You know the old, universal idiom ‘’History repeats itself’’? There is no place where that famous saying is truer than the forex market, only in this case historical events are replaced by prices and charts. Even though machines and algorithms are doing most of the work, we tend to forget that the market itself will always fall victim to the flaws of the human psyche. As a result, the market trends have a tendency to repeat themselves, and the best traders exploit these recurrences to their advantage by detecting patterns through forex indicators. How? Here is what you need to know about forex indicators.
Simple Moving Average
One of the most common forex indicators that traders use is the simple moving average. A simple moving average (SMA) is a way to calculate the average price over a predetermined time period. The formula is simple arithmetic – you add the closing price of a particular security for a specific number of time periods, and then divide the sum by the number of time periods to get the result.
The simple moving average is one of the easiest ways to calculate the average price of a security over a time period and to confirm a trend. However, it is not perfect as it takes into account all price fluctuations, some of which might be irrelevant in the grand scheme of things because the market does not operate in a predetermined way – some trends or patterns will emerge as quickly as they disappear.
Therefore, when using the simple moving average, be aware of the fact that this is a lagging indicator and that there is a slight possibility that as you are adapting your strategy to exploit the newfound pattern, it might have been replaced by another one.
Exponential Moving Average
While the exponential moving average (also known as EMA or exponentially weighted moving average) might be similar in some respects to the simple moving average, this particular has one big advantage over its counterpart: it focuses solely on recent price fluctuations and reacts more quickly to sudden price changes.
Unlike the simple moving average, which takes into account all asset price changes in equal measure, the exponential moving average filters out irrelevant data and gives a clearer picture of developing or ongoing trends.
This indicator is especially useful for technical traders who are always looking for Forex S&R lines to exploit, and build a strong foundation for future deals as well by determining in which direction the market trends are headed. In other words, by using this indicator correctly, you can always have a position by either going long on a particular currency pair or shorting it.
The Bollinger Band
Like every other financial sector, the forex market too is prone to periods of sudden, high volatility, and all serious traders need an indicator to make sense out of them. The Bollinger band, invented by financial analyst during the 1980’s, is a volatility channel that, similar to the moving averages or the Keltner channel, filters out irrelevant data and identifies market patterns.
Its purpose is to offer traders a clear, mathematical definition of low and high prices in a market. The Bollinger Band employs a simple, yet effective methodology to identify market patterns: if a certain price exceeds a moving average plus an extra amount, then experts can safely assume that a new trend has appeared on the market. The Bollinger Band functions by two parameters:
- The period (usually in days) that the moving average was set to take into account
- The amount of standard deviations that the moving average is set to filter out
As a result, a Bollinger band is capable of reacting to market volatility and help traders make sense out of the chaos and identify patterns to exploit to their advantage. The band will react in tandem with the market volatility: it grows as the market volatility increases, and it contracts as the market is in the process of stabilization. That is why the Bollinger if used correctly and at the right time, is one of the best forex indicators to include in your trading strategy as it will help you make smart forex investments.
Moving Average Convergence/Divergence Oscillator
This tongue-twister of an indicator (MACD) is arguably one of the best indicators that you could use. By exploiting the entire power of the moving averages, this indicator is perfect for traders whose strategies focus on taking full advantage of sudden, short-lived market patterns. How? Simple: it calculates the divergence value between a rapid exponential moving average and a slower exponential moving average
This indicator displays two distinct lines on the price chart – most commonly, the calculation is done by subtracting a 26-day long exponential moving average from a 12-day EMA, after which a 9-day long exponential moving average of the MACD is interpreted as a signal line. When the MACD goes under the signal line, it usually means that it is high time you sell the asset. This indicator is complex, and it can be used to calculate many variables, and it is up to you how and when you decide to utilize it. As with every indicator, the best way to find out is by practicing and experimenting.
The forex market is a fascinating place filled with opportunities for business savvy traders who know how to quickly identify market patterns and exploit them to their advantage. To make the best out of your efforts, using a few specialized indicators such as the MACD, moving averages or the Bollinger Bands will give you an edge over other traders. But remember, these tools will not magically make you a better trader or help you get rich overnight – experimentation, trial an error and practice are key. Make sure to read through this article, and you will get all the information that you will need.