Four Highly Effective Trading Indicators Every Trader Should Know

Traders tend to overcomplicate things when they’re starting out in this exciting market. This fact is unfortunate but undeniably true. Traders often feel that a complex trading strategy with many moving parts must be better when they should focus on keeping things as simple as possible.

The Benefits of a Simple Strategy

As a trader progresses through the years, they often come to the revelation that the system with the highest level of simplicity is often best. Trading with a simple strategy allows for quick reactions and less stress. If you’re just getting started, you should seek the most effective and simple strategies for identifying trades and stick with that approach. Also, new traders would be served well by finding the common traits of FXCM’s successful Traders here.

One way to simplify your trading is through a trading plan that includes chart indicators and a few rules as to how you should use those indicators. In keeping with the idea that simple is best, there are four easy indicators you should become familiar with using one or two at a time to identify trading entry and exit points. Once you are trading a live account a simple plan with simple rules will be your best ally.

The Tools at Your Service for Different Market Environments

Because there are many fundamental factors when determining the value of a currency relative to another currency, many traders opt to look at the charts as a simplified way to identify trading opportunities. When looking at the charts, you’ll notice two common market environments. The two environments are either ranging markets with a strong level of support and resistance, or floor and ceiling that price isn’t breaking through or a trending market where price is steadily moving higher or lower.

Using Technical Analysis allows you as a trader to identify range bound or trending environments and then find higher probability entries or exits based on their readings. Reading the indicators is as simple as putting them on the chart. Knowing how to use any one or more of the four indicators like the Moving Average, Relative Strength Index (RSI), Slow Stochastic, and Moving Average Convergence & Divergence (MACD) will provide a simple method to identify trading opportunities.

Trading With Moving Averages

Moving averages make it easier for traders to locate trading opportunities in the direction of the overall trend. When the market is trending up, you can use the moving average or multiple moving averages to identify the trend and the right time to buy or sell. The moving average is a plotted line that simply measures the average price of a currency pair over a specific period of time, like the last 200 days or year of price action to understand the overall direction.

You’ll notice a trade idea was generated above only with adding a few moving averages to the chart. Identifying trade opportunities with moving averages allows you see and trade off of momentum by entering when the currency pair moves in the direction of the moving average, and exiting when it begins to move opposite.

Trading With RSI

The Relative Strength Index or RSI is an oscillator that is simple and helpful in its application. Oscillators like the RSI help you determine when a currency is overbought or oversold, so a reversal is likely. For those who like to ‘buy low and sell high’, the RSI may be the right indicator for you.

The RSI can be used equally well in trending or ranging markets to locate better entry and exit prices. When markets have no clear direction and are ranging, you can take either buy or sell signals like you see above. When markets are trending, you only want to enter in the direction of the trend when the indicator is recovering from extremes (highlighted above).

Because the RSI is an oscillator, it is plotted with values between 0 and 100. The value of 100 is considered overbought and a reversal to the downside is likely whereas the value of 0 is considered oversold and a reversal to the upside is commonplace. If an uptrend has been discovered, you would want to identify the RSI reversing from readings below 30 or oversold before entering back in the direction of the trend.

Trading With Stochastics

Slow Stochastics are an oscillator like the RSI that can help you locate overbought or oversold environments, likely making a reversal in price. The unique aspect of the stochastic indicator is the two lines, %K and %D line to signal our entry. Because the oscillator has the same overbought or oversold readings, you simply look for the %K line to cross above the %D line through the 20 level to identify a solid buy signal in the direction of the trend.

Trading With the Moving Average Convergence & Divergence (MACD)

Sometimes known as the king of oscillators, the MACD can be used well in trending or ranging markets due to its use of moving averages provide a visual display of changes in momentum. After you’ve identified the market environment as either ranging or trading, there are two things you want to look for to derive signals from this indictor. First, you want to recognize the lines in relation to the zero line which identify an upward or downward bias of the currency pair. Second, you want to identify a crossover or cross under of the MACD line (Red) to the Signal line (Blue) for a buy or sell trade, respectively.

Like all indicators, the MACD is best coupled with an identified trend or range-bound market. Once you’ve identified the trend, it is best to take crossovers of the MACD line in the direction of the trend. When you’ve entered the trade, you can set stops below the recent price extreme before the crossover, and set a trade limit at twice the amount you’re risking.

Priceless and Free Reinforcement Training

Now that you have the knowledge of the four effective indicators, you are many steps closer to closing profitable trades. Of course, there is only opportunity and no guarantee. To help you spot daily opportunities, DailyFX has created a 4-week no-cost course via their twitter feed, @DailyFXEDU. In a few minutes a day you can follow @DailyFXEDU to see daily opportunities that align with the indicators presented today.

