Forex technical indicators
What is a Forex technical indicator?A Technical Indicator is a series of data points used to predict movements in currencies. Have a look on the most popular technical indicators of the Forex and learn how to build your own and adapted technical indicator.
- Relative Strength Index (RSI)
- Stochastic Oscillator
- Moving Average Convergence Divergence (MACD)
- Number theory
- Chart formations
This index is a popular indicator of the Forex (FX) market. The RSI measures the ratio of up-moves to down-moves and normalises the calculation so that the index is expressed in a range of 0-100. If the RSI is 70 or greater then the instrument is seen as overbought (a situation whereby prices have risen more than market expectations). An RSI of 30 or less is taken as a signal that the instrument may be oversold (a situation whereby prices have fallen more than the market expectations).
This is used to indicate overbought/oversold conditions on a scale 0-100%. The indicator is based on the observation that in a b up trend, closing prices for periods tend to concentrate in the higher part of the period's range. Conversely, as prices fall in a b down trend, closing prices tend to be near to the extreme low of the period range.
Stochastic calculations produce two lines, %K and %D which are used to indicate overbought/oversold areas of a chart. Divergence between the stochastic lines and the price action of the underlying instrument gives a powerful trading signal.
This indicator involves plotting two momentum lines. The MACD line is the difference between two exponential moving averages and the signal or trigger line which is an exponential moving average of the difference. If the MACD and trigger lines cross, then this is taken as a signal that a change in trend is likely.
The Fibinacci number sequence (1,1,2,3,5,8,13,21,34…..) is constructed by adding the first two numbers to arrive at the third. The ratio of any number to the next larger number is 62%, which is a popular Fibonacci retracement number. The inverse of 62%, which is 38%, is also used as a Fibonacci retracement number. (used with the Elliott wave theory, see hereunder)
W.D. Gann was a stock and a commodity trader working in the 50's who reputedly made over $50Mio in the markets. He made his fortune using methods which he developed for trading instruments based on relationships between price movement and time, known as time/price equivalents. There is no easy explanation for Gann's methods, but in essence he used angles in charts to determine support and resistance areas and predict the times of future trend changes. He also used lines in charts to predict support and resistance areas.
Elliott wave theory:
The Elliott wave theory is an approach to market analysis that is based on repetitive wave patterns and the Fibonacci number sequence. An ideal Elliott wave patterns shows a five wave advance followed by a three wave decline.
Gaps are spaces left on the bar chart where no trading has taken place.
- An up gap is formed when the lowest price on a trading day is higher than the highest high of the previous day.
- A down gap is formed when the highest price of the day is lower than the lowest price of the prior day. An up gap is usually a sign of market strength, while a down gap is a sign of market weakness.
- A breakaway gap is a price gap that forms on the completion of an important price pattern. It signals usually the beginning of an important price move.
- A runaway gap is a price gap that usually occurs around the mid-point of an important market trend. For that reason, it is also called a measuring gap.
- A exhaustion gap is a price gap that occurs at the end of an important trend and signals that the trend is ending.
A trend refers to the direction of prices. Rising peaks and troughs constitute an uptrend; falling peaks and troughs constitute a downtrend, that determine the steepness of the current trend. The breaking of a trendline usually signals a trend reversal. A trading range is characterized by horizontal peaks and troughs.
Moving averages are used to smooth price information in order to confirm trends and support and resistance levels. They are also useful in deciding on a trading strategy particularly in futures trading or a market with a b up or down trend.
For simple moving averages, the price is averaged over a number of days. On each successive day, the oldest price drops out of the average and is replaced by the current price- hence the average moves daily. Exponential and weighted moving averages use the same technique but weight the figures-least weight to the oldest price, most to the current.