All You Need to Know About Technical Indicators
Technical Indicator: Definition
Before we start, let’s define what a technical indicator is. A technical indicator is a set of mathematical calculations that use historical price movements to predict future price direction.
Technical tools are famous among investors, as they give reliable signals regarding the entry and exit points, along with the direction of the trend and its force. They ease the process of market analysis and help with possible profit. You should know that indicators serve different aims as well as to be aware of when and how to implement them.
How Do Forex Indicators Work?
A technical indicator is a tool that calculates previous price movements. It can use prior open, close, high, and low prices for a specific period of time to predict the future rate direction. Traders don’t have to do any calculations, and the indicator is applied automatically.
Still, to read the indicator’s signals, you need to practice a lot. Some technical tools provide several signals, and you should keep them in mind. It may sound complicated. However, if you choose what indicators suit your trading strategy best, it’s enough to be equipped with only three to five of them.
Technical indicators can be used for different securities such as stocks, currencies, commodities.
It’s worth mentioning that technical indicators can be used for different securities such as stocks, currencies, commodities. Moreover, most of them work perfectly well for stocks, for example, and currencies. Technical indicators have different settings you should know about to use them efficiently. Usually, they differ regarding the timeframe you trade on.
Most of the popular indicators are set by default in trading platforms, for instance, MetaTrader. So, it’s enough to do several clicks to put an indicator on the chart.
Let’s consider how to do this using MetaTrader 4. Click “Insert” window. Choose “Indicators”. After you can choose from trend indicators, oscillators, volumes, and Bill William indicators. Each of the groups includes different instruments.
Trading Indicators: Types
There are many types of technical instruments. However, we would like to highlight three of them. Those are overlays, oscillators, and Bill Williams indicators:
- Overlays are applied directly to the chart. So, they interact with the price. Overlays are so-called trend indicators. Thus, you can see the current trend, its force, and its direction.
- Oscillators are another type of technical tool. The indicators usually appear below the price chart in a separate window. Oscillators provide perfect entry and exit points. However, they can also give signals about the trend direction and its strength.
- Bill Williams Indicators. These indicators serve the same aims as the previous ones. For convenience, experts mark a group of indicators developed by Bill Williams, a famous trader who invented his own trading theory and six famous technical instruments. All of them will be discussed later.
Trend indicators or overlays are used to define the direction and force of the current trend. The trend is your friend. Have you heard of this phrase? The trend is one of the most important patterns you should be able to determine on the chart. If you find a trend, you can be sure you will find useful entry and exit points. There is a wide range of trend indicators, and we will mention the most effective of them.
Trend indicators are used to define the direction and force of the current trend.
Moving Average is one of the leading indicators. Its popularity is based not only on its simplicity but also on its effectiveness. It is widely used to build other indicators, you will notice it if you read the whole list of indicators. Many traders like it because it provides strong signals.
Moving Average indicator is widely used to build other indicators.
There are four types of moving averages that serve different aims, such as simple, smoothed, exponential, and linear weighted. However, all of them have something in common. They use average prices, which smooth out the market fluctuations.
The indicator consists of one line, but traders usually use two to three lines with different settings to catch a signal. Moving Average has two main functions: first, it determines the trend direction; second, it serves as a support level.
This indicator has three lines and is based on the Moving Average indicator. It is a perfect measure of market volatility. When lines move apart from each other, market volatility is high. When they are close to each other, the market is consolidating.
Using Bollinger Bands, you can find an entry point if the price rebounds from either the upper or lower band. The middle line can be used as a support level.
Ichimoku Kinko Hyo
It’s one of the most complex indicators. Although it sounds complicated, it’s not too difficult to read its signals. Ichimoku includes three lines and one cloud. This instrument shows the trend’s direction, strength, and momentum. Also, its lines can be used as support and resistance levels. An Ichimoku indicator submits trade signals to open a long or short trade.
Unlike other technical instruments, ADX determines the strength of the trend but doesn’t show its direction. Although it’s a trend indicator, it is placed in a separate window below the price chart. The ADX consists of three lines: ADX, +DMI, and –DMI and has several levels that are important to define the trend’s force.
If the index is below 25, the trend is weak. If it consolidates between 25 and 50, the trend is strong. In the range between 50 and 75, the trend is robust. When ADX rises above 75, the trend is powerful. Besides the strength of the trend, you can get buy and sell signals with this indicator. When +DMI breaks above –DMI, it’s time to buy. If it's the opposite, the asset is worth selling.
SAR means Stop and Reverse. This means that this tool can both determine the trend and signal when to close the trade. The indicator interacts with the price chart and is represented by dots not lines. When dots are placed above the price, the trend is bearish. If dots are located below the price, the trend is bullish. The trend confirmation appears when there are at least three dots. It can also be used as a signal to buy or sell.
The indicator is used to measure the strength of volatility. It’s placed in a separate window and has only one line. When the line rises significantly, it’s a sign of high volatility. And vice versa, when the indicator fluctuations are mere, volatility is low.
Oscillators are another big group of technical indicators that mostly helps find entry and exit points. They are momentum instruments. Usually, their signals are based on bouncing between specific levels. Let’s look at those that will provide the most reliable signals.
Oscillators help find entry and exit points.
MACD or Moving Average Convergence Divergence is an oscillator which is calculated on two Exponential Moving Averages. The tool is used to determine trend reversal points that may become the perfect entry and exit point together with the strength of the trend. There are four main signals the indicator provides: divergence, overbought/oversold points, signal line crossover, and zero-line crossover that show the trend’s direction. It’s one of the most straightforward indicators you can apply to any timeframe.