Of course, it’s FREE to follow and designed to be very easy to understand. If you’re building up your knowledge of trading Forex, we want to be there to assist you and your strategy development. Because the only limit to your success is your knowledge, we hope to see you there

https://www.dailyfx.com/forex/education/trading_tips/post_of_the_day/2013/02/08/Four_Highly_Effective_Trading_Indicators_Every_Trader_Should_Know.html

4 Types Of Indicators FX Traders Must Know

Many forex traders spend their time looking for that perfect moment to enter the markets or a telltale sign that screams "buy" or "sell". And while the search can be fascinating, the result is always the same. The truth is, there is no one way to trade the forex markets. As a result, successful traders must learn that there are a variety of indicators that can help to determine the best time to buy or sell a forex cross rate.

Here are four different market indicators that most successful forex traders rely upon.

Indicator No.1: A Trend-Following Tool

It is possible to make money using a countertrend approach to trading. However, for most traders the easier approach is to recognize the direction of the major trend and attempt to profit by trading in the trend's direction. This is where trend-following tools come into play. Many people misunderstand the purpose of trend-following tools and try to use them as separate trading systems. While this is possible, the real purpose of a trend-following tool is to suggest whether you should be looking to enter a long position or a short position. So let's consider one of the simplest trend-following methods – the moving average crossover.

A simple moving average represents the average closing price over the number of days in question. To elaborate, let's look at two simple examples – one longer term, one shorter term. (For related information on moving averages, see Exploring The Exponentially Weighted Moving Average.)

Figure 1 displays the 50-day/200-day moving average crossover for the euro/yen cross. The theory here is that the trend is favorable when the 50-day moving average is above the 200-day average and unfavorable when the 50-day is below the 200-day. As the chart shows, this combination does a good job of identifying the major trend of the market - at least most of the time. However, no matter what moving average combination you choose to use, there will be whipsaws.

Figure 1: The euro/yen with 50-day and 200-day moving averages

Source: ProfitSource

Figure 2 shows a different combination – the 10-day/30-day crossover. The advantage of this combination is that it will react more quickly to changes in price trends than the previous pair. The disadvantage is that it will also be more susceptible to whipsaws than the longer term 50-day/200-day crossover.

Figure 2: The euro/yen with 10-day and 30-day moving averages

Source: ProfitSource

Many investors will proclaim a particular combination to be the best, but the reality is, there is no "best" moving average combination. In the end, forex traders will benefit most by deciding what combination (or combinations) fits best with their time frames. From there, the trend - as shown by these indicators - should be used to tell traders if they should trade long or trade short; it should not be relied on to time entries and exits. (For additional information, check out Forex: Should You Be Trading Trend Or Range?)

Indicator No.2: A Trend-Confirmation Tool

Now we have a trend-following tool to tell us whether the major trend of a given currency pair is up or down. But how reliable is that indicator? As mentioned earlier, trend-following tools are prone to being whipsawed. So it would be nice to have a way to gauge whether the current trend-following indicator is correct or not. For this, we will employ a trend-confirmation tool. Much like a trend-following tool, a trend-confirmation tool may or may not be intended to generate specific buy and sell signals. Instead, we are looking to see if the trend-following tool and the trend-confirmation tool agree.

In essence, if both the trend-following tool and the trend-confirmation tool are bullish, then a trader can more confidently consider taking a long trade in the currency pair in question. Likewise, if both are bearish, then the trader can focus on finding an opportunity to sell short the pair in question.

One of the most popular – and useful – trend confirmation tools is known as the moving average convergence divergence (MACD). This indicator first measures the difference between two exponentially smoothed moving averages. This difference is then smoothed and compared to a moving average of its own. When the current smoothed average is above its own moving average, then the histogram at the bottom of Figure 3 is positive and an uptrend is confirmed. On the flip side, when the current smoothed average is below its moving average, then the histogram at the bottom of Figure 3 is negative and a downtrend is confirmed. (Learn more about the MACD in A Primer On The MACD.)

Figure 3: Euro/yen cross with 50-day and 200-day moving averages and MACD indicator

Source: ProfitSource

In essence, when the trend-following moving average combination is bearish (short-term average below long-term average) and the MACD histogram is negative, then we have a confirmed downtrend. When both are positive, then we have a confirmed uptrend.

