Common Technical Indicators in Forex Trading
Forex technical indicators are used to analyze the market trends, generate trading signals and also to define the possible resistance and support levels. The following section covers the concept of technical indicators in general. You may also check the detailed guides to the common technical analysis indicators.
Concept and History
Prices keep changing continuously in any trading markets. Even during strong long-term trends the prices do move against the trends before falling again in the ongoing direction. The actual economic facts and data, demand and supply are the main drivers of the changing prices but what moves the market more is the speculations of the same and the market sentiments. None of these are really quantifiable. How can you quantify the ever changing sentiments and determine the price of a stock, or currency pair or any commodity? Forget the price but at times even determining the direction the price movement would take may be difficult. When all this quantifying and at times even qualifying may be difficult then how do we analyze the market and prices? Especially the volatility in the Forex markets may be quite high at times and here various technical indicators can be used to analyzed the market technically.
Technical indicators are used to recognize the price action patterns in order to predict the future possibilities of the price action. Technical indicators work on the historical data and try to check the patterns. As they are not just checking the historic price data but also the present data continuously, a comparison of the current data is made with the historical price data. Whenever there is a significant change in the price action, a signal is generated.
Generating a signal about some significant change in the pattern of the price action is one use of technical indicators. The other use is to see the pattern in a graphical form by eliminating the insignificant market moves which are also called market noises. Now these patterns can also be used to indicate the underlying trend situations and also to know the possible supports and resistance levels.
While the history of the concepts of technical analysis can be traced to the Jewish merchant Joseph de la Vega who was born in Spain. Japan’s rice merchant Homma Munehisa, born in 1724, can be called father of the technical analysis indicators. Homma Munehisa’s technical analysis methods evolved in candlestick chart patterns and a candlestick chart itself is a form of technical indicator, as it clarifies the underlying price action pattern in a much better way by eliminating the market noises.
Technical indicators help us in analyzing the following:
Identification of the Trend
Analyze the price movement to see whether the trend for the currency pair is bullish (uptrend) or bearish (downtrend). Or the currency pair is running sideways (range movement).
Strength of the trend
To confirm if there is a trend (up or down) then whether the trend is strong and hence may continue or it's weak. If the trend is weak and getting weaker then it may indicate that a correction or reversal may take place soon.
Resistance and Support levels
If the currency pair price is falling then at what levels we can expect support and expect a reversal to upward movement. And If the currency pair is having an uptrend then at what levels we can expect resistance and can expect a reversal to downward movement. Resistance and support levels help us in deciding the entry, exit, stop loss and profit taking targets.
Extent of reversal in case of a consolidation
Let's say that a currency pair is having a trend (up or down) and the trend is slowing down. Our analysis says that the trend should continue even after this slow down but a correction in opposite direction may take place before the trend continues again... but correction to what level? Indicators like Fibonacci retracements indicate the possible retracement levels during a reversal or price correction during a trend.
There are so many technical indicators available with various online trading platforms. We prefer to keep it simple and to use a few popular ones. Let's have an overview of some of those.
Why Do Technical Indicators Work?
Technical indicators are not magic and should not be considered as one. Let's see why the technical indicators work. As we had mentioned under the "concept and history" heading, an indicator analyzes the price action and tries to see the underlying patterns by eliminating the market noises. It also checks when there is a sudden break in the pattern and any new pattern forms. These changes generates trading signals. The same patterns also help us in knowing the possible supports and resistances and the trend situation.
(Photo courtesy: B. Biswal)
All the above points help us in analyzing the price action to take trading decisions. To simplify it as an example let's assume that an indicator generates a signal that the ongoing downtrend has slowed down drastically and current price action has broken out of the ongoing downtrend pattern. This would indicate a good probability that at least some more upward gains can be expected and we can consider this indication as a bullish (buy) signal. This is the basic concept behind the technical indicators and that is also the reason that technical indicators work.
However, the indicators do not work only because of the above. The most important reason lies somewhere else. A lot of traders may be using the same indicator and some very large volumes may be bought and sold because of the signals generated. When these large transactions take place those, in turn, move the prices further in that direction. This phenomenon increases the effectiveness of the technical indicator.
While the above statements seem to be very convincing about the effectiveness of the technical analysis indicators but there is a word of caution there. You may be trading on an hourly chart while those big traders making those large transactions may be working on a chart of some other time frame. Hence the signal you are getting would not be same as the signals those other traders may be getting. The time frame of the charts play a key role when you work with any indicator. Please check this topic under the Forex technical analysis section.
Please check the details of the most common and popular technical indicators used in Forex analysis on the following pages: