Forex trading is one of the most prevailing trading markets in the world and is abuzz with more activity than the stock market in itself. The premise is that to take advantage of any slight changes in exchange rates, that allows a trader to make profits by buying and selling different currencies at a point in price that is beneficial to the trader.
What are forex indicators?
Forex indicators help analyze the market data while trading foreign currency. Forex indicators can make predictions about the future market behavior, price movements, and what patterns are more likely to be repeated again.
To make a well-informed trading decision, a trader needs some historical data like the currency pair price, volume and market performance, exchange rates.
Types of Forex Indicators:
Below, we have categorized forex indicators into 4 sections that most forex traders rely upon for successful returns.
Trend Following Forex Indicators
It’s easy for forex traders to trade in the direction of the underlying trend. A trend-following tool helps the traders in identifying the direction of the trend.
The real purpose of the trade-following forex indicator is to tell a trader whether to enter the market for a long position or a short position.
Trend Confirmation Indicators
As trend-following tools can quickly change the trend direction, that makes the reliability factor of the tool slightly questionable.
The trend-confirmation forex indicators help forex traders decide to hold on to security for a long position if both the forex indicators agree as a bullish trend.
If both the tools agree to be in a bearish trend, then the trader can make a call to sell short.
In essence, the downtrend and uptrend can be confirmed only if the trend-following tool agrees with the trend confirmation tool.
Overbought & oversold indicators rely on the momentum of the price of a foreign currency. It determines whether prices have moved too far away & waiting for a reversal.
Relative strength index or RSI is the most useful forex indicator for identifying overbought and oversold conditions of a foreign currency.
Volume Indicators for Forex
Volume indicator shows the strength or weakness of a trend.
It shows information related to a number of forex trading happening during a timeframe. When rates are moving up but volumes are decreasing, it indicates traders’ interest has gone down. A possible uptrend reversal might be coming up.
List of Top 15 Forex Indicators used by forex traders:
Let us now take a look at the top 15 Forex indicators and learn their application in the Forex market.
1. Elliott Wave
Elliott Wave is one of the most popular technical analysis tools and it has its own niche in Forex trading analysis. Elliot wave strongly indicates that investor psychology is the driving force of price movements in the financial market. The Elliott Wave indicator is used to infer detailed and profitable results in the Forex market.
Many Forex traders adopt the following approach while applying the Elliott wave in Forex trading.
- Choose one method to generate Elliott Wave count
- Identify and trade in Wave 3 which is always the best to trade.
- Confirm the trend
- Decide stop-loss
- Place “stop-loss” order
- Decide target profits
- Have a trade exit plan in event of losses
Elliott wave theory states that the market behavior or the crowd trading behavior flows as waves like in the sea. Elliot identified Three impulse waves denoted as waves 1, 3, and 5, and corrective waves which is 2 and 4 which itself is subdivided into 3 waves denoted as waves a, b and c.
Let us understand the Elliot wave technical indicator better with the help of the image below.
The above image is the Elliott wave pattern for an uptrend, where the impulse waves are in the direction of the trend and the corrective waves are in the direction opposite to the trend. In case of a market reversal, that is in a downtrend chart, the impulse waves move in a declining motion and the corrective waves are in the rising.
Elliot wave technical indicator helps in determining where an Elliott wave ends and a new one begins. This tells the trader about the price trend and future price movements.
2. Moving Averages
The moving average is one of the forex indicators that is the average price of the last number of candles that represent the overall sentiment of the price.
If a given price is above the moving average, then it is a strong indicator that the price is being controlled by the buyers. In case is it below the average, that indicates that the price is being controlled by the sellers.
Hence, as a trader, it is advised to focus on buy trades if the price is moving above average. Moving averages indicators is one of the best forex indicators that a trader should employ for technical analysis.
A Forex trader can devise a simple trading strategy and take advantage of trading opportunities by using only a few moving averages. This Forex indicator is primarily used as a trend indicator. There are two most commonly used moving averages. They are as follows.
