What is the most popular technical indicator in Forex? The million dollar question… Only if it was that easy! The truth is that success comes from knowledge. And knowledge of technical indicators is a huge part of Forex trading.
The Forex market has a tendency to behave in certain ways under certain conditions. The market behaviour repeats itself, meaning the certain price patterns will occur again and again. And that’s where Forex indicators come in. They are designed to recognise these patterns as they are formed and help you interpret them to your advantage. However, more often than not, Forex traders don’t give them a chance because they assume they are complicated.
Average True Range, MACD, Relative Strength Index, Stochastic. It sounds more like parts of the washing machine than anything Forex related. But don’t judge the book by its cover. They’re not as complicated as they may seem.
Below, we will discuss the role of trading indicators in the financial markets and, in particular, introduce seven of the most popular technical indicators and explain how they can help your trading in 2021! Remember, if your indicators generate signals that don’t translate into profit over time, then they’re simply not the way to go!
Simple Moving Average, also often referred to as SMA, are technical indicators that refer to the average closing prices over a certain time period. They are plotted on the chart as lines that smooth out price action and can be used to determine the trend.
Simple Moving averages can be calculated by taking a certain number of closing prices, adding them together and dividing them by the total number of closing prices used. For instance, if you wanted to calculate the SMA for a five-day period, you would use the closing prices of the last five days and then divide it by five.
So if the last closing prices were: 80, 81, 81, 82 and 83, you would add these together and divide it by five, resulting in an average of 81.4. Afterwards, each time a new price becomes available, the average “moves”.
In our case, let’s say the next number in the sequence would be 82, the oldest rate (80) would be dropped and the new average would equal 81.8.
The longer your chosen SMA period, the slower it will react to the price movement.
The shorter your chosen SMA period, the faster it will react to the price movement.
Exponential Moving Averages, also often referred to as EMA, are trend indicators similar to Simple Moving Average, that differ in the fact that they give more weight to the most recent price values and the closing prices of the first few candles will have almost no effect.
As a result, compared to SMA, EMAs are more responsive to changes and represent recent price action more accurately. So if we used the same example as above and we wanted to calculate the EMA for a five-day period, you would put more weight on the prices of the most recent (day 3, 4 & 5) and less weight on day 1 and 2.
The formula to calculate the EMA is rather complex and goes like this:
EMA = (Close – previous EMA) x (2 / n + 1) + previous EMA
In comparison to SMA, traders consider the EMA to be more accurate of the current market situation as it is less responsive and therefore affected by a larger number of data points.
The Moving Average Convergence Divergence (MACD) is a momentum oscillator used to trade trends.
It is designed to measure the characteristics of a trend which include its direction, magnitude, and rate of change.
The MACD indicator is displayed on a forex chart as two lines MACD and signal line, and one histogram (bars). It fluctuates above and below a centerline (zero line) as the moving averages converge, cross and diverge.
So if the distance between EMAs gets bigger, the histogram rises. It is also called divergence.
If the distance between EMAs gets closer, the histogram reduces. It is also called convergence.
When the MACD crosses above the signal line, this signals an emerging uptrend. Forex traders use this as an indication to buy. When the MACD falls below the signal line, this signals an emerging downtrend. Traders use this as an indication to sell.
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