Do Forex Indicators Really Work
10 Technical Indicators A Trader Should Know About (2021)
Technical indicators: Are you confusing the colored lines on your trader friend's stock market charts? What additional value can these wild lines give to your chart analysis?
We want to find out in this article.
In technical analysis, these colored lines are technical indicators that are used to predict the market. There are a multitude of trading indicators, and creative traders come up with a myriad of new ones every day.
However, it is not at all necessary to master all of these indicators. However, there are ten technical indicators that you should be familiar with.
I will briefly explain the basic calculations of these trading indicators. We need to understand what factors are in each indicator without being inundated with a jumble of intimidating formulas.
(The exact calculations of many indicators can be found in the ChartSchool.)
I will also explain the basic application possibilities for each indicator and illustrate them with an example chart and other additions.Earn money with the FIBO CROSS signal indicator >>
Moving averages of courses
The moving average is one of the simplest technical indicators derived from rates. Although there is a multitude of versions, there are only two general basic versions.
Simple Moving Average (SMA)
The simple moving average (SMA) has been popular as a technical indicator in the past because it was easy to calculate without the use of a computer. Today it is still very popular and, despite the possibilities of powerful chart software, continues to attract traders simply because of its simplicity.
Calculating the moving average (SMA)
The SMA is calculated by adding the average closing prices of X bars or candlesticks over a given period of time. These values are then divided by the corresponding time period X.
It's easy, isn't it?
The interpretation of the simple moving average
The basic approach to this trend following indicator is to compare prices with the SMA to capture market sentiment.
- Prices above the moving average → bullish
- Prices below the moving average → bearish
You can also look at the slope of the SMA:
- The moving average line is sloping up → bullish
- The moving average line is sloping down → bearish
By placing the moving average on the price chart, it can also be used as a support and resistance level.
Learn more about the SMA
The Exponential Moving Average (EMA)
In the past there was only the simple moving average (SMA) as a technical indicator. But over time, traders were no longer satisfied with these simple indicators as they always are with simple methods. So you started experimenting with the SMA. As a result of these thought processes, you then called the original average “simple” in order to distinguish it from the new, complex methods.
One of these complex versions is the exponential moving average (EMA).
Calculating the Exponential Moving Average (EMA)
Like the SMA, the EMA is based on adding up the closing prices, dividing the total by the X price bars for the corresponding time period. However, this is not a simple, but a weighted average.
In this version, the current or more recent courses are weighted more heavily than the earlier or older courses. This exponentially smoothed moving average therefore reacts more strongly to the current prices.
Interpretation of the Exponential Moving Average (EMA)
Basically, the interpretation of the EMA is the same as that of the SMA.
The point is to capture the interplay between SMA and EMA. Since the exponential average reacts more strongly to the more recent prices, it generates more trading signals from bullish to bearish market events or vice versa. However, the more signals a moving average produces, the less reliable the respective signal is.
This is an inevitable conflict that occurs with all technical indicators.
Learn more about the EMA
- Learn About the Difference Between SMA and EMA
- The 9/30 setup uses a 9-period EMA and a 30-period WMA (Weighted Moving Average).
Oscillators measure the momentum, i.e. the strength of the price movement or the speed of a trend. This indicator points to a market that may have gone too far in one direction and which may now move in the opposite direction. This situation is expressed in the so-called overbought (downward price reversal expected) or oversold (upward price reversal expected).
Let us now turn to three common oscillators used in technical analysis.
The stochastic oscillator
George C. Lane's stochastic oscillator has been a classic oscillator since it was invented decades ago.
Calculation of the stochastic oscillators
Standard setting of the stochastic (14.3)
The "stochastic" is made up of two (exponential) average lines, which are referred to as the% K-line and% D-line and oscillate between 0 and 100.
For example, let's look at the fluctuation range over the past two weeks. If the price is near the high of this range, the two-week stochastic will produce a high% K value. If the price is close to the low of the price range, the result is a low% -K value.
The% D line, which is normally a 3-period moving average of% K, serves as the signal line.
Some adjustments in his formula ensure that the Stochstik always moves between 0 and 100.
Interpretation of stochastics
If extreme market values (high or low) develop in the current trading range, there is clearly a strong price movement in one direction. But the momentum might not be sustainable. Therefore, so-called overbought and oversold areas arise.
