Indicators are considered essential when trading in the forex market. Several forex traders use these indicators daily, which helps them understand when they can buy or sell in the forex market. These indicators are known as an important part of technical analysis, and every technical or fundamental analyst should be aware of these indicators.
Moving average (MA) is a crucial forex indicator that indicates the average price value over a particular period that has been chosen.
If the price trades are above the moving average, it means buyers are controlling the price, and If the price trades are below the moving average, it means sellers are controlling the price.
Therefore in trading strategy, a trader should focus on buy trades if the price is above the moving average. The moving average is one of the best forex indicators that every trader should know.
When it comes to measuring the price volatility of a particular security, the Bollinger bands indicator is used to determine the entry and exit points for a trade.
Bollinger bands come in three parts, the upper, middle, and lower brands. These bands are often used to determine overbought and oversold conditions.
The best part about this indicator is that it helps characterize the price and volatility over time of a financial instrument.
When the bands tighten during a period of low volatility, it raises the likelihood of a sharp price move in either direction. This may begin a trending move. Watch out for a false move in opposite direction which reverses before the proper trend begins.
When the bands separate by an unusual large amount, volatility increases and any existing trend may be ending.
Prices have a tendency to bounce within the bands’ envelope, touching one band then moving to the other band. You can use these swings to help identify potential profit targets. For example, if a price bounces off the lower band and then crosses above the moving average, the upper band then becomes the profit target.
Price can exceed or hug a band envelope for prolonged periods during strong trends. On divergence with a momentum oscillator, you may want to do additional research to determine if taking additional profits is appropriate for you.
A strong trend continuation can be expected when the price moves out of the bands. However, if prices move immediately back inside the band, then the suggested strength is negated.
Average True Range (ATR) is the average of true ranges over the specified period. ATR measures volatility, taking into account any gaps in the price movement. Typically, the ATR calculation is based on 14 periods, which can be intraday, daily, weekly, or monthly. To measure recent volatility, use a shorter average, such as 2 to 10 periods. For longer-term volatility, use 20 to 50 periods.
An expanding ATR indicates increased volatility in the market, with the range of each bar getting larger. A reversal in price with an increase in ATR would indicate strength behind that move. ATR is not directional so an expanding ATR can indicate selling pressure or buying pressure. High ATR values usually result from a sharp advance or decline and are unlikely to be sustained for extended periods.
A low ATR value indicates a series of periods with small ranges (quiet days). These low ATR values are found during extended sideways price action, thus the lower volatility. A prolonged period of low ATR values may indicate a consolidation area and the possibility of a continuation move or reversal.
ATR is very useful for stops or entry triggers, signaling changes in volatility. Whereas fixed dollar- point or percentage stops will not allow for volatility, the ATR stop will adapt to sharp price moves or consolidation areas, which can trigger an abnormal price movement in either direction. Use a multiple of ATR, such as 1.5 x ATR, to catch these abnormal price moves.
ATR = (Previous ATR * (n – 1) + TR) / n
Where: ATR = Average True Range n = number of periods or bars TR = True Range
The True Range for today is the greatest of the following:
Today’s high minus today’s low
The absolute value of today’s high minus yesterday’s close
The absolute value of today’s low minus yesterday’s close
Support and resistance levels are important points in time where the forces of supply and demand meet. These support and resistance levels are seen by technical analysts as crucial when determining market psychology and supply and demand. When these support or resistance levels are broken, the supply and demand forces that created these levels are assumed to have moved, in which case new levels of support and resistance will likely be established.
Support is the level at which demand is strong enough to stop the stock from falling any further. In the image above you can see that each time the price reaches the support level, it has difficulty penetrating that level. The rationale is that as the price drops and approaches support, buyers (demand) become more inclined to buy and sellers (supply) become less willing to sell.
Resistance is the level at which supply is strong enough to stop the stock from moving higher. In the image above you can see that each time the price reaches the resistance level, it has a hard time moving higher. The rationale is that as the price rises and approaches resistance, sellers (supply) become more inclined to sell and buyers (demand) become less willing to buy.
Let’s use a few examples of market participants to explain the psychology behind support and resistance.
First let’s assume there are buyers who’ve been buying a stock close to a support area. Let’s say that support level is $50. They buy some stock at $50 and now it moves up and away from that level to $55. The buyers are happy and want to buy more stock at $50, but not $55. They decide if the price moves back down to $50, they will buy more. They’re creating demand at the $50 level.
Let’s take another group of investors. These are the people that were uncommitted. They were thinking about buying the stock at $50 but never “pulled the trigger.” Now the stock is at $55 and they regret not buying it. They decide that if it gets to $50 again, they will not make the same mistake and they will buy the stock this time. This creates potential demand.
