Four patterns that new FX traders can utilize

Author: Forex Live | Category: Education

Which technical indicators to watch when you're starting out

Which technical indicators to watch when you're starting out

For many newer traders, foreign exchange (FX) can seem a bit overwhelming at first glance. Given the complexity of the data or charts, it is not always clear what the best tools or patterns are to use in your trading.

Indeed, figuring out the optimal indicators for your strategy and trading goals can take years of trial and error, as well as fine tuning and endless small adjustments. However, there are generally four very powerful and reliable patterns that FX traders can harness that are amongst the most popular for traders of all experience levels. This article will highlight four such indicators.

1. Relative Strength Index (RSI)

Relative Strength Index (RSI) constitutes a gauge of a trend's momentum that can indicate whether the asset being analyzed is in the overbought or oversold region. This distinction is extremely relevant for future price action and relies on a simple calculation.

For the purpose of calculation, the RS in the equation below is the Average gains during upswings/Averages Loss during downturns within the timeframe being looked at. As such, we can represent this via a simple formula.

RSI = 100 - 100/(1+RS)

Broadly speaking, RSI oscillates between the range of 0-100 if the price moves below 30 - this means that is in the oversold region, and if the price moves above 70 that means it is in the overbought region. However, it's crucial to understand why this is important.

For example, if a given asset is oversold or overbought, there is a high probability the current trend will undergo a price reversal. By extension, traders can use RSI (cross-referencing it against other indicators to avoid false signals), by using a drop below 30 as a "buy" signal and a cross above the 70 level as a "sell" signal and anything in between a sign to hold the position.

2. Simple Moving Average (SMA)

A tried and true indicator, the Simple Moving Average (SMA) represents the sum of all the closing prices of a specific time period divided by the time intervals. This can sound like a lot of data that is more complex than it actually is.

As its name suggests, the indicator is a simplified display of prices over a given interval of time. For example, if you want the SMA of the last 10 days, you would add the closing prices of the last ten days and then divide them by 10. 

Expanding this to other intervals, depending on the time frame that is used to calculate the SMA it can show price changes rapidly. If the SMA is calculated on a short timeline or slower to react (but better at revealing long term trends) then the timeline is longer. 

Longer-term SMA can visually normalize a given price movement whereby affording you a better gauge of emerging longer-term trends. Conversely, the first shorter term SMA shows smaller fluctuations in the price, which is a better analytical tool for traders using shorter-term strategies such as intraday.

3. Bollinger Bands

Bollinger Bands have evolved into one of the most popular indicators in recent years, given its versatility and utility. The indicator excels in helping traders identify periods of volatility, as the upper and lower bands will converge when volatility is lower as they diverge when volatility increases

The reason many traders swear by the Bollinger Bands indicator is due to it giving more specific short and long signals (comparable to other indicators).For example, when a high price crosses an upper band, a short signal is given and where the low price crosses the lower band, a long signal is given (as indicated in the circles in the image below).

Bollinger Bands

Bollinger bands also occasionally act like support and resistance, like other indicators do as well.

4. Moving Average Convergence Divergence (MACD)

Finally, one of the other more common and helpful indicators used by traders is the Moving Average Convergence Divergence MACD. While MACD is a touch more complex in terms of calculation and analysis, the indicator has a variety of uses for traders.

MACD is a trend-following momentum indicator, which highlights a relationship between two moving averages of an asset. MACD is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA.

Consequently, the result of this calculation is the MACD line. A 9-day EMA of the MACD, known as the "signal line," is then plotted on top of the MACD line, which can function as a trigger for buy and sell signals.

Traders may be incentivized to buy when the MACD crosses above its signal line and sell - or short - when the MACD crosses below the signal line. MACD indicators can also be interpreted in several ways, but the more common methods are crossovers, divergences, and rapid rises/falls.

Generally speaking, MACD can help traders identify the speed of crossovers taken as a signal of a market being overbought or oversold. Moreover, MACD also assists investors in understanding whether bullish or bearish movement in the price is strengthening or weakening.

This article was submitted by InstaForex.

By continuing to browse our site you agree to our use of cookies, revised Privacy Notice and Terms of Service. More information about cookiesClose