Here we will look at the best technical indicators in terms of, seeing the volatility of the market, moving averages to define trends and momentum oscillators, to confirm divergence of momentum from price to help spot price reversals. The list below is of course subjective but I personally think, these indicators should be part of any traders essential Forex education.
A technical indicator is simply a mathematical calculation, where the value is derived price activity studied so let's look at which are the best FX technical indicators to look at but first, let's take a look at the argument which rages among many currency traders which is - should you use them or should you just use a simple Forex price action strategy.
Price Action Trading Or Use Indicators?
There are many traders who think just trading price action is the best way to trade Forex markets but my own view is – indicators can give you a deeper perspective on where prices may go.
I would however stress, that when using technical indicators there are a huge number to choose from but don't be tempted to put to many in your trading strategy! It's a fact, simple trading systems work best and if you clutter a system with to many indicators, it will simply will not work and generate to many conflicting trading signals. Less is more in terms of indicators and I think you should use no more than 4 in total.
Lets look at the indicators we consider the best to incorporate in your trading strategy and the place I want to start is with the classic book from Wells Wilder Written in 1978 – New Concepts in Technical trading which introduces two of my favourite indicators – the Relative Strength Index (RSI) and the Average Directional Movement Indicator (ADX)
Average Directional Movement (ADX)
This indicators was designed to show the strength of a trend. An ADX level that is below 10 indicates that the currency is trading in a channel or range so indicates sideways or choppy price action. An ADX level which rises above 30 shows a moderately strong trend and when the line moves above 40 a strong trend is present.
Relative Strength Index (RSI)
This probably one of the most popular divergence indicators among Forex traders. The RSI shows the strength of a trend and you can see this by - how strongly the line is rising or falling but it's main use is to spot trend changes. When the RSI moves above 70, its considered overbought and a turn down warns of a correction and when the line moves below 30 and turns up, it warns of an upturn.
I actually like this as a back up indicator to show the strength of a trend but the best momentum indicator to warn of divergence is the one which we will look at next which is the stochastic.
Stochastic Fast and Slow
I love the stochastic and it comes in two forms - the fast stochastic and the slow. The fast is more sensitive and provides more signals than the slow but both, have there uses. The indicator is not a new one and was created George C. Lane in the late 1950s. It has been called the flash point indicator online by people who re named it but that's all it is another name – the logic its based on is exactly the same. The indicator shows, the location of the close relative to the high-low range over a period of time and simply follows the speed or the momentum of price.
The normal setting for the Stochastic is 14 periods. A 14-period %K would use the up to date close or price, the highest high over the last 14 periods and the lowest low over the last 14 periods. %D is just a 3-day simple moving average of %K. The %D line acts signal generator or trigger line and these signals are normally taken when the stochastic is overbought or oversold to indicate a trend change. The levels normally used are 70 to indicate overbought and 30, to indicate oversold but I prefer a setting of 80 – 20 to filter out false signals generally the more extreme the indicator is overbought or oversold the more valid the trading signal will be when bullish or bearish divergence occurs. My own view is the stochastic if used correctly, is the ultimate momentum indicator.
Bollinger Bands are a volatility indicator and can warn of explosive price movements for example, when prices break out of a range on high volatility and they can also be used as a support and resistance indicator to. Support is usually found at the lower Bollinger Band while resistance is found at the Upper Bollinger Band.
The bands are a set deviation of price from a mid Band which is a 20 day simple moving average and this average is great at providing resistance in a down trend and support in an up trend. If you want to trade currencies successfully you need a vo0latility indicator and Bollinger bands are the one I would consider my top choice.
Simple Moving Averages
We have already mentioned the 20 day simple moving average above which is a great one to study and other popular ones are – the 9 day MA, the 40 day MA and the 200 day MA. Moving averages give you the average price for the period studied and give you a clear idea of the trend for period studied with the short term fluctuations smoothed out.
They have been used for a long time and many traders, like more complex indicators but there very effective in terms of defining trends, spotting reversals and timing entry so make sure you know how to use them
Moving Average Convergence Divergence (MACD)
Created by Gerald Appel, the MACD has two moving averages which are turned into a momentum indicator by - subtracting the longer term moving average from the shorter term moving average.
The MACD is seen as both a trend following indicator and also a momentum oscillator. The MACD will move above and below the zero line as the moving averages converge, crossover and diverge. Traders can look can look for signal line cross overs, centre line cross overs and divergence in the indicator to generate trades in the market. It's a flexible indicator being both able to show the strength of a trend and also reversals and is very popular with Forex traders.
Above you have 6 of the best technical indicators and we have provided more information on each of them, in other areas of this site. There are many more you can look at but the six above, give you a great place to start in terms of the best technical analysis indicators, to consider using in your own Forex trading strategy.