Technical indicators are tools used in trading strategies to help traders to gauge price movement of a particular asset. In forex trading, technical analysis plays a pivotal role owing to the fact that forex traders don’t get the ‘luxury’ of estimating price movements and formulating trading strategies based solely on fundamental information like their equity counterparts do. In today’s age, there are wide varieties of technical indicators available for any trader who wishes to formulate trading strategies based on them. The usefulness of the technical indicators depends on what exactly are you using them for, some indicators help you in getting a good entry or exit, some help you in observing how strong a trend is, others might help you in putting your stop-losses at the right place. Let’s have a look at the best technical indicators that the most successful traders use in their trading strategy.
- Simple Moving Average (SMA) – As the name suggests, a simple moving average gives you the average closing price of an asset over a time period of time. Ex. a 15 day SMA shows you the average of the closing price of the asset for the last 15 days. You would have encountered the SMA in charts in form of a line that follows the prices. When prices fall below the line, the market is said to be weak and vice versa. SMA works as a wonderful trend-following tool. Depending upon your preference or trading strategy you can select the time period, the 20-period SMA is the most widely used one among forex traders.
- Exponential Moving Average (EMA) – An EMA is similar to the SMA as both are price averages but whereas the SMA pays importance to each period in calculating the average, the EMA gives more importance to the last periods in the calculation (exponentially weighing the periods). Some traders find EMA a better alternative to SMA as it reacts faster to the price changes than the conventional SMA. Forex trader mostly use the 12 and 26 period EMAs in their trading strategies though you can choose the period according to your preference.
- CCI – CCI has become a widely followed indicator ever since its inception in 1980. It is a great indicator when estimating if a currency has reached overbought or oversold levels. The CCI uses moving average and the normal deviation from that moving average in its calculation. The CCI move between positive and negative territory, depending on whether the price is rising or falling. More than 75% of the time the CCI reading is within -100 and +100 levels, any reading above these are considered oversold and overbought respectively. Depending upon your trading strategy, you can select the MA for the CCI.
- Relative Strength Index (RSI) – The RSI is another momentum indicator widely used to estimate if an asset is overbought or oversold. The RSI indicator ranges from 0 to 100. When a currency pair reaches 70 it’s considered to be reaching overbought levels and when it reaches 30 it’s considered to be reaching oversold levels. Some forex traders also use trendlines on RSI chart for formulating trading strategies with a good risk to reward ratio.
- Bollinger Bands – Bollinger bands consist of two bands and a moving average in between on which the two bands are formulated. They are widely used by traders in formulating trading strategies owing to their characteristic of demonstrating two things – whether a currency pair is overbought or oversold and the volatility in the market. In highly volatile markets the Bollinger bands widen, while in slow moving markets they contract.
- Average Directional Index (ADX) – The ADX is one of its kind indicator as it shows the strength of a trend regardless of whether the trend is bullish or bearish. The ADX works as a great profit booking tool as it helps traders in gauging when a trend is coming to an end. A reading of below 10 shows that there is no trend in the market while a reading above 40 shows a strong trend in place.
- Moving Average Convergence Divergence (MACD) – The MACD is a widely used tool for trade confirmation. It uses the difference between two EMA and compares it to a SMA to plot values on a histogram that tells traders whether the market is in an uptrend or a downtrend. The MACD can be used in variety of ways in a trading strategy as apart from confirming trends it also helps traders in estimating the right entry and exit in a trade.