As we already know, in their daily trading activitiy, traders can use either the fundamental analysis or the technical analysis. Fundamental analysts attempt to evaluate a currency’s intrinsic value based on financial or macroeconomic data, while technical analysts observe patterns of price movements, trading signals or charting tools.
Technical analysis is based on the observation of forex market historical trading data and on the use of technical indicators to make them profitable. Technical indicators capture, as we said, historical trading data, such as currencies’ price, volume and volatility.
The technical analysis literature uses to make a distinction between two types of technical indicators: overlays and oscillators. The former use the same scale as prices and are plotted over the top of the prices on a currency chart. The most notable examples of this type of indicators are moving averages (MA) and Bollinger Bands. The latter are those who oscillate between a local minimum and maximum and are plotted above or below a price chart. Examples include the stochastic oscillator, MACD or RSI.
Traders often combine different indicators when analyzing a currency path. With a great deal of different options, the trouble for a trader is choosing the indicators that are most profitable and familiarize themselves with how they work. There is not a single rule which explain how to combine them and this activity is subjective, based on traders’ risk and return goals and on their experience. Technical indicators can also be incorporated into automated trading systems given their quantitative nature and more and more traders use trading signals to enter and exit the forex market.
Yesterday we introduced the technical indicators, illustrating their meaning and main functions. Today, we describe the most important categories of technical indicators: trend indicators, momentum indicators, volatility indicators and volume indicators.
Trend indicators – they capture both the direction and the strenght of a trend, by using trendlines and averages of currency prices. When a currency pair moves above the average, this is interpreted as a bullish (or upward) trend. When it moves below the average, this is interpreted as a bearish (or downward) trend. The most famous trend indicators are Moving Averages (MAs), Convergence and Divergence (also known as MACD) and parabolic stop and reverse.
Momentum indicators – they capture the dimension of a currency change by comparing currency prices over time. They are calculated by comparing currenct prices against previous ones and they look like a line below a price chart which oscillates as momentum changes. Stochastic oscillators and Relative Strenght Index (RSI) are the most famous momentum indicators and capture the market turning points and price reversals.
Volatility indicators – they capture the strenght of a movement, regardless of direction, by exploring changes in the highs and lows, suggesting traders a range of buying and selling and points where forex markets can change directions. Bollinger bands, average true range and standard deviation are the most common volatility indicators.
Volume indicators – they capture the streght of a movement, by averaging or smoothing volume data. The existence of a strong correlation between volume and trend strenght is a well-know phenomenon in forex markets. Chaiking oscillators, on-balance volume (OBV) and volume rate of change are the most famous volume indicators.