I bet you’ve heard about forex technical indicators.
Actually, wherever you look, it’s likely someone’s trying to sell you some indicator.
They sell these as the cure all: “If you’re not using technical indicators you won’t make money…”
Such statements are so prevalent, some traders think of technical indicators when they hear indicator in in the context of the forex market.
Which helps explain why so many people swear by technical and never learn fundamental analysis:
Forex indicators are only numbers or signals the trading platform spits at them from time to time (neglecting the whole aspect of economic indicators).
But well… I’ve digressed.
Let’s begin, as usual, with the basics.
A forex technical indicator is something telling you which way price will likely move.
The huge caveat here is:
Technical indicators are based on past price action.
In other words, these indicators are calculated based on metrics currency markets have hit thus far.
Have you ever read the following?
“Past performance is not indicative of future results”
You should treat technical indicators (and other indicators) with a grain of salt.
One of the simplest indicators are moving averages.
You average the prices of as many previous days as you like, let’s say 60.
Voila! You now have a line you can add to your chart, displaying the current average of the past 60 days.
(Yes, this works for any timeframe you’re trading on, just switch days for 4 hours, hour, or whatever you’re using).
You can get creative and build another moving average, this time for 20 days.
If the markets are on a trend, these two will go together, but if there’s a reversal, it’s likely the 20 day (short term moving average) will cross the long term moving average (60 day, in this case).
Some traders using this kind of double-average
indicators will take the crossing as a signal and trade based on this.
In this example, if the markets were in an uptrend and then suddenly reversed, this would be an opportunity to buy low, or an opportunity to start selling (depending on your views).
Of course, there’s a bazillion different kinds of technical indicators, and systems which mix several different ones (in an effort to increase the probability of a successful trade).
But we can mostly separate these into two major
types: leading and lagging forex technical indicators.
Leading indicators (also called oscillators) are forex technical indicators which send trading signals at the start of a potential trend.
Why do I say a potential trend?
Because the major weakness of this type of indicator is how frequently you get false signals.
A false signal is just a buy or sell signal which loses you money (if you enter a trade based on it).
As usual, let’s clarify with an example.
Take the Stochastic.
This is an oscillator between 0 and 100. If the
market reaches a Stochastic below 20, it is said to be “oversold”. If it goes
above 80, the market is “overbought”.
What does this mean?
When the market’s oversold, it means sellers are losing steam. They have pushed currency pair price too low, so the pair is bound to rebound now.
The converse is true for the “overbought” condition: buyers are losing steam, price is too high, it’s bound to go down next.
So all of this looks awesome at first glance.
And in many occasions it does work, however….
There are many other cases in which the “oversold” market continues to drop…. And drop… and drop….
If you bought at the beginning thinking prices would recover… well, you get the idea.
The same happens if you sell when the Stochastic yells “overbought”. Prices may continue to rise, leaving your account in the dust (if you’re not smart with your money management).
Hence, why the Stochastic and other leading indicators (like the Relative Strength Index, RSI, for example) are tricky.
Yes they are “leading” in the sense they allow
you to jump in when a trend begins to form, but it may be a false alarm
On the other side of the coin we have lagging indicators.
As the name shows, these tell you to buy or sell after a trend has begun.
You won’t receive as many false signals as you do with leading indicators, but since you have to wait for confirmation of the move, it may be too late for you enter.
Imagine there’s a short upward movement in price.
If you wait for a lagging indicator, you may try to buy when price is almost at the top (or worse, almost about to go down again).
On the other hand, the trend may be long and fruitful, in which case you will make a ton of pips (yay!).
Of course, you won’t be in it from the beginning, thus leaving some money on the table (gusp…).
Some examples of lagging indicators are the MACD, any moving average, or Bollinger bands, among many others.
Now I don’t want to leave you with a sour taste.
But it’s imperative you know the flaws in each type of forex technical indicator before you trade your money.
These are tools you can use to your benefit, and you must be aware of their limitations.
Before cutting this piece out, let’s mention a few extra tools.
Fibonacci’s and pivot points.
These two work as a pseudo-form of support and resistance zones (if you don’t know what I’m talking about check Forex Technical Analysis).
With these, you get a better idea of the zones from which price is likely to rebound from since many other traders are paying attention to them, and will act based on it.
You can use the proximity of price to these zones as a forex technical indicator. Hence, whenever price gets close to one of these zones, you have a forex signal (buy or sell).
That’s enough for some basic, cursory look of forex technical indicators.
I’ll go more in-depth later.
See you soon,
The Forex Economist
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