If you have ever traded forex, I am sure that you know at least one technical indicator.
Any trader who uses forex charts when trading knows that there are different technical indicators that are available.
There are those indicators that traders like to use, such as Stochastics, RSI, Moving averages, and others you might not have ever heard.
It is important for you as a trader to learn the different types of technical indicators and play around with each of them.
You can also combine different trading indicators and come up with a trading strategy that can help you identify high probability trading opportunities.
In this article, I will help you understand the different types of technical indicators.
What is a Technical Indicator?
A technical indicator is a set of calculations that traders use depending on the exchange rate, volume or open interest of a currency pair.
Technical traders in the stock market typically look at the stock price, but forex traders typically look at the exchange rate of a currency pair.
Most forex indicators are calculated from exchange rates.
Majority of forex traders approach the market through technical analysis.
Technical analysis is the study of the past and the present price action to be able to accurately predict the future behavior of the market.
Technical indicators are the premier tools for the practice of technical analysis.
Indicators come in different forms, and they all help traders place an evolving price action into a manageable context.
There are many indicators that are available for you, but each indicator either helps you to identify the market rate or identify any potential trading opportunities.
The good thing with indicators is that traders have freedom and flexibility when using them.
Technical indicators are versatile in that they can be used in isolation or within the structure of a broader strategic framework.
In the next sections, I will be helping you understand the different types of technical indicators.
Types of Forex Indicators
The following are the various types of technical trading indicators…
Traders use trend indicators to determine the strength and direction of a market trend.
Of course, there are high chances of making profit when one trades in the same direction as the market.
That’s why most traders keep on watching the market for the trend direction.
Trend indicators will make this work easy for you and increase your chances of becoming a successful forex trader.
It is not advisable for traders to use trend indicators as separate trading systems.
The reason is that trend indicators help traders determine whether they should enter a long or a short position.
There are different types of trend indicators available for you.
Let’s discuss them…
#1: MACD (Moving Average Convergence Divergence) Indicator
MACD is a technical indicator that measures the relationship between Exponential Moving Averages (EMAs).
The MACD indicator is made up of three main components…
- MACD line- this line shows the difference between the 12 EMA and the 26 EMA.
- Signal line- this line is similar to the MACD line smoothed by a nine period SMA.
- Histogram- the Histogram shows the difference between the MACD line and the Signal line.
So, the MACD indicator is built based on the 12 and 26 EMAs, but there are some changes that have been made to it.
The good thing is that you don’t have to do calculations in order to get these values because they are provided in most trading platforms.
The MACD indicator can help you know whether there is an uptrend or a downtrend in the market.
When the MACD line moves above the Signal line, it’s an indication that there is a bullish trend in the market.
When the MACD lines moves below the Signal line, it’s an indication that there is a bearish trend in the market.
The bars of the Histogram show the difference between the MACD and the Signal lines of the indicator.
When there is a huge difference between the two lines, the Histogram shows large bars.
When there is a small difference between the two lines, the Histogram shows small bars.
Again, when there is an uptrend in the market, the Histogram bars run vertically upwards.
When there is a downtrend in the market, the Histogram bars run vertically downwards.
Consider the chart given below…
The above graphic shows the MACD indicator added on a price chart.
The MACD indicator has been shown on the lower section of the chart.
The MACD line, the Signal line, and the Histogram have been pointed by black arrows.
A close observation of the price action and the indicator shows that when the price action is in a bearish trend, the MACD line is moving below the Signal line.
Also, when the MACD line is moving above the Signal line, the market is in a bullish trend.
A crossover between these two lines shows a change of market direction.
When there is a bullish move in the market, the Histogram shows green bars running vertically upwards.
When the price is in a downtrend, the Histogram shows red bars running vertically downwards.
The size of the bars also reflect the difference between the MACD and the Signal lines.
When there is a huge difference/gap between the two lines, the Histogram shows large bars.
When there is a small difference/gap between the two lines, the Histogram shows small bars.
#2: ADX (Average Directional Movement Index) Indicator
The ADX indicator can help traders determine the overall strength of an indicator.
The indicator is calculated by determining the average of the expanding price range values.
The ADX indicator is part of the Directional Movement System developed by Welles Wilder.
