in control of the market.
This means that there is a bullish move in the market.
If the -DI line is above the +DI line, it indicates that the bears have overpowered the bulls, and they are in control of the market.
This means that there is a bearish move in the market.
The curvature of the lines also shows a value, which demonstrates the speed of the rate of change.
The ADX is a lagging indicator used to evaluate the strength of a trend.
So, this indicator can help a trader know the correct time to enter a buy or a sell trade.
#2: Aroon
The Aroon is a technical indicator that determines whether there is a trend, how it’s developing and its strength.
Aroon indicators work based on the idea that a trend can be measured by determining how recent the previous highest highs and the lowest lows were.
The Aroon’s bullish line shows the recentness of the highest high, while the Aroon’s bearish line shows the recentness of the lower lows.
Consider the chart given below…
The above chart shows the Aroon indicator added to a chart.
The two lines for the indicator, the bearish and the bullish lines have been marked.
The two lines should oscillate between 0 and 100.
When the bullish line moves too high close to 100 mark and the bearish line moves lower just above 0, it’s an indication that higher highs are often and lower lows are seldom.
This translates to the fact that there is a strong bullish trend in the market.
A crossover between the two lines is an indication that the market is changing direction.
The Aroon is also a lagging technical indicator and it helps traders confirm whether a trend has remained intact.
#3: Moving Average Convergence/Divergence (MACD)
The MACD indicator reveals changes in the direction, strength, momentum, and duration of a trend.
The indicator is built upon the moving averages 12 and 26 periods, but some interesting alterations have been made to it.
From this, you can conclude that when you use moving averages, it’s like using a lagging indicator, and that since 12 and 26 sound like a trading fortnight and a trading month, the indicator should be used on daily charts.
Despite the alterations that have been made to the indicator, it is made up of three components which include the following…
- MACD line- this is the difference between the 12 EMA and the 26 EMA.
- Signal line- this is similar to the MACD line smoothed by a nine period SMA.
- Histogram- it shows the difference between the MACD and the signal.
Consider the chart given below…
The above chart shows the MACD indicator added to a chart.
The MACD Line, the Signal Line, and the Histogram for the indicator have been shown.
Whenever the MACD line is above the Signal line, the price action is in a bullish move.
This is shown by the Histogram in the form of many green bars moving vertically upwards.
Whenever the Signal line is above the MACD line, the price action is in a bearish trend.
This is also shown by the histogram in the form of red bars moving vertically downwards.
A crossover between the MACD and Signal lines is also an indication that the price action has changed direction.
Also, consider the size of the bars of the Histogram.
When there is a huge gap or difference between the MACD line and the Signal line, the Histogram shows very large bars.
When there is a small gap or difference between the MACD line and the Signal line, the Histogram shows small bars.
So, the Histogram reflects the difference between the two lines.
Due to this, traders use the Histogram bars to identify divergences.
A divergence normally occurs after the price makes a higher high or a lower low that the Histogram doesn’t support, which also makes a higher high or a lower low accordingly.
A divergence acts as a signal that the trend has changed its direction.
Momentum Indicators
Momentum is an important concept in technical analysis.
Momentum indicators measure the speed of movement or the rate of change of the price of a financial instrument.
The indicator measures the most recent closing bar to the previous closing bar in periods ago.
When we analyze the rate of change, we can know the strength of “momentum” in a forex pair or any other financial instrument.
A waning momentum is an indication that the market is becoming exhausted and can make a reversal or retracement anytime.
An accelerating momentum is an indication that the current trend is strong and is most likely to continue.
With such knowledge, you can determine whether it is prudent to enter a trade or not.
Most momentum trading techniques like breakout of a recent range depend on this idea of accelerating momentum.
There are different indicators that can help you measure the momentum of a trend.
Let’s discuss them…
#1: Relative Strength Index (RSI)
The RSI indicator is the first in the group of momentum indicators next to Williams % range and the Stochastic.
They serve a similar task but using different approaches.
Momentum indicators help traders know whether a financial instrument is overbought or oversold.
This is achieved by determining the magnitude and the velocity of the price movements.
Remember that momentum is just the rate at which the price changes.
The RSI indicator compares the closing prices for the current and the previous candles for up and down trends.