- Simple moving average – the average price over a given period of the time period
- Exponential moving average – gives more importance to the recent prices.
Both simple moving average or SMA and exponential moving average or EMA together form the basic Forex trading structure which we will discuss below.
Exponential Moving Average trading strategy
Since this type of average is designed to garner a quick response to the price changes, it uses the EMA.
To strategize a trading plan with a moving average, first, a trader must set up three exponential moving averages – a 5 period, a 20 period, and a 50 period EMA.
For a sell trade, sell when the five-period EMA crosses from above to below the 20-period EMA, and both EMAs and the price are below the 50-period EMA. And for a buy trade, place an initial stop loss order below the 20 periods EMA or about 10 pips from the entry point.
Moving Average Envelops Trading Strategy
These are percentage-based envelopes that are set above and below a moving average. Since the type of MA is set as the basis for the envelope is of no significance, the traders in Forex trading can use either exponential or simple moving average.
To best employ an envelop strategy, a trader should test out different percentages, time intervals, and currency pairs. Ideally, a trader must buy when there is a significant directional bias to the price. Similarly, to exit a market the trading indicators must indicate that the price has moved to the lower band for a short trade and upper band for a long trade.
Moving Average Ribbon Trading Strategy
This is one of the best Forex Indicators employed in the market by traders for technical analysis. This type of technical indicator is used for strategies based on a slow transition of the market trends change.
The conventional buy or sell signals for the moving average ribbon are the same as the crossover signals used with other MA strategies. Since there are numerous crossovers involved, a trader must choose the number of crossovers that constitute as good trading indicators.
To use this technical indicator to its maximum potential, the following few tips can be applied while making a trade.
- look for the technical indicators to form one thick line rather than individual lines indicating that the price had flattened out to the sideways range.
- Identify a narrow trading range and attach it with a buy order above the high of the range and a sell order below the low of the range.
3. Relative Strength Index(RSI)
Relative Strength Index or RSI is another best Forex indicator for technical analysis out there that ranges from 0 to 100. These technical indicators indicate when the price action in the market is likely to reverse.
In the above image, as you can see, there is an uptrend above 70 levels. This is an indicator of the bearish market reversal. Similarly, if there is a downward trend below 30, that indicates an impending bullish reversal. In simple terms, RSI of above 70 is considered an overbought market and below 30 is considered an oversold market.
But, it is also common for the RSI to give false signals and in a few cases of market volatility, RSI can remain above 70 or below 30 for longer periods without a reversal. RSI is a great indicator to identify the market’s oversold or overbought condition.
4. Moving Average Convergence Divergence (MACD)
Moving Average Convergence Divergence (MACD) or a MACD indicator is also one of the popular technical analysis tools that many traders use for currency trading. MACD is one such trading indicator that consists in itself a histogram and an EMA.
MACDs are trend-following momentum indicators and show the relationship between two MAs of a security’s price. Apart from being excellent Forex indicators, MACD is used by the technical trader for trading stocks, bonds, and commodities as well.
In MACD, the regular divergence is an indicator of the market reversal whereas the hidden divergence is an indicator of market continuation. The main purpose of these Forex indicators is to calculate divergence with the price.
The above image is an example of regular MACD divergence. A regular MACD divergence is clearly visible and the trend takes a sharp turn upward or downward, in this case, upward. Hidden divergence is not followed by a significant change in trend and this is an indicator of continuation as you can find in the image below.
5. Bollinger Bands
Bollinger bands, created by John Bollinger are one of the best Forex indicators used by traders for trading Forex. Bollinger bands are apparently very easy to use and reliable forex indicators. There are two standard deviations in this type of technical indicators, and they are the upside deviation, the downside deviation, and a conventional moving average in the middle.
The upper and lower lines in these technical indicators work as the dynamic support and resistance levels. Any rejections from level support and resistance levels in an indicator of a possible entry to the market and breakouts from these levels can also provide the trader with profits while trading forex.