This system measures the strength of price movement in a positive or negative direction The ADX indicator was developed upon the Exponential Moving Averages (EMAs) of two other indicators, +DI and –DI.
The DI’s (Directional Movements) help traders know the relationship between the highs, the lows, and the closing of the current day and the highs, the lows, and the closing of the previous day.
After getting the sum of the figures, it is divided by the ATR value (Average True Range).
The +DI shows the strength of the bull for the day compared to the previous day, while the –DI shows the strength of the bear for the day compared to the previous day.
From this, the ADX can tell traders who is strong for the current day compared to the previous day, whether the bull or the bear.
The ADX indicator comes with three lines, the ADX, the +DI, and the –DI lines.
Consider the chart given below…
The above chart shows the ADX indicator with DI’s added on a forex pair price chart.
The three lines of the indicator, the ADX, +DI, and –DI lines have been pointed to by black arrows and named accordingly.
There is also a horizontal dotted line at the level of 20.
This line helps traders determine the strength of the trend in the market.
From the chart, you can tell that whenever the ADX line is below 20, it’s a signal that there is a weak trend in the market.
A threshold of 40 is an indication of trend strength and everything above 50 indicates a strong trend.
Whenever the +DI is above the –DI line, this is an indication of a bullish move in the market.
So, the bulls have taken over the market and they are in control.
Whenever the +DI line is below the –DI line, it’s an indication of a bearish move in the market.
So, the bears have overpowered the bulls and they have taken over control of the market.
The value shown by the curvature of the lines shows the rate at which the price of the forex pair is changing.
So, with the ADX indicator, a trader can easily know the correct time to enter the market.
The Aroon is a technical indicator used by traders to identify the trend changes in the price of an asset and the strength of the trend.
Basically, the indicator measures the time between the highs and the time between the lows over a period of time.
The indicator works based on the idea that strong uptrends will regularly see new highs, while strong downtrends will regularly see new lows.
The Aroon indicator is made up of the “Aroon up line” for measuring the strength of the uptrend and the “Aroon down line” for measuring the strength of the downtrend.
Consider the chart given below…
The above graphic shows the Aroon indicator added to a price chart of a forex pair.
The Aroon up line is the line pointed by a black arrow marked as Aroon up.
The Aroon down is the line pointed by a black arrow marked as Aroon down.
The two lines oscillate between the 0 and 100 level marks.
When the Aroon up line moves too high close to 100 mark and the Aroon down line moves lower just above 0, it’s an indication that there are frequent higher highs and less frequent lower lows.
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 a lagging technical indicator that traders use to confirm whether a trend has remained intact or not.
Other than the trend indicators discussed above, the moving averages is another type of trend following indicator.
Momentum indicators are oscillating indicators that help traders determine overbought and oversold positions and they are useful in signaling traders when a new trend is starting.
When performing technical analysis, you will need to know when a trend is strong as well as when the trend is weak.
With such knowledge, you can know whether the trend will continue for some time or whether it’s about to end.
This can help you make a sound decision on whether to enter a trade or not.
It can also help you know whether it’s the right time to exit a trade or not.
This requires you to measure the momentum of the trend, which is the rate of acceleration or the speed at which the price of a forex pair changes.
The momentum indicators measure the most recent closing bar to the previous closing bar in periods ago.
Let’s discuss the various momentum indicators that are available for you…
#1: RSI (Relative Strength Index) Indicator
The RSI is another oscillator that measures the current price strength in relation to the previous prices.
The RSI indicator can help you know the speed of the current trend.
The indicator oscillates between the levels 0 and 100.
RSI positions above 70 are considered overbought, while RSI positions below 30 are considered oversold.
Signals are generated by looking for divergences and failure swings.
Traders can also use the RSI indicator to identify the general trend.
RSI compares the closing prices for the current and the previous candles for up and down trends.
The obtained result is turned into an EMA (Exponential Moving Average) or in other cases a SMA (Simple Moving Average).
The relationship between the uptrend EMA and the downtrend EMA when oscillated on a scale of between 1 and 100 is then calculated.
A huge difference between today and yesterday is a signal of a stronger momentum.
The RSI indicator can also make 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 graphic shows the RSI indicator added on a chart.
The RSI indicator is the line shown on the lower window of the chart.