The outcome of this is turned into an EMA (Exponential Moving Average), or in other cases a SMA (Simple Moving Average).
It then calculates the relationship between the uptrend EMA and the downtrend EMA when oscillated on a scale of between 1 and 100.
A big difference between today and yesterday is an indication of a stronger momentum.
So, if every future close is higher than the previous one, the RSI will oscillate upwards, and once it reaches a threshold of 80 (overbought area), it will send a sell signal.
The RSI indicator also makes divergences.
If the price action creates a higher high, and the RSI indicator makes a lower low, it will generate a bearish signal.
The vice versa is also true.
Consider the following chart…
The above chart shows the RSI indicator added on a chart.
The RSI indicator is the line shown on the lower part of the above chart.
The RSI indicator exhibits a similar behavior as the price action.
When the price action makes a bullish move, the RSI indicator also makes a bullish move.
When the price action makes a bearish move, the RSI indicator also makes a bearish move.
From the chart, it’s possible to tell the strength of both the bearish and the bullish trends from the RSI indicator.
When the RSI indicator makes a strong bullish move, the price action also makes a strong bullish move.
When the RSI indicator makes a weak bullish move, the price action also makes a weak bullish move.
The same is also the case for strong and weak bearish trends.
When the RSI indicator makes a strong bearish move, the price action also makes a strong bearish move.
When the RSI indicator makes a weak bearish move, the price action also makes a weak bearish move.
Hence, traders can use the RSI indicator to measure the momentum of market trends.
#2: Stochastic Oscillator
Any technical indicator that jumps up and down within a set scale is oscillated.
This means that even trend indicators can be oscillators because of their characteristics.
The Stochastic Oscillator helps traders identify the overbought and oversold positions by measuring momentum.
When it comes to Stochastic, it is done by evaluating how close the closing price was in relation to the price range.
When the market is in an uptrend, the price should close near the highs of the trading range.
When the market is in a downtrend, the price should close near the lows.
The stochastic is also plotted within a scale of 0 to 100.
Positions above 80 are considered overbought, while positions below 20 are considered oversold.
Consider the chart given below…
The above chart shows the Stochastic Oscillator added to a chart.
The Stochastic Oscillator is shown by the two lines marked as %K and %D on the lower part of the chart.
So, when talking about the Stochastic Oscillator, you are referring to the %K and %D which are calculated as follows…
%K = (Current Close – Lowest Low) / (Highest High – Lowest Low) * 100
%D = 3-day SMA of %K
Where,
Lowest Low is the lowest low for a look-back period of the previous 14 trading sessions.
Highest High is the highest high for a look-back period of the previous 14 trading sessions.
%K is the most recent market rate for the currency pair. It is multiplied by 100 to move the decimal point to two places.
%D = 3-day is a simple moving average of %K.
The two lines can help you determine the momentum of the market price.
When the Stochastic is within the overbought/oversold levels, it’s an indication of a strong momentum in the market.
If it’s within the overbought level, it’s an indication of a strong bullish momentum in the market.
If it’s within the oversold level, it’s an indication of a strong bearish momentum in the market.
Note that the lower window of the chart where the indicator has been added has two dotted lines running horizontally.
The dotted line at the top is at the 80 level mark, and positions above it should be considered overbought.
The dotted line at the bottom is at the 20 level mark, and positions below it should be considered oversold.
Volatility
These are special types of technical indicators that measure how far an asset strays from its mean directional value.
An asset with a high volatility strays far from its average direction.
An asset with a low volatility has a strong sense of direction.
When trading forex, you need to know how volatile the forex pair in question is.
This will help you make sound trading decisions.
The good news is that this is possible using the best volatility-based indicators.
These include the following…
#1: Average True Range (ATR)
As you know, volatility-based indicators help traders monitor changes in the market price of an asset.
These changes are then compared to the historical values.
The range denotes the high of the day minus the low of the day.
The true range extends this to the closing price of yesterday if it was outside the range of today.
The ATR is an EMA (Exponential Moving Average) of true range.
ATR is the greater of the following:
- The current high minus the current low
- The absolute value of current low less than the previous close
- The absolute value of current high less than the previous close
A higher price difference between any of the above means a higher value of ATR and a higher volatility in the market.