The third group bought the stock below $50; let’s say they bought it at $40. When the stock got to $50, they sold their stock, only to watch it go to $55. Now they want to re-establish their long positions and want to buy it back at the same price they sold it, $50. They’ve changed their sentiment from sellers to buyers. They regret selling it and want to right that wrong. This creates more demand.
Now let’s change things up to help understand resistance. Take all the above participants and say they all own the stock at $50. Imagine yourself as one of the owners at $50. The stock goes to $55 and you don’t sell. Now the stock goes back to $50, where you own it. What are you feeling? Regret for not selling it at $55? Now it goes back to $55 and you sell as much as you can this time. So do the other owners of the stock. The stock can’t get past $55 and retreats. There are at least 3 groups of stock owners that are trying to sell their supply at $55. This creates a resistance level at $55.
These are just a few examples of many possible scenarios. If you’ve traded before, you’ve probably been through all of these scenarios and experienced the emotions and psychology behind them. You’re not alone. There are countless market participants going through the same emotions and thought processes as you, and this is what helps determine some of the market psychology behind support and resistance, and technical analysis in general.
A key concept of technical analysis is that when a resistance or support level is broken, its role is reversed. If the price falls below a support level, that level will become resistance. If the price rises above a resistance level, it will often become support. As the price moves past a level of support or resistance, it is thought that supply and demand has shifted, causing the breached level to reverse its role.
Example of resistance becoming support
Example of support becoming resistance
This is one of those indicators that tell the force that is driving in the forex market. In addition, this indicator helps identify when the market will stop in a particular direction and will go for a correction. The Moving Average Convergence/Divergence indicator is a momentum oscillator primarily used to trade trends. Although it is an oscillator, it is not typically used to identify over bought or oversold conditions. It appears on the chart as two lines which oscillate without boundaries. The crossover of the two lines give trading signals similar to a two moving average system.
MACD crossing above zero is considered bullish, while crossing below zero is bearish. Secondly, when MACD turns up from below zero it is considered bullish. When it turns down from above zero it is considered bearish.
When the MACD line crosses from below to above the signal line, the indicator is considered bullish. The further below the zero line the stronger the signal.
When the MACD line crosses from above to below the signal line, the indicator is considered bearish. The further above the zero line the stronger the signal.
During trading ranges the MACD will whipsaw, with the fast line crossing back and forth across the signal line. Users of the MACD generally avoid trading in this situation or close positions to reduce volatility within the portfolio.
Divergence between the MACD and the price action is a stronger signal when it confirms the crossover signals.
An approximated MACD can be calculated by subtracting the value of a 26 period Exponential Moving Average (EMA) from a 12 period EMA. The shorter EMA is constantly converging toward, and diverging away from, the longer EMA. This causes MACD to oscillate around the zero level. A signal line is created with a 9 period EMA of the MACD line.
Note: The sample calculation above is the default. You can adjust the parameters based upon your own criteria.
The Fibonacci retracement tool plots percentage retracement lines based upon the mathematical relationship within the Fibonacci sequence. These retracement levels provide support and resistance levels that can be used to target price objectives.
Fibonacci Retracements are displayed by first drawing a trend line between two extreme points. A series of six horizontal lines are drawn intersecting the trend line at the Fibonacci levels of 0.0%, 23.6%, 38.2%, 50%, 61.8%, and 100%.
The percentage retracements identify possible support or resistance areas, 23.6%, 38.2%, 50%, 61.8%, 100%. Applying these percentages to the difference between the high and low price for the period selected creates a set of price objectives.
Depending on the direction of the market, up or down, prices will often retrace a significant portion of the previous trend before resuming the move in the original direction.
These countertrend moves tend to fall into certain parameters, which are often the Fibonacci Retracement levels.
Fibonacci numbers are a sequence of numbers in which each successive number is the sum of the two previous numbers: 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, and so on.
The Relative Strength Index (RSI), is a momentum oscillator that measures the speed and change of price movements. The RSI oscillates between zero and 100. Traditionally the RSI is considered overbought when above 70 and oversold when below 30. Signals can be generated by looking for divergences and failure swings. RSI can also be used to identify the general trend.
RSI is considered overbought when above 70 and oversold when below 30. These traditional levels can also be adjusted if necessary to better fit the security. For example, if a security is repeatedly reaching the overbought level of 70 you may want to adjust this level to 80.
Note: During strong trends, the RSI may remain in overbought or oversold for extended periods.
RSI also often forms chart patterns that may not show on the underlying price chart, such as double tops and bottoms and trend lines. Also, look for support or resistance on the RSI.
In an uptrend or bull market, the RSI tends to remain in the 40 to 90 range with the 40-50 zone acting as support. During a downtrend or bear market the RSI tends to stay between the 10 to 60 range with the 50-60 zone acting as resistance. These ranges will vary depending on the RSI settings and the strength of the security’s or market’s underlying trend.