A closer look at the indicator reveals that it exhibits the same behavior as the price action.
When the price action enters a bearish trend, the RSI indicator enters a bearish trend.
When the price action enters a bullish trend, the RSI indicator enters a bearish trend.
The RSI indicator can also reveal the strength of the trend in the market.
When the price action is showing a strong bullish move, the RSI indicator is also showing a strong bullish move.
When the price action is showing a strong bearish move, the price action is also showing a strong bearish move.
This is also the case when the price action is in a weak bearish move.
This shows that the RSI indicator can help a trader determine the momentum of the current trend.
#2: Stochastic Oscillator
This technical indicator compares the closing price of a security to a range of its prices over a particular period of time.
You can reduce the sensitivity of the oscillator to the price movements by adjusting that time period or by calculating the moving average of the result.
The Stochastic Oscillator generates overbought and oversold signals and it oscillates between 0 and 100.
The Stochastic Oscillator and other oscillators in general generate clear buy and sell signals.
However, a trader who over-relies on these signals without a deeper understanding of oscillators is more likely to get frustrated.
Hence, you need to have a clear understanding of the Stochastic Oscillator and how to view it in relation to the market conditions.
The indicator is made up of two moving lines that oscillate between two horizontal lines,
The two moving lines are the %K and the %D lines.
Consider the following chart…
The above graphic shows the Stochastic Oscillator added to a chart.
The indicator has been added on the lower window shown on the chart.
The two lines of the indicator, the %K and the %D, have been marked clearly.
The indicator also oscillates between 0 and 100.
All positions above 80 are considered overbought, while all positions below 20 are considered oversold.
The two lines are calculated as follows…
%K = (Current Close – Lowest Low) / (Highest High – Lowest Low) * 100
%D = 3-day SMA of %K
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.
As a trader, you can use the two lines of the Stochastic indicator to determine the momentum of the price action.
When the indicator lines are within the overbought/oversold levels, it’s an indication that there is a strong trend in the market, that is, high momentum.
When the indicator lines enter the overbought position (above 80), it’s an indication that there is a strong bullish momentum in the market.
When the indicator lines enter the oversold position (below 20), it’s an indication that there is a strong bearish momentum in the market.
To know the overbought and oversold levels, use the two dotted lines running horizontally on the indicator section of the chart.
The first line is drawn at the 80 level mark and positions above it are considered overbought.
The second line is drawn at the 20 level mark and positions below it are considered oversold.
Volume indicators show the volume of trades behind a certain price movement which can be very useful because a price movement backed up by a high volume gives a much stronger signal than a price movement that is based on a low volume.
However, it is never easy to find the volume data for any particular currency.
Due to this, volume indicators are popular among stock traders.
There are many volume-based indicators that you can use, but these are not generally shown when looking at forex pairs because of the unavailability of volume data.
If you need to have a look at the volume data for a forex pair, you have to do your own research and identify a charting platform or broker that publishes such kind of data, which means that it has indicators that are based on that data.
Let’s discuss the different types of forex volume-based indicators…
#1: On-Balance Volume (OBV) Indicator
OBV is a technical indicator that uses volume to predict changes in the price of an asset.
It was developed by Joseph Granville in 1963.
The indicator was developed based on the idea that volume is the key factor behind markets and it was developed to predict when major moves will occur in the markets as a result of volume changes.
The OBV indicator works based on the idea that volume precedes price, and that it can be used by traders to confirm price moves.
The total daily volume is assigned a positive number if it increases in relation to the previous day.
The total daily volume is assigned a negative number if it decreases in relation to the previous day.
Consider the chart given below…
The above graphic shows the OBV indicator added to a forex pair chart.
The OBV indicator has been added on a separate window on the lower part of the chart.
When the price action strongly goes in one direction, the OBV should do the same.
This is what is shown in the above chart.
In case a divergence occurs between the OBV indicator and the price, it signals that that there is a weakness in the market move.
#2: Chaikin Money Flow (CMF) Indicator
The CMF indicator is a volume-weighted average of distribution and accumulation over a certain period of time.
The standard period for this indicator is 21 days.
It works based on the principle that the nearer the closing price is to the high, the more the accumulation that has taken place.
Conversely, if the closing price is nearer to the low, it signals that more distribution has taken place.
