If an indicator suggests a reversal, confirm the shift before you act. That might mean waiting for another period to confirm the same indicator's signal, or checking out another indicator. Patience will help you read the signals accurately and respond accordingly.
Trend indicators smooth price data out, so that a persistent up, down or sideways trend can be easily seen. (Examples: moving averages, trend lines)
Strength indicators describe the intensity of market opinion on a certain price by examining the market positions taken by various market participants. Volume or open interest are the basic ingredients of strength indicators.
Volatility refers to the magnitude of day-to-day price fluctuations, whatever their directional trend. Changes in volatility tend to anticipate changes in prices. (Example: Bollinger Bands)
Cycle indicators indicate repeating market patterns from recurrent events such as seasons or elections. Cycle indicators determine the timing of a particular market pattern. (Example: Elliott Wave)
Support and resistance describes the price levels where markets repeatedly rise or fall and then reverse. This phenomenon is attributed to basic supply and demand. (Example: Trend Lines)
Momentum indicators determine the strength or weakness of a trend as it progresses over time. Momentum is highest when a trend starts and lowest when the trend changes.
When price and momentum diverge, it suggests weakness. If price extremes occur with weak momentum, it signals an end of movement in that direction. If momentum is trending strongly and prices are flat, it signals a potential change in price direction. (Example: Stochastic, MACD, RSI)
Types of Moving Averages
One of the most widely used indicators, moving averages help traders verify existing trends, identify emerging trends, and view overextended trends about to reverse. As the name suggests, these are lines overlaid on a chart that average out short-term price fluctuations, so you can see the long-term price trend.
- A simple moving average weighs each price point over the specified period equally. The trader defines whether the high, low, or close is used, and these price points are added together and averaged, forming a line.
- A weighted moving average gives more emphasis to the latest data. It smoothes out a price curve, while making the average more responsive to recent price changes.
- An exponential moving average weighs more recent price data in a different way. An exponential moving average multiplies a percentage of the most recent price by the previous period's average price.
Finding the best moving averages and period for your pair
It can take a while to find the best combination of moving average and period length for your currency pair. The right combo will make the trend you're looking for clearly visible, as it develops. Finding that optimal fit is called curve fitting.
Usually traders start by comparing a few timeframes for their moving averages over a historical chart. Then you can compare how well and how early each timeframe signaled changes in the price data as they developed, then adjust accordingly.
When you've found a moving average that works well for your currency pair, you can consider this as a line of support for long positions or resistance for short positions. If prices cross this line, that often signals a currency is reversing course. Here's an example:
Longer-term moving averages define a trend, but shorter-term MAs can signal its shift faster. That's why many traders watch moving averages with different timeframes at once. If a short-term MA crosses your longer-term MA, it can signal your trend is ending - and time to pare back your position.
Stochastic studies, or oscillators, help monitor a trend's sustainability and signal reversals in prices. Stochastics come in two types, %K and %D, measured on a scale from 0 to 100. %K is the fast, more sensitive indicator, while %D is slow and takes more time to turn.
Stochastic studies aren't useful in choppy, sideways markets. In these conditions %K and %D lines might cross too frequently to signal anything.
Relative Strength Index (RSI)
Like stochastics, RSI measures momentum of price movements on a scale of 0 to 100.
Always confirm RSI signals with other indicators. RSI can remain at lofty or sunken levels for a long time, without prices reversing course. All that means is that a market is quite strong or weak - and likely to stay so for a while.
Adjust your RSI to the right timeframe for you. A short-term RSI will be very sensitive and give out many signals, not all of them sustainable; a longer-term RSI will be less choppy. Try to match your RSI timeframe to your own trading style: short-term for day traders, longer-term for position traders.
Divergences between prices and RSI may suggest a trend reversal. Of course, make sure you confirm your signals before acting.
Bollinger Bands are volatility curves used to identify extreme highs or lows in price. Bollinger Bands establish bands around a currency's moving average, using a set number of standard deviations around the moving average. Creator Jon Bollinger recommends the following:
Touching a high or low band doesn't necessarily mean an immediate trend reversal. Bollinger Bands adjust dynamically as volatility changes, so touching the band just means prices are extremely volatile. Use Bollinger Bands with other indicators to determine the trend's strength.
MACD - Moving Average Convergence Divergence
Developed by Gerald Appel, MACD (pronounced Mac-Dee) plots the difference between 26-day and 12-day exponential MAs.
A 9-day MA serves as a trigger line: when MACD crosses below the trigger, it's a bearish signal; when MACD crosses above the trigger, it's a bullish signal.
If MACD turns positive and makes higher lows while prices are still tanking, this could be a strong buy signal. Conversely, if MACD makes lower highs while prices are making new highs, this could be a strong bearish divergence and a sell signal.
Fibonacci retracement levels are a sequence of numbers discovered by the noted mathematician Leonardo da Pisa in the 12th century. These numbers describe cycles found throughout nature; technical analysts use them to find pullbacks in the currency market.
After a significant price move, up or down, prices often retrace most or all of the original move. As prices retrace, support and resistance levels often occur at or near the Fibonacci Retracement levels. For currencies, that means retracements usually happen at 23.6%, 38.2%, 50% or 61.8% of the previous move.