The Bands show that the prices in relation to the average are subject to rapid changes, and traders can expect price movements to be anywhere in between the two bands. Forex traders can use the bands to place sell orders at the upper band limit and buy orders at the lower band limit.
Many traders use the Bollinger Bands technical analysis to get relatively clear buying and selling signals on steady ranges of security such as currency pairs. Sometimes it is possible to have reactions that are not as intense, and that can make the traders can miss profits if the orders are set directly on the upper and lower Bands.
To avoid this, it is wise to determine entry and exit points near these lines and evade a disappointment
Stochastic was developed in the 1950s, and as a price momentum indicator, it is one of the best forex indicators. The primary purpose of the Stochastic indicator is to identify the overbought and oversold conditions in the market.
The stochastic oscillator works when during an uptrend if the prices remain the same as or above the previous closing price or if the prices remain the same as or below the last closing price during a downtrend.
The stochastic oscillator uses a scale to measure the change between the prices from a closing period and uses it to predict the continuation of the current direction trend.
Like Bollinger Bands, the stochastic oscillator also moves from 0-100 levels.
When the lines measure above 80, which are indicated in the above chart are red dotted lines, are then it means the market is overbought. When the lines are below 20, as depicted in the chart as blue dotted lines, then it means that the market is possibly oversold.
The general rule of thumb is that we buy when the market is oversold, and we sell when the market is overbought.
7. Ichimoku Kinko Hyo
Ichimoku Kinko Hyo, which is also popularly known as Ichimoku cloud, is undoubtedly one of the best forex indicators as it has all the elements that are required to construct a complete trading strategy.
Kumo cloud is one such element in the Ichimoku cloud that helps in identifying the market trend. If the price action is below the Kumo cloud, that is an indicator of a bearish trend, and if the price action is above the Kumo cloud, then the trend must be bullish.
The below chart will depict the Kumo cloud, Tenkan Sen and Kijun Sen.
The Tenkan Sen and Kijun Sen move with the price and any rejection from these two denotes an entry into the market.
To make the best out of the Ichimoku cloud, the following tips can be of use.
- Referring to Kijun or Tenkan crossovers for isolating moves in the price action.
- Confirming the downtrend or the uptrend with chikou will increase the probability of a trade.
- Price action should break through the cloud as this will increase the probability of a trade working in a trader’s favor.
- Follow money management when placing entries to reduce risks and heighten rewards.
Fibonacci analysis can greatly improve the forex performance for both short as well as long-term positions in the market, as it helps in identifying the key price levels that show hidden support and resistance. Fibonacci, when used in conjunction with other forms of technical analysis always builds very a powerful foundation for trading strategies that will perform well through all types of market conditions at various volatility levels.
Fibonacci is a great trading tool as it shows the most accurate market direction since it is related to every little thing in the universe.
Let us now understand the two subdivisions of Fibonacci, which are Fibonacci Extension and Fibonacci Retracement.
8.1 Fibonacci Extensions
The general idea in Fibonacci extensions is to take profits on a long trade at a Fibonacci Price Extension Level.
You can determine the Fibonacci extension levels with the use of just three mouse clicks.
Click 1: on a significant low swing, then drag your cursor
Click 2: on a very recent high swing.
Click 3: Drag the cursor back and click on any retracement levels.
With these three clicks, the Price Extension Levels will be displayed showing both the ratio and corresponding price levels.
As described in the above image, the Fibonacci extension can help the trader to see the point which would have been a good place to take off some profits.
8.2 Fibonacci Retracement
In trading, ideally, the traders wait for prices to approach the Fibonacci retracement levels and act in accordance with their strategy. Usually, the traders also look for a reversal signal on these widely watched Fibonacci retracement levels before opening their positions in the Forex market.
Drawing a Fibonacci retracement level can be a simple three-step process as we will see below.
