Technical indicators use chart data to analyze the movement in the stock prices and generate signals that help guide trading decisions. In Forex, it means studying the historical prices of one currency against another.
For many traders, indicators are an indispensable part of technical analysis. Besides, both are rooted in key trading concepts like volume, momentum, volatility, and trends. In a way, it’s impossible to do technical analysis without indicators. But are indicators that important for Forex traders? If so, why?
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How to Do Technical Analysis of Currency Pairs
Technical analysis boils down to looking at currency pair charts and using the insights from them to predict future movement. For this, traders use qualitative and quantitative techniques. The former includes chart patterns and support and resistance lines. The latter includes momentum, moving averages, and market trends.
Forex markets are particularly well-suited for technical analysis. This is due to the fact that the market has high liquidity, a large number of participants, and a high sensitivity to the news. All this means that trends and patterns tend to develop to their full extent, which offers more opportunities to interpret that data into a buy or sell decision.
As mentioned in the guide to indicators in Forex trading, there are different types of indicators that suit certain trading conditions and styles. So, make sure to define your style before experimenting with indicators.
Functions of Technical Indicators
Broadly speaking, indicators serve three main functions: alerting the trader, confirming upcoming price action, and predicting a change in the trend. All three make a big impact on which positions traders open, hold, or close.
Indicators can alert the trader about key changes in the price – e.g., that the momentum is declining or rising, the asset is breaking the support or resistance level, etc. If you’re away from your computer, it’ll signal you to come back and decide whether it’s the right time for a buy, sell, or some other move.
When the price action has already begun, the lagging indicators will be able to confirm other technical analysis tools. You might be missing out on a great opportunity!
It can also be the case when you’ve anticipated a change and are simply waiting for a signal to reaffirm your analysis. And when markets finally develop strong trends, your indicators will confirm that.
Predicting the direction of future prices is the task for leading indicators. Think of these as the yellow traffic light indicating that there is a price action change coming very soon. A currency pair may be on its way from the red zone to the green zone, and a trader should respond in time.
How Many Indicators You Should Use
There are four main types of indicators: trend following, oscillators, volatility, and support/resistance. Many traders apply one or two indicators of each type. For example:
- To define the trend: Moving Average + On-Balance Volume (OBV)
- To define your area of value: Stochastics + Relative Strength Index (RSI)
- To serve as an entry trigger: Bollinger Bands + Average True Range (ATR)
- To manage your trades: Moving Average Convergence Divergence (MACD) +Pivot Pivots
It’s nice to receive confirmations, but it’s also important to keep your trading setup neat and manageable. A balanced combination of different types of indicators helps traders avoid confusion, redundant information, or incomplete information.
Key Benefits of Using Indicators for Technical Analysis
Here are the opportunities that indicators open up for traders:
- Mathematical precision – Indicators are based on various mathematical models that have been refined by several generations of professionals.
- Variety of choice – There is no need to force yourself to use a certain tool, you can choose whatever you like and customize it.
- Early signals – You can get signals before the price action.
- Plenty of insights – Indicators provide ample information to guide trading decisions (especially when you use multiple ones).
- Emotional control – Indicator-backed market evaluation helps filter out the emotional element, allowing you to operate based on logic.
An important clarification: technical analysis and indicators are not a crystal ball. Any trading tool has its limitation and cannot be correct in each instance.
Takeaway + Tips for Making Technical Analysis More Accurate
Here are a few tips for making more accurate predictions about future changes to the currency market:
- Only use the tools you understand well.
- Don’t fixate on small moves and pay attention to broader market trends.
- Follow the volume.
- Balance risk and reward and don’t expect the odds to always change in your favor.
- Being aware of the limitations of technical analysis.
- Remember about fundamentals, especially for major currencies.
Take the time to do research about every single indicator you plan to introduce into your tradings. And before applying them to real trades, consider practicing with them in a simulated environment.