This knowledge can be helpful to you as a trader especially when adjusting your stops.
Consider the chart given below…
The above chart shows the ATR indicator inserted into a chart.
It is the single line pointed to by an arrow marked as ATR inside the lower window.
The chart shows that this indicator fluctuates within a range.
High prints for the ATR line signal that the market is experiencing a high volatility.
Depressed ATR levels signal that the market is experiencing a relatively low volatility.
Traders can use the prints of the ATR indicator to determine the entry and exit points based on volatility.
When there is a high volatility, there are high chances that the currency pair is dynamic and moving faster.
On the other hand, when there is a low volatility, it is an indication of a consolidation period or a quiet market.
#2: Bollinger Bands
The Bollinger Bands is another technical indicator for measuring market volatility of an asset.
It uses an SMA or EMA, and then it envelopes it by two standard deviations.
This develops a dynamic corridor in which the price can bounce in.
Bollinger bands can help traders differentiate Ranges from Trends.
Bollinger Bands is made up of two bands that go through the tops and the bottoms of the price action, creating a channel.
It also has a 20-period moving average at the middle.
The volatility bands have the price action dynamics.
Low volatility normally results from low trading volumes.
High volatility normally results from higher trading volumes.
So, the Bollinger Bands indicator helps forex traders to identify Ranges and Trends.
When the Bollinger Bands are tight, it’s an indication that the market is quiet and there is low volatility.
When the Bollinger Bands begin to expand, it’s an indication that there is a high volatility in the market and the price is beginning to move.
Consider the chart given below…
The above chart shows Bollinger Bands indicator added on a chart.
The Bollinger Bands are the three wavy lines running across the chart.
What you must have observed is that when the price action is in a range/sideways movement, the Bollinger Bands remain tight.
This has been shown on the chart by the three arrows marked as “Tight Bollinger Bands”.
This is an indication that there is less volatility in the market.
When the price action starts a new trend, either bullish or bearish, the Bollinger Bands expand.
This is an indication that there is a high volatility in the market.
This has been shown on the chart by the three arrows marked as “Expanded Bollinger Bands”.
Volume Indicators
It is impossible to measure the total market volume of the Forex spot market at the rate and depth that is required by traders unlike say in commodities, stocks, or even Forex futures.
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 have on your platform is obtained from the data stream of your 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.
Here is the most common volume indicator among Forex traders…
#1: On-Balance Volume (OBV)
This is a great technical indicator for technical analysis.
The OBV indicator measures the increases or decreases in the volume of the traded instrument, relative to its price.
This is based on the idea that volume precedes price, and that traders can use it to confirm price moves.
The total daily volume is normally given a positive number if it increased in relation to the previous day.
The total daily volume is given a negative number if it decreased in relation to the previous day.
Consider the chart given below…
The above chart shows the OBV indicator added on a price chart.
The OBV has been shown on the lower window of the chart.
When the prices strongly go in one direction, the OBV should do the same.
This has been depicted clearly on the chart given above.
If a divergence occurs between the OBV and the price, it’s an indication that there is a weakness in the market move.
Conclusion:
This is what you have learned in this article…
- A technical indicator refers to a mathematical tool that analyzes the open price, high, low, closing price, and the volume of a security.
- There are different types of technical indicators in Forex.
- These indicators are classified into different categories based on the purpose they serve.
- Trend indicators determine the strength and the direction of a market trend.
- They help traders determine the current direction of the market and trade in that direction.
- Momentum indicators determine the speed of movement or the rate of change of the price of a financial instrument.
- When the momentum is accelerating, it acts as an indication that the current market trend is strong and it may continue for some time.
- When the momentum is waning, it acts as an indication that the current market trend is weak and may be coming to an end.
- Volatility indicators measure how far a forex pair strays from its mean directional value.
- A forex pair with a high volatility strays far from its average direction.
- A forex pair with a low volatility has a strong sense of direction.
- Each forex indicator is associated with both strengths and weaknesses.
- It’s up to you as a trader to determine the strengths and weaknesses of each indicator and work out on them.
- Most trading platforms come with indicators, so you don’t have to worry about where to get them.
- You can also create your own indicators if you have coding knowledge.