While it sometimes seems that developing the best forex trading strategy can be a bit of a guessing game, using a diverse set of technical indicators will help you trade with a much greater sense of precision. Technical indicators make it easy to quantify current price trends and, in response, predict which currencies are most likely to increase in value.
The best forex trading strategies will usually involve the use of multiple technical indicators, allowing traders to gain a broader view of the forex market. The forex market experiences more than $5 trillion in trading volume every single day. Additionally, the widespread use of leverage throughout the entire market makes it easy to gain or lose large sums of money in a short amount of time.
Generally, technical trading indicators can be categorized as either lagging or leading. As these terms imply, leading indicators are “input-oriented’ and are used for making predictions about the future. Lagging indicators, on the other hand, are “output-oriented.” These categories can be found throughout the trading world and various other areas of business. Because leading and lagging indicators both have pros and cons, forex traders will often use at least one of each.
In this article, we will discuss 8 technical indicators that can potentially broaden your view of the market. By understanding the many different ways in which trends can be identified, you may find new opportunities for opening profitable forex positions. The more you can do to understand the market, the more likely you’ll be able to succeed as a forex trader.
1. Ichimoku Cloud
Originally developed in Japan, the Ichimoku Cloud is one of the most comprehensive technical indicators in use around the world. As a momentum indicator, the “cloud” seeks to reveal not only which direction markets are moving (something that can usually be found from a simple price chart or candlestick chart), but also the strength of the current trend. Without knowing the strength of the trend, traders will have no way of evaluating the risk of a given position. The Ichimoku Cloud includes six distinct lines, revealing averages from different time periods. The space between these lines is known as “cloud” and reveals ample information about the market’s performance.
2. Bollinger Bands
Bollinger Bands, named after their creator John Bollinger, are one of the most popular “channel indicators” in current use. These bands not only reveal when a currency (or other speculative assets) is near the edges of its predicted price range, they also reveal whether an asset’s price range has been getting wider or narrower over time. This information is incredibly useful for traders seeking to either pursue or avoid assets with high levels of volatility. Bollinger Bands contain two standard deviations of price movements, meaning that roughly 95 percent of these movements are captured within the bands.
3. Relative Strength Index (RSI)
Like the Ichimoku Cloud, the Relative Strength Index (RSI) is a momentum indicator designed to help traders predict whether their prospective currency is overbought and oversold. The RSI is especially useful in the forex market because it allows traders to quickly compare multiple different currency pairs. The RSI is reflected on a scale of 1 to 100, with lower numbers suggesting a security is undervalued, higher numbers suggesting the security is overvalued, and middle numbers (30 to 70) suggesting uncertainty.
4. Average Directional Index (ADX)
The Average Directional Index (ADX) is illustrated on a scale of 0 to 100, with readings above 50 indicating that the current trend is very strong (readings below 20 suggest a weak trend). As one of the clearest indicators of a trend’s current strength, the “ADX is typically used to identify whether the market is ranging or starting a new trend.” Despite its simplicity, some traders consider the ADX to be comprehensive enough” to trigger the opening or closing of a given position.
5. Awesome Oscillator (AO)
The Awesome Oscillator (AO) combines both short-term and mid-term data in order to recognize whether a trend’s momentum has measurably changed. The indicator combines both 34-period and 5-period simple moving averages (SMA). When the 5 period SMA crosses over (or under) the 34 period SMA, this suggests that the strength of the current trend has fundamentally changed. Using these types of indicators can be useful—even if a price is moving in a specific direction, that doesn’t necessarily mean it will move in that direction for very long.
6. Donchian Channel Indicator
The Donchian Channel Indicator is, like Bollinger Bands, a channel indicator that is incredibly useful for day traders. According to Trading Strategy Guides—a leader in developing innovative trading strategies—the Donchian Channel trading strategy helps forex traders gauge the trend, spot breakouts, and identify “market swing highs and lows, support and resistance levels, [and] market volatility.” When the price moves toward the edges of the channel, forex traders will be able to decide whether to open a new position.
7. Parabolic Stop and Reverse
First introduced by J. Welles Wilder, Jr., the Parabolic Stop and Reverse (Parabolic SAR) helps traders recognize when trends are most likely to reverse direction. Because many forex traders rely heavily on the classic “buy low, sell high” mantra, indicators such as the Parabolic SAR allow them to ride their positions for as long as they feasibly can. The indicator is frequently used to set trailing stop losses, which are ubiquitous in the world of currency trading.
8. Weighted Moving Average (WMA)
The Weighted Moving Average (WMA) was developed out of the recognition that the SMA, while useful, wrongfully considers old data to be just as useful as new data. In the fast-moving world of forex trading, this assumption rarely proves to be true. The WMA places additional weight on newer data, allowing traders to make more timely trading decisions. Furthermore, these weights can easily be adjusted, depending on your specific trading objectives.
Conclusion – 8 Technical Indicators All Forex Traders Should Use in 2020
These are just eight of the thousands of technical indicators you may consider using as a forex trader. Experimenting with multiple technical indicators while trading on paper will make it easier to recognize which ones are most effective for you. If you can remain disciplined and continue using a forex trading strategy supported by data, you should be able to achieve your 2020 trading objectives.