Everything you learn about trading is like a tool that is being added to your forex trader’s toolbox.
Your tools will give you a better chance of making good trading decisions when you use the right tool at the right time.
Bollinger bands are used to measure the market’s volatility. They act like mini support and resistance levels.
- A strategy that relies on the notion that price tends to always return to the middle of the Bollinger bands.
- You buy when the price hits the lower Bollinger band.
- You sell when the price hits the upper Bollinger band.
- Best used in ranging markets.
- A strategy that is used to catch breakouts early.
- When the Bollinger bands “squeeze”, it means that the market is very quiet, and a breakout is imminent. Once a breakout occurs, we enter a trade on whatever side the price makes its breakout.
MACD is used to catch trends early and can also help us spot trend reversals.
- It consists of 2 moving averages (1 fast, 1 slow) and vertical lines called a histogram, which measures the distance between the 2 moving averages.
- Contrary to what many people think, the moving average lines are NOT moving averages of the price. They are moving averages of other moving averages.
- MACD’s downfall is its lag because it uses so many moving averages.
- One way to use MACD is to wait for the fast line to “cross over” or “cross under” the slow line and enter the trade accordingly because it signals a new trend.
This indicator is made to spot trend reversals, hence the name Parabolic Stop And Reversal (SAR).
This is the easiest indicator to interpret because it only gives bullish and bearish signals.
- When the dots are above the candles, it is a sell signal.
- When the dots are below the candles, it is a buy signal.
- These are best used in trending markets that consist of long rallies and downturns.
- Used to indicate overbought and oversold conditions.
- When the moving average lines are above 80, it means that the market is overbought and we should look to sell.
- When the moving average lines are below 20, it means that the market is oversold and we should look to buy.
Relative Strength Index (RSI)
- Similar to the stochastic in that it indicates overbought and oversold conditions.
- When RSI is above 70, it means that the market is overbought and we should look to sell.
- When RSI is below 30, it means that the market is oversold and we should look to buy.
- RSI can also be used to confirm trend formations. If you think a trend is forming, wait for RSI to go above or below 50 (depending on if you’re looking at an uptrend or downtrend) before you enter a trade.
Average Directional Index (ADX)
- The ADX calculates the potential strength of a trend.
- It fluctuates from 0 to 100, with readings below 20 indicating a weak trend and readings above 50 signaling a strong trend.
- ADX can be used as confirmation whether the pair could possibly continue in its current trend or not.
- ADX can also be used to determine when one should close a trade early. For instance, when ADX starts to slide below 50, it indicates that the current trend is possibly losing steam.
Ichimoku Kinko Hyo
Ichimoku Kinko Hyo (IKH) is an indicator that gauges future price momentum and determines future areas of support and resistance.
Ichimoku translates to “a glance”, kinko means “equilibrium”, while hyo is Japanese for “chart”.
Putting that all together, the phrase ichimoku kinko hyo stands for “a glance at a chart in equilibrium.”
- If the price is above the Senkou span, the top line serves as the first support level while the bottom line serves as the second support level. If the price is below the Senkou span, the bottom line forms the first resistance level while the top line is the second resistance level.
- The Kijun Sen acts as an indicator of future price movement. If the price is higher than the blue line, it could continue to climb higher. If the price is below the blue line, it could keep dropping.
- The Tenkan Sen is an indicator of the market trend. If the red line is moving up or down, it indicates that the market is trending. If it moves horizontally, it signals that the market is ranging.
- The Chikou Span is the lagging line. If the Chikou line crosses the price in the bottom-up direction, that’s a buy signal. If the green line crosses the price from the top-down, that’s a sell signal.
Each chart indicator has its imperfections. This is why forex traders combine many different indicators to “screen” each other.
As you progress through your forex trading career, you will learn which indicators you like the best and can combine them in a way that fits your forex trading style.