At the bottom of Figure 4 we see another trend-confirmation tool that might be considered in addition to (or in place of) MACD. It is the rate of change indicator (ROC). As displayed in Figure 4, the red line measures today's closing price divided by the closing price 28 trading days ago. Readings above 1.00 indicate that the price is higher today than it was 28 days ago and vice versa. The blue line represents a 28-day moving average of the daily ROC readings. Here, if the red line is above the blue line, then the ROC is confirming an uptrend. If the red line is below the blue line, then we have a confirmed downtrend. (For more on the ROC indicator, refer to Measure Momentum Change With ROC.)

Note in Figure 4 that the sharp price declines experienced by the euro/yen cross from mid-January to mid-February, late April through May and during the second half of August were each accompanied by:

• The 50-day moving average below the 200-day moving average
• A negative MACD histogram

A bearish configuration for the ROC indicator (red line below blue)

Figure 4: Euro/yen cross with MACD and rate-of-change trend confirmation indicators

Source: ProfitSource.com

Indicator No.3: An Overbought/Oversold Tool

While traders are typically well advised to trade in the direction of the major trend, one must still decide whether he or she is more comfortable jumping in as soon as a clear trend is established or after a pullback occurs. In other words, if the trend is determined to be bullish, the choice becomes whether to buy into strength or buy into weakness. If you decide to get in as quickly as possible, you can consider entering a trade as soon as an uptrend or downtrend is confirmed. On the other hand, you could wait for a pullback within the larger overall primary trend in the hope that this offers a lower risk opportunity. For this, a trader will rely on an overbought/oversold indicator.

There are many indicators that can fit this bill. However, one that is useful from a trading standpoint is the three-day relative strength index, or three-day RSI for short. This indicator calculates the cumulative sum of up days and down days over the window period and calculates a value that can range from zero to 100. If all of the price action is to the upside, the indicator will approach 100; if all of the price action is to the downside, then the indicator will approach zero. A reading of 50 is considered neutral. (More on the RSI can be found in Relative Strength Index Helps Make The Right Decisions.)

Figure 5 displays the three-day RSI for the euro/yen cross. Generally speaking, a trader looking to enter on pullbacks would consider going long if the 50-day moving average is above the 200-day and the three-day RSI drops below a certain trigger level, such as 20, which would indicate an oversold position. Conversely, the trader might consider entering a short position if the 50-day is below the 200-day and the three-day RSI rises above a certain level, such as 80, which would indicate an overbought position. Different traders may prefer using different trigger levels.

Figure 5: Euro/yen cross with three-day RSI overbought/oversold indicator

Source: ProfitSource

Indicator No.4: A Profit-Taking Tool

The last type of indicator that a forex trader needs is something to help determine when to take a profit on a winning trade. Here too, there are many choices available. In fact, the three-day RSI can also fit into this category. In other words, a trader holding a long position might consider taking some profits if the three-day RSI rises to a high level of 80 or more. Conversely, a trader holding a short position might consider taking some profit if the three-day RSI declines to a low level, such as 20 or less.

Another useful profit-taking tool is a popular indicator known as Bollinger Bands®. This tool adds and subtracts the standard deviation of price data changes over a period from the average closing price over that same time frame to create trading "bands". While many traders attempt to use Bollinger Bands® to time the entry of trades, they may be even more useful as a profit-taking tool.

Figure 6 displays the euro/yen cross with 20-day Bollinger Bands® overlaying the daily price data. A trader holding a long position might consider taking some profits if the price reaches the upper band, and a trader holding a short position might consider taking some profits if the price reaches the lower band. (Refer to The Basics Of Bollinger Bands® for more information on this tool.)

Figure 6: Euro/Yen cross with Bollinger Bands®

Source: ProfitSource

A final profit-taking tool would be a "trailing stop." Trailing stops are typically used as a method to give a trade the potential to let profits run, while also attempting to avoid losing any accumulated profit. There are many ways to arrive at a trailing stop. Figure 7 illustrates just one of these ways.

The trade shown in Figure 7 assumes that a short trade was entered in the forex market for the euro/yen on January 1, 2010. Each day the average true range over the past three trading days is multiplied by five and used to calculate a trailing stop price that can only move sideways or lower (for a short trade, or sideways or higher for a long trade).

Figure 7: Euro/yen cross with a trailing stop

The Bottom Line

If you are hesitant to get into the forex market and are waiting for an obvious entry point, you may find yourself sitting on the sidelines for a long while. By learning a variety of forex indicators, you can determine suitable strategies for choosing profitable times to back a given currency pair. Also, continued monitoring of these indicators will give strong signals that can point you toward a buy or sell signal. As with any investment, strong analysis will minimize potential risks.

Read more: 4 Types Of Indicators FX Traders Must Know | Investopedia http://www.investopedia.com/articles/forex/10/indicators-fx-traders-must-know.asp#ixzz4FHYvIDbW