If the price action consistently closes above the midpoint of the bar on increasing volume, the CMF will have a negative value.
Consider the chart given below…
The above graphic shows the CMF indicator added to a chart.
The indicator has been added on a separate window on the lower section of the chart.
See the dotted line running horizontally on the indicator window.
This line has been drawn at a level of 0.
A CMF value of above the zero line is an indication of a strong trend in the market, while a CMF value of below the zero line is a sign of a weak trend in the market.
This has been depicted clearly on the chart.
You can also use the CMF indicator to determine the direction of the current market trend.
Simply wait for the CMF to confirm the breakout direction of the price action through support and resistance or trendlines.
For example, if the price breaks out through the resistance, just wait for the CMF to have a positive value as a confirmation for the breakout direction.
The CMF generates a sell signal when the price action create a higher high into overbought zones, and the CMF diverges with a lower high before it begins to fall.
The CMF generates a buy signal when the price action creates a lower low into oversold zones, and the CMF diverges with a higher low and begins to rise.
Volatility is a key factor that each trader should consider knowing.
Volatility is simply a way of quantifying the variability of a price, which means that volatility measures the rate at which the market moves.
A market is said to be volatile if it shows rapid fluctuations in price.
A stable or non-volatile market shows moderate price fluctuations.
When volatility is high, it means that there is less certainty about movements in the market.
After entering a trade, no trader wants to be caught by surprise by market volatility after the price moves in a direction that they did not anticipate.
There are different indicators that you can use to measure market volatility.
Let’s discuss them…
#1: Bollinger Bands
Bollinger Bands is a technical indicator that traders use to measure market volatility.
It uses an EMA or SMA by enveloping it by two standard deviations.
It is made up of two moving lines that create a corridor for the price to bounce in.
The Bollinger Bands can help you differentiate ranges from trends.
At the middle of the two Bollinger Bands is a 20-period moving average.
When the Bollinger Bands are tight, it sends the signal that the market is quieter, meaning that there is low volatility.
When the Bollinger Bands expand, it sends the signal that the market volatility is high and that the price is moving.
Consider the following chart…
The above graphic shows the Bollinger Bands indicator added to a price chart of a forex pair.
Note that the Bollinger Bands have been added on the price chart itself rather than on a separate window.
The Bollinger Bands are the two outer lines with the same color running across the chart.
At the middle of the Bollinger Bands is the 20-period moving average.
The first part of the chart shows expanded Bollinger Bands.
The reason is that there is a high volatility in the market as shown by the price action.
You can see that there are higher highs and lower lows during this time.
When the price action entered a range, the Bollinger Bands tightened.
During this time, the price is only making a sideways movement.
So, the Bollinger Bands indicator can help a trader know the amount of volatility in the market.
#2: Average True Range (ATR)
The ATR is another volatility indicator that shows how much an asset moves during a particular period of time.
Day traders use it to determine whether they should initiate a trade or not.
It also helps them determine the ideal place to place a stop loss order.
The ATR indicator will move up and down as the price moves of the asset become larger or smaller.
The calculation of the ATR reading is done as each time period passes.
If you are using a one-mine chart, a new ATR reading will be calculated after every minute.
If you are using a daily chart, a new ATR reading will be calculated every day.
All the readings are then plotted to create a continuous line for traders to see how volatility has changed over time.
See the chart given below…
The above graphic shows the ATR indicator added on a price chart for a forex pair.
The indicator has been added on a separate window on the lower part of the chart.
When the ATR line creates high prints, it indicates that the market is in a period of high volatility.
During periods of low volatility in the market, the ATR indicator is depressed.
So, the ATR indicator can be used to determine the level of volatility in the market.
This is what you’ve learned in this article…
- Technical indicators help traders perform technical analysis.
- There are four types of technical indicators namely Trend indicators, Momentum indicators, Volume indicators, and Volatility indicators.
- Trend indicators help traders determine the direction and strength of a trend. Such knowledge helps traders determine whether to enter a buy or sell trade.
- Momentum indicators help traders determine the rate at which the price of a forex pair is changing.
- With such knowledge, traders can know for how long a trend will continue.
- They can then decide on whether it’s too early/late to enter/exit a trade.
- Volatility indicators help traders determine how dynamic the price of a forex pair is.