4.40 Which Technical Indicator to Trade With in Forex?

 
The Best Indicator for Forex trading.
 
 
Yes, yes, yes... we know! We know that on one hand you got a good level of clarity about various technical indicators but on the other hand you got a big bucket full of confusion as to which Indicator is the best to trade Forex. Let's talk about this.
 

It's not about "Which" but "How"

 
First of all it is not the question of "Best". There is nothing in this world which can be termed as Best, leave aside Forex trading. It is all about how to make the best use of any indicators. 
 
To start with, do not try to mess up with all the indicators. Experiment with a chosen few. Put the indicators on your trading charts and see how they had done in the past. Use those on charts of different time frames and use different parameters, especially with moving averages. 
 
If you ask us, we will give more votes to Ichimoku cloud, clearly a very versatile indicator and which tells you more or less everything you wish to know. We also suggest to use moving averages, MACD and at least one oscillator like stochastic or RSI or CCI. As mentioned in the previous lesson, there is no point in working with multiple indicators of the same type. Choose one. We will also recommend to keep your Fibonacci retracement tool handy when you are going along with a trend. price can always go for some consolidation, right? An eye on ADX to know the strength of the trend will also not hurt.
 
As mentioned above, the most important factor is how you use your chosen indicators. The time-frame of chart, the stop-loss level , the profit target and the timing all make big differences. Your indicator has given a buy signal but you have not optimized your stop-loss level and though the signal proved to be correct but a bit of correction in the price hit your stop-loss order. Or the price action reverses before meeting the profit target. Or you take a position around the time of a big economic release and the market moves unexpectedly. There are a number of factors which can go against what the indicator is indicating and hence against your trade.
 
Let's list out the points which need to be kept in mind while using technical analysis:
 

Know the trend - Both long-term and short-term

 
There are trend which may last for years but during those trends there may be reversal trends which may last for days or even months and then there will be reversal of those reversal trends which may last for a few days or for hours.
 
As a short-term or day trader, you may want to trade with the short-term trends but knowing the overall trend situations is very important. Know the long-term trend, the mid-term trend and short-term trend. Know them all as that will tell you where to enter and where to exit. Knowing the long-term trend may increase your profits dramatically if your risk taking appetite is good enough.  Have a look on the following chart with a multi-year trend of USD/CHF and reversals of reversals:
 
 
Multi-year trend of USD/CHF showing trends inside the trends. 
 
 
Have a look on the following daily chart which indicates a strong uptrend which has been in place for months. The area around point "A" shows the price bouncing up from the lower trend line of the ascending channel. That offers a buying opportunity, right? But what happened next?
 
 
USD/CHF April to November 2008 trend reversal - Not keeping the eyes on the overall situation would have ended badly.
 
 
You would have been better prepared for this possible disaster by not going long if you had been following the longer term chart. Here is that:
 
 
Overall trend and signals from the technical indicator.
 
 
The longer-term chart would have clearly told you that the price was approaching a strong resistance zone and the entry at that time might not have been such a good idea.
 

Check Out the Trend-Lines

 
This point has been clearly emphasized in the previous chapter i.e. " Indicators Put Together – The Complementary Approach" and does not need any further explanation. However, for the sake of repetition, always give preference to trend lines over the signal received by technical indicators.
 
Let's check out the charts used in the previous lesson for the visual explanation.
 
 
Not depending on the indicator alone but checking out other tools such as dynamic supports and resistances.
 
Indicator saying "Buy" but trend-lines says "wait"
 
What happened next?
 
Even the best indicator may fail if not used with other tools.
 

Check out Support and Resistance levels

 
This point is similar to the point about the trend lines above. Sometimes there are trend lines indicating dynamic support and resistances and sometimes there could be fixed levels of resistances and supports. Indicator might be giving a buy or sell signal while the price may be near a resistance or support. 
 

Check out Psychological Support and Resistance Price Levels

 
Psychological price levels which you should not ignore at any cost. These levels may come very heavy and overrule many other signals. One example is in the monthly chart of USD/CHF above, which shows that the parity level, rather the zone i.e. 1.0000 ranges kept coming as support and cause moves worth of couple of thousands pips. Then the same level turned to be resistance and the story kept on repeating.
 
Let's check one more example:
 
Signals from the technical indicator versus psychological price levels.
 
This is USD/JPY daily chart when the pair was coming up from 100.00. MACD's sell signal at point "A" confirmed with the psychological resistance of 110.00 but while you might be in the short trade, we would not have liked to keep your eyes on the still bearish MACD. We should have paid attention to approaching psychological level of 105.00 for a possible strong support.
 

Check out the Chart Patterns

 
Chart patterns are again a mirrors for market sentiments. And sentiments run the market better than any indicators. Checking out for any emerging pattern and seeing whether it is confirming the signals by the technical indicator is a good way to go. In case there is a contradiction then it's better to wait and watch. Preference will again be to the chart patterns. 
 

Keep an Eye on Fibonacci Retracement Levels

 
There will always be consolidations even during very strong trends. And these consolidations may be equally strong to suggest that the trend may be reversing. While your ADX may start telling you that the new trend is very strong or while your MACD or any other indicator keeps confirming the new trend, keep an even on Fibonacci retracement levels. Retracements to 50% levels are quite common but it may extend to 61.8% or more. These levels tend to come up as the drivers to put the price-action back to the original track. Keep an eye there.
 

Optimize Your Stop-Loss Levels and Profit Targets

 
You simply can not ignore the importance of your stop-loss and profit targets in your trading. Your indicators tells you buy or sell but they don't tell you where you should put your stop-loss. You may like to take profits when your indicator starts showing the signs of reversal but at that time  you might not be in front of your computer to take action.
 
You need to enter the stop-loss and take-profit orders while entering the trade. If you are not careful enough then you may end up seeing 50% or more of your positions going south just because you decided the wrong levels, while your entry was perfect. Optimizing these levels based the following factors are simply very important:
 
  • Based on volatility at the time of trading and any expected changes
  •  

  • Based on the currency pair
 
Conclusion: It is not about the Best Technical Indicator, it's all about how best you use those.
 

 

    
         

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