- Stochastic value over 80 → overbought (look for sales opportunity)
- Stochastic value below 20 → oversold (look for buying opportunity)
The combination of% K and% D creates accurate signals.
- % K-line falls below% D-line → sell signal
- % K line exceeds% D line → buy signal
Learn more about stochastics
The Relative Strength Index (RSI)
When we talk about technical indicators, there is one person we cannot get past and that is J. Welles Wilder. The RSI is a tool along with many other indicators that came from Welles Wilder.
Calculating the Relative Strength Index (RSI)
The Relative Strength Index measures the speed and extent of current price movements. The indicator is based on the principle of average increases and decreases.
The RSI combines the average increase and average decrease into a single ratio (RS) that represents price momentum. Then smoothing is carried out similar to the EMA.
As with the stochastic oscillator, the range of values is between 0 and 100.
The interpretation of the RSI
If the average increase persistently exceeds the average decrease, prices will likely fall. If the average decline predominates, this suggests that prices will rise soon.
Standard setting of the RSI (14)
- RSI value over 70 → overbought (look for sales opportunity)
- RSI below 30 → oversold (look for buying opportunity)
If you would like to learn directly from Welles Wilder, click on this link.
Learn more about the RSI
Commodity Channel Index (CCI)
The CCI, developed by Donald R. Lambert, is also very popular. Although this technical indicator was originally intended for trading in the commodity markets, it is also used for other financial instruments.
The calculation of the CCI
Standard setting of the CCI (14)
For the CCI, the deviation between the price and its moving average is used to capture the momentum. To do this, the deviation between the current observation period and the average deviation of the past X time periods is compared.
In contrast to the stochastic oscillator and the RSI, the values of the CCI are not limited. But in practice the CCI moves between -100 and +100 due to its construction.
Remarkably, the CCI does not use the closing prices, but the typical prices (high + low + closing price / 3). Then the difference or distance between the typical course and the moving average is determined.
The interpretation of the CCI
As the name suggests, the CCI is based on the assumption that prices are normally within an invisible channel around the moving average.
If you trust this invisible channel to hold, follow these rules:
- CCI values above +100 → overbought (look for sales opportunity)
- CCI values below -100 → oversold (look for buying opportunity)
Learn more about the CCI
Trend following indicators
The indicators presented above are intended to filter out the trend reversals. The technical indicators in this section attempt to accurately show trends.
Average Directional Index (ADX)
Now we want to welcome Welles Wilder again. He was of the opinion that one has to find out whether the market is in a trend or in a trading range (sliding zone). And that's exactly why he created this ADX tool.
The calculation of the ADX
Default setting of the ADX (14)
The ADX is based on the unique principle of directional movement. The positive direction of movement (+ DM) refers to the difference between the high of a price bar and the high of the previous bar. The negative direction of movement (-DM) refers to the difference between the low of the price bar and the low of the previous bar.
Of course, the + DM is high when the market is bullish. When the market is in a bearish mood, -DM is high.
By combining + DM and -DM in Wilder's formula, the ADX gives us a benchmark for the strength of the trend.
The interpretation of the ADX
The ADX is an indicator for measuring trend strength. High values indicate a trending market, while low values indicate a listless market.
- ADX values above 25 → The market is trending.
- ADX values below 25 → The market meanders along.
Something seems to be missing. Doesn't the ADX show us the direction of the trend in a market?
He doesn't do that. But the ADX is often represented in terms of the + DM and -DM values. For example, if the + DM is above the -DM and the ADX is above 25, as is the case in the chart above, then the market is in an uptrend.
There is another way to interpret the ADX.
Learn more about the ADX
Moving Average Convergence Divergence (MACD)
The MACD was developed by Gerald Appelt and is one of the most intuitive technical indicators around. It elegantly expands the moving average to capture both trend and momentum.
Calculating the MACD
Default setting MACD (12, 26, 9)
The MACD shows the difference between two moving averages, usually with time periods 26 and 12.
A 9-period moving average is then displayed as the signal line on the MACD.
If a histogram is displayed in the MACD indicator, then this shows the difference between the MACD and its signal line.
The interpretation of the MACD
The MACD works because in a trending market the gap between the two moving averages increases. Because the MACD always subtracts the shorter moving average from the longer one, its value rises in an uptrend and falls in a downtrend.
- MACD above the signal line → strong bullish momentum
- MACD below the signal line → strong bearish momentum
The histogram also highlights the market momentum.