- identify the market trend
- Attach the Fibonacci retracement tool on the bottom (for an uptrend) or top (for a downtrend) and drag it to the right (for an uptrend) or left (for a downtrend) all the way to the top (for an uptrend) or bottom (for a downtrend).
The above image is a representation of an uptrend Fibonacci uptrend.
A Fibonacci retracement is more reliable if a trader can also find a confluence of signals, which means looking for more reasons to take action on security. It is wrong to assume that the market will reverse based only on the price reaching a Fibonacci level.
Combining Fibonacci levels with candlestick patterns, oscillators, and other indicators can give out much stronger signals.
9. Average True Range
Measuring the volatility of the market is very important while trading in forex market as it is directly related to the market movement. Average True Range is a technical indicator that indicates the volatility of currency pairs.
The increase and decrease of volatility in financial markets indicate the market reversal and continuity respectively.
Forex traders can use the prints of the Average True Range line to consider their entry and exit points basing it on the price volatility. When the price volatility is high, Forex currency pairs are more likely to be dynamic and move faster. In contrast, when the price volatility is low, it indicates a quiet market or consolidation period.
The above image is an indicator where the low volatility Average True Range is indicated by a low ATR.
Therefore, if you find the volatility to be low, you can extend your profit take and on the other hand, in the lower volatility, you can also find reversal trade setups.
Even though the ATR indicator is not quite as widely used by all retail traders as compared to other momentum-based indicators, it still serves an important purpose for traders who are conscious about the market volatility, and those who gauge the current volatility level and try to anticipate potential price breakouts.
10. Parabolic SAR
The parabolic SAR or Parabolic Stop and Reverse is a very popular indicator used primarily by traders to identify the future short-term momentum of a particular asset. Parabolic SAR was developed by a famous technician, J. Welles Wilder, Jr.
This indicator is applied to a trading strategy to make the decision of placing stop orders easier for the traders.
Parabolic SAR can indicate the market trend of a pair of currencies.
The parabolic SAR is graphically indicated on a chart as a series of dots that are placed either above or below the price depending on the momentum of an. A small dot is placed below the price when the trend is upward, and a dot is placed above the price when for a downward trend, as you can see in the chart below.
If the current market price is above the Parabolic Stop and Reverse, then the overall trend is deemed to be bullish, as you can see in the chart above. On the contrary, if the price is below the Parabolic Stop and Reverse, then the overall trend is identified as bearish.
A market rejection from the Parabolic Stop and Reverse indicator is a potential entry point for the traders.
11. Pivot Point
A pivot point was ideally developed to determine the potential turning points in the commodities market by the floor traders. It is also now used in the Forex market and other markets for the determination of support and resistance levels and thus identifying the possible turning points in them from bullish or bearish or bearish to bullish.
Traditionally, Pivot Points are calculated by taking into account the previous day’s highs lows, and closing prices, and in the Forex market, pivot points are calculated with the help of the entire 24 hours of the trading period.
The pivot point indicates the equilibrium level of supply and demand of a currency pair. If the price reaches the pivot point level, it is an indicator that the supply and demand of the particular pair of currencies are the same.
If the price is above the pivot point level, then the demand for a currency pair is high and if it is below the pivot point, the supply would be high.
As seen on the image above, the rejection from the pivot point poses as the possible trading entry point into the Forex market.
Even though pivot points can be quite accurate in their prediction of turning points, the traders will still need a viable system if they intend to win consistently in the market.
The most successful trading methods use pivot points with other technical indicators, such as trend lines, Fibonacci levels, moving averages, previous highs and lows, and previous closing prices.
12. Donchian Channels
Donchian Channels are three lines that are generated by MA calculations that comprise form an indicator created by upper and lower bands around a median band. The upper band indicates the highest price of a security or a currency pair over a set period of time. The lower band of the indicator marks the lowest price of the same security over the same period of time.
The area between these upper and lower bands is the Donchian Channel.
As you can see in the above image, the red lines that run through the middle of the chart represent the Donchian Channel area that is the median of the upper and lower bands.