Relative Strength Index (RSI)
This oscillator shows changes in the price movement, it signals when the market is overbought and oversold, so giving perfect entry points. The indicator has two main levels: 30 and 70. When the RSI is above 70, the market is overbought. When it’s below 30, the market is oversold. It’s also possible to find a divergence between the indicator and the price to determine a trend reversal. RSI and MACD are often applied together for more trustworthy signals. 14 period is a standard setting for the indicator.
Average True Range (ATR)
This oscillator shows how volatile the market is and an average volume of the trading range regarding the timeframe. However, the oscillator doesn’t show the direction of the trade. It just rises when the volatility is high, and the trend becomes more reliable and falls when volatility isn’t significant.
This oscillator is commonly used to define the oversold and overbought market and price targets. It’s based on two Moving Averages. Sometimes, envelopes are called types of Bollinger Bands. Although the envelopes indicator consists of only two lines, they form a channel within which the price moves. You can purchase and sell according to the price movements within the channel.
Stochastic oscillator resembles the RSI. It also shows overbought and oversold market points together with a possible trend reversal. It has two levels: 20 and 80. It makes it possible to trade on divergence and another important fact is that the rules are the same as they are for the RSI lines. However, the indicator has two lines that submit additional buy/sell signals. The oscillator can be implemented at any timeframe.
In general, momentum reflects the strength of the trend. Such indicators as MACD, RSI, and Stochastic Oscillator are used to gauge the momentum. However, there is a specific indicator - momentum. Momentum shows the direction of the trend. When it’s above 100, the trend is bullish. When it’s below 100, the trend is bearish. You can use the indicator with the Moving Average, and the crossover may provide buy/sell signals.
Commodity Channel Index (CCI)
Like most of the indicators, CCI provides entry points, the strength and the direction of the trend. When applying the indicator, you should keep in mind the period you choose in your settings. The shorter the period is, the more fluctuated the indicator will be. Thus, if you need to smooth the market movements, you had better choose longer time periods. 14 and 20 are the most popular settings. CCI shows the periods of overbought/oversold conditions and can be used for convergence/divergence.
Relative Vigor Index (RVI)
This is another indicator that gauges the strength of a trend. The RVI is similar to the Stochastic Oscillator. It has two main lines. Same as MACD and RSI, RVI reflects convergence/divergence and overbought/oversold areas. As there are two lines, their crossover will serve as a signal to buy or sell.
Bill Williams Indicators
The third famous group of symbols is Bill Williams’ indicators. Although lots of traders invented their indicators, only the Bill Williams’ indicators are in high demand.
Bill Williams indicators are widely used by traders all around the world.
This tool is widely used to determine the price change. AD turns around before the price momentum changes. As a result, it can be used to forecast the price turn. It looks the same as the Awesome Oscillator. Nevertheless, its signals should be read differently. AD can provide signals related to the market reversal as long as there is an entry point.
Alligator is implemented to define the direction of the trend. Also, it helps filter signals leaving the range-bound market. It includes three lines. So, based on other indicators, you can see that the lines crossover will provide buy/sell signals, while their direction will reflect the trend.
This tool gauges the momentum and predicts price reversals and corrections. The Awesome Oscillator gives bearish and bullish signals. It precisely determines the direction of the trend. So, you can use it to enter the market and trade on the trend.
Fractals are easily found in any price chart. However, to ease traders' lives even more, Bill Williams created this indicator. It’s used to find entry points, together with stop-loss levels.
This tool defines when the market is trending and when it’s consolidating. The Gator Oscillator shows the periods of market volatility. It works well with the Alligator and almost resembles it.
Market Facilitation Index (MFI)
This instrument gauges the strength and weakness of the price movement. The indicator shows the strength of the trend, so you will know whether to trade it or not. The moment when a new trend has chances to start, and when it is best to avoid entering the market.
Tips on How to Use Forex Indicators
Although there are plenty of indicators, we gathered several tips that you can apply to any of them for efficient usage.
- Remember the settings. If you use MetaTrader, all of the indicators we mentioned above are set automatically. However, their settings should differ depending on the timeframe you trade on. Otherwise, there is a risk of fake signals.
- Combine. It’s never enough to use only one indicator. Have at least 3-5 tools to check signals. To confirm the signal, we recommend using two to three indicators at once.
- Combine wisely. Previously, we recommended combining indicators. However, it’s highly essential to combine wisely. Did you notice that some indicators are similar? So, you shouldn’t use them for signal confirmation. Choose ones that serve the same aim but don’t resemble each other.
To conclude, there is a wide range of forex indicators that can help you determine a trend, its force, find perfect entry/exit points, and support/resistance levels. However, to find the tools that will match your trading strategy, you need to practice. It’s better to do it on a free Libertex demo account. The whole range of indicators and real market conditions will help you build a strong strategy.
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Let’s answer the most common questions about technical indicators.
What Are the Different Types of Forex Indicators?
There are around 20 types of technical indicators. The most famous ones are trend (overlays), oscillators, and Bill Williams indicators.
How Many Technical Indicators Are There?
There are hundreds of technical indicators. However, only around 20 are the most reliable. All of them are set in MetaTrader by default, so you don’t need to download them.
What Are the Leading Technical Indicators?
MACD, Moving Average, RSI, Awesome Oscillator, Ichimoku Kinko Hyo can be considered the leading indicators.
How Are Technical Indicators Used?
Technical indicators are applied to the price chart to determine the trend, its force, buy/sell signals, support/resistance levels.
How Do You Combine Technical Indicators?
You should never combine indicators that resemble each other. Find those that serve the same aim but are based on different calculations.
Are Technical Indicators Useful?
Technical indicators are useful if you implement them correctly. Still, you should keep in mind the fundamental analysis that provides additional information about market conditions.