- High positive values of the histogram → strong bullish momentum
- High negative values of the histogram → strong bearish momentum
Because the MACD is not limited in its values, it is not useful for defining oversold and overbought areas. It is preferable to use the MACD divergence method.
Learn more about the MACD
Price / price channels
The courses / prices are not linear. Rather, they run in waves and swings up and down. And often the market looks like it is essentially only moving sideways with an upper and a lower limit.
This is why so many traders prefer the technical indicators that highlight channel-like price movements.
This technical indicator is one of the most famous and was named after its inventor, John Bollinger. As a software component, the Bollinger Bands have long been standard equipment for many technical traders.
The calculation of the Bollinger Bands
Standard setting Bollinger Bands: (20, 2)
The Bollinger Bands may look unpredictable and aimless with their sudden expansions and contractions. But they are indeed a simple and logically designed technical indicator.
First graph the moving average of the past X time periods. Then calculate the standard deviation of these past X periods.
To get the upper band, move the moving average up by taking a multiple of the standard deviation. To get to the lower band, move the moving average by the same distance.
Interpretation of the Bollinger Bands
For trading in a sliding zone:
- The price is touching the upper band → look for a sales opportunity
- The price touches the lower band → look for an opportunity to buy
The so-called gimmee price bar is an example of the use of Bollinger Bands in a sideways market.
For a breakout trade:
- Price closes above the upper Bollinger Band → look for buying opportunity
- Price closes below the lower Bollinger Band → look for sales opportunity
You can also use Bollinger Bands with the MACD.
Learn more about the Bollinger Band
This technical indicator is also named after its creator Richard Donchian, who pioneered managed futures and the famous turtle trend following method. There is no getting around this indicator.
The calculation of the Donchian Channel
Standard setting of the Donchian channel: (20)
The common standard time period of 20 days aims to record the trading activity of 4 weeks on the daily chart.
The Donchian channel represents the highest high of the last X time periods on the upper channel line. The lowest low of the last X time periods can be seen on the lower line of the channel.
The interpretation of the Donchian Channel
The Donchian channel is intended for trend following. Any breakout from the channel may be the start of a new trend.
- Price breakout above the channel → potential upward trend
- Price breakout below the channel → potential downtrend
Learn more about the Donchian Channel
The Keltner Channel as a technical indicator, as most traders know it, combines the ideas of Chester Keltner and Linda Bradford-Raschke.
The calculation of the Keltner Channel
The structure of the Keltner Channel is similar to that of the Bollinger Bands.
But instead of using the standard deviation to represent the Bollinger Bands, the Average True Range from Wilders is used here. This difference makes the Keltner Channel look calmer and more even than the Bollinger Bands.
The interpretation of the Keltner Channel
For trading in a trading range:
- The price touches the upper channel line → look for a sales opportunity
- Price is touching the lower channel line → look for buying opportunity
Trading an Outbreak:
- Price closes above the upper channel line → look for buying opportunity
- The course closes below the lower channel line → look for a sales opportunity
Learn more about the Keltner Channel
We have now discussed the key fundamentals of the ten essential technical indicators, but there is much more to learn before you can actually take advantage of them.
You need to understand that rules are a guide
The interpretations of the rules outlined above sound simple and downright mechanical, but they are merely guidelines. The reality is that if you apply these rules mechanically, you will not make money.
Master the technical indicators by taking the following advice to heart:
- Understand the context and circumstances of the market in which you work.
- Learn to read price action and use the technical indicators to complete your knowledge.
- Learn from the Masters by following the links in the “Learn More” sections above.
- Combine the technical indicators for a complete picture.
A solid education on the technical indicators can be obtained from this book - Technical Analysis: The Complete Resource for Financial Market Technicians (2nd Edition)
Experiment with historical data
The behavior of all technical indicators varies depending on the periods chosen. The default settings do not always make sense. Experiment!
(This 2-period ADX strategy is a product of my own experiments.)
Take volume indicators with you
The ten technical indicators discussed above are based on the courses. Volume is another important component of market data.
When you're ready, you can add volume indicators to your analysis. Start with the OBV indicator.
>>> back to the beginning of the article 10 technical indicators that a trader should know
This article was originally published by Galen Woods on his website: 10 Technical Indicators You must know for Trading
German translation by Karsten Kagels and Gaby Boutaud
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