If underlying prices make a new high or low that isn’t confirmed by the RSI, this divergence can signal a price reversal. If the RSI makes a lower high and then follows with a downside move below a previous low, a Top Swing Failure has occurred. If the RSI makes a higher low and then follows with an upside move above a previous high, a Bottom Swing Failure has occurred.
The RSI is a fairly simple formula, but is difficult to explain without pages of examples. Refer to Wilder’s book for additional calculation information. The basic formula is:
<p> RSI = 100 – [100 / ( 1 + (Average of Upward Price Change / Average of Downward Price Change ) ) ]
Pivots Points are price levels chartists can use to determine intraday support and resistance levels. Pivot Points use the previous days Open, High, and Low to calculate a Pivot Point for the current day. Using this Pivot Point as the base, three resistance and support levels are calculated and displayed above and below the Pivot Point.
Pivot Point support and resistance levels can be used just like traditional support and resistance levels. As with all indicators, it is important to confirm Pivot Point signals with other aspects of technical analysis.
Resistance Level 3 = Previous Day High + 2(Pivot – Previous Day Low)
Resistance Level 2 = Pivot + (Resistance Level 1 – Support Level 1)
Resistance Level 1 = (Pivot x 2) – Previous Day Low
Pivot = Previous Day (High + Low + Close) / 3
Support Level 1 = (Pivot x 2) – Previous Day High
Support Level 2 = Pivot – (Resistance Level 1 – Support Level 1)
Support Level 3 = Previous Day Low – 2(Previous Day High – Pivot)
The Stochastic Oscillator is a momentum indicator that shows the location of the close relative to the high-low range over a set number of periods. The indicator can range from 0 to 100.
The closing price tends to close near the high in an uptrend and near the low in a downtrend. If the closing price then slips away from the high or the low, then momentum is slowing. Stochastics are most effective in broad trading ranges or slow moving trends. Two lines are graphed, the fast oscillating %K and a moving average of %K, commonly referred to as %D.
Generally, the area above 80 indicates an overbought region, while the area below 20 is considered an oversold region. A sell signal is given when the oscillator is above the 80 level and then crosses back below 80. Conversely, a buy signal is given when the oscillator is below 20 and then crosses back above 20. 80 and 20 are the most common levels used but can be adjusted as needed.
A crossover signal occurs when the two lines cross in the overbought or oversold region. A sell signal occurs when a decreasing %K line crosses below the %D line in the overbought region. Conversely, a buy signal occurs when an increasing %K line crosses above the %D line in the oversold region.
Divergences form when a new high or low in price is not confirmed by the Stochastic Oscillator. A bullish divergence forms when price make a lower low, but the Stochastic Oscillator forms a higher low. This indicates less downward momentum that could foreshadow a bullish reversal. A bearish divergence forms when price makes a higher high, but the Stochastic Oscillator forms a lower high. This shows less upward momentum that could foreshadow a bearish reversal.
%K= 100[(C – L14) / H14 – L14)] Where: C = Latest Close L14 = Lowest low for the last 14 periods. H14 = Highest high for the same 14 periods
%D = simple moving average of %K (3 period simple moving average is the most common)
Welles Wilder’s Parabolic Stop and Reverse (SAR) is a trailing stop-based trading system; it is often used as an indicator as well. The SAR uses a trailing stop level that follows prices as they move up or down. The stop level increases speed based on an “Acceleration Factor.” When plotted on the chart, this stop level resembles a parabolic curve, thus the indicator’s name. The parabolic function accepts three parameters. The first two control the acceleration during up and down moves, respectively. The last parameter determines the maximum acceleration.
The Parabolic SAR assumes that you are trading a trend and, therefore, expects price to change over time. If you are long, the Parabolic SAR will move the stop upward every period, regardless of whether the price has moved. Parabolic SAR moves downward if you are short.
The Parabolic SAR trading system uses the parabolic level as a “stop and reverse” point, calculating the stop for each upcoming period. When the stop is hit you close the current trade and initiate a new trade in the opposite direction. This system keeps you invested in the market at all times.
The indicator is usually shown as a series of dots above or below the price bars. The dots are the stop levels. You should be short when the stops are above the bars; you should be long when the stops are below the bars.
The Parabolic SAR may cause whipsaws during sideways or trendless markets.
The Parabolic SAR excels in fast-moving trends that accelerate as they progress. The stops are also calculated to accelerate; hence you need to have the correct “Acceleration Factor” to match the market you are trading. Up and down acceleration parameters may be different.
Current SAR = Prior SAR + Acceleration Factor (Prior Extreme Point – Prior SAR)
The AF used by Wilder is 0.02. This means move the stop 2 percent of distance between EP and the original stop. Each time the EP changes, the AF increases by 0.02 up to the maximum acceleration, 0.2 in Wilders’ case.
If long then EP is the highest high since going long, if short then EP is the lowest low since going short.
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