The indicator is intended to determine the bullish extreme and bearish extreme that tends to favor reversals as well as higher and lower breakouts, breakdowns in the market, and emerging trends in the market.
Donchian Channels can identify the comparative relationships between the current price and the trading ranges over a predetermined period set by the trader.
Although the Donchian channel and Bollinger bands may seem similar on many occasions, the difference is that the Donchian channel plots the highest high and lowest low for a given period, whereas the Bollinger bands result in a more balanced calculation that reduces the impact of big high or low prints.
The only limitation to a Donchian channel is that since the market keeps moving over a great many cycles of activity, the given period value of a Donchian channel may not be the most appropriate reflection of the current market conditions. This can probably generate false signals that as a result may undermine the trading and investment performance.
Although the Trendlines are one of the most simplest and common forms of technical analysis in Forex trading, it is the most underutilized indicators in practice. A trendline connects the significant low in an uptrend and the noticeable highs in a downtrend. It shows the prevailing direction of the price.
Thus, trendlines, being the best fit for some data, gives the trader comprehensive knowledge on the movement of price in the market. Trendlines work as excellent Forex indicators. If you can treat it with a little patience, you can take advantage of these indicators.
Here is a pro tip: buy during bullish trendlines and sell during bearish trendlines.
Below you can see charts of buying at bullish and selling at the bearish trendline.
14. Currency Correlations
Correlation is a statistical measure of two variables and how they relate to one another. In the Forex market, the currencies are compared, priced, and analyzed in pairs of two, which makes their correlation a significant phenomenon.
The currency pairs are considered to be closely aligned with respect to the strength of their correlation. Understanding the correlation between currencies is important for a trader as it will help in improving the trader’s portfolio exposure.
The correlation in currencies is of two types as described below.
- Positive Correlation – indicating that the currency pair will move in the same direction
- Negative Correlation – indicating that the currency pair will move in the opposite direction
Given below is a chart that shows currency pairs reflecting positive and negative correlations:
Since trading currencies that move in the opposite direction can lead to zero pairs, it is not a recommended option. This indicator is used by the traders to manage the risks that come with buying positions of the same currency pairs.
The forex market is a volatile one and is affected by multiple factors on a daily basis. By understanding the correlation between currencies, these risks can be reduced, and that gives the traders a better shot at making profits.
Currency correlation is one of the most used Forex trend indicators.
ADX or average strength index helps the traders in determining when the price is trending strongly. It is the golden rule in trading that trading in the direction of trend reduces risks and increases the chance of making a profit. To measure the strength of an ongoing trend, ADX is considered to be the ultimate indicator.
ADX calculations are made based on the MA of price range over a given period of time. It is plotted as a single line with a range of 0-100. It is non-directional and states the trend strength depending on if it is going up or down, as you can see in the chart below.
As shown in the image above, the ADX is derived from the two directional movement indicator or DMI lines which are usually plotted in a separate window. The above chart is an example of the uptrend reversing into a downward trend.
The best of the profits are made from trading the strongest trend as well as avoiding certain range conditions. ADX not only helps in determining the trending conditions, but it also helps the trader to find the strongest trends to trade-in.
Although the Forex indicators are very important and useful technical analysis tools that most traders should be familiar with, their effectiveness relies on how it is utilized by the trader. To increase the chances of a profitable trading experience, the traders are often advised to use multiple technical indicators with variable parameters.
What is the 90% rule in forex?
The 90/10 Rule signifies the importance of trade management techniques. 90% rule states that the trader’s major action is to manage the trade and keep it from hitting stop loss.
What is Grid strategy forex?
It is one of the automated methods of trading, where several buy and sell stop orders are placed with predetermined intervals above or below the current market price
What is a sniper entry in forex?
The Sniper trading strategy breaks some of the Price Action principles in some way. It is designed for short intervals within a day with a short range of profit per trade.
How is Forex drawdown calculated?
This is normally calculated by getting the difference between a relative peak in capital minus a relative trough.