Technical Analysis depends on Technical Indicators. Traders use Technical Indicators in making their trading decisions. Every trader has his/her own favorite list of technical indicator. Some Technical Indicators are lagging while others are leading. The most basic and the most popular indicator that is widely used by traders is the Moving Average. Moving Average can be Simple or Weighted or Exponential.
Moving Averages are lagging indicators. Lagging means that it always lags somewhat behind the price action.
Moving Average Crossovers and Moving Average Convergence Divergence (MACD) are two highly popular indicators used in divergence trading. Let’s discuss some of the important technical indicators.
Directional Movement Indicator (DMI) consists of the Average Directional Index (ADX) and the Directional Index (DI). The Average Directional Index measures the strength of a prevailing trend. It rises when the trend is strong and falls when the prior confirmed trend or direction is weakening. ADX measures the trending quality of the market. It isolates those periods where the market is not trending.
Directional Index (DI) is positive DI+ and negative DI-. DI+ and DI- show direction. When DI+ rises above DI-, an upward direction is confirmed. When DI- rises above DI+, a downward direction is confirmed. A strong move in the markets is confirmed when ADX is rising and both DI+ and DI- are apart.
The Stochastic Indicator identifies swings, tops and bottoms. The Stochastic Indicator is often referred to as the overbought or oversold indicator. It measures the relationship between the closing price of a currency pair and its high or low during a specific number of days or weeks.
The Stochastic Indicator does a wonderful job in finding the reversal tendencies in prices. As the price of the currency pair rises, the closing price tends to be closer and closer to the extreme high prices of the currency pair. Similarly as the prices fall, the closing price tends to fall on average closer and closer to the extreme low prices.
The Stochastic Indicator is considered to be a highly accurate method of picking the tops and bottoms. It is very popular among the traders. This indicator tries to find a correlation between the moving closing price of the currency pair and its reversal tendencies. It is a very useful tool that can be used as a timing aid in knowing when to take action in a currency pair particularly when it is used in conjunction with other technical indicators.
Moving Average Convergence Divergence (MACD pronounced Mac Dee) is the difference between the 26 day and 12 day exponential moving averages. A 9 day exponential moving average called the signal line or a trigger line is plotted on top of MACD to show buy/sell opportunities.
Traders use MACD in three popular ways: Crossover, overbought/oversold conditions and divergences. In wide swinging markets, MACD proves most effective. When MACD falls below the signal line, the basic rule is to sell and when MACD rises above the signal line and cuts it from below, it is a buy signal.
When the shorter moving average pulls away from the longer moving average, it is likely the price is overextended itself. This indicates, it will comeback to the realistic levels soon. MACD is also very useful tool in telling whether the market is overbought or oversold.
An indication that an end to the current trend may occur soon is when MACD diverges from the currency pair. A bullish divergence occurs when the MACD is making new highs but the currency price fails to reach those highs and a bearish divergence occurs when MACD is making new lows and the currency price fails to reach those lows.
Momentum is an oscillator that indicates the rate of price change not the actual price level and it is the net difference between the currency pair closing price and the oldest closing price from the predetermined period. The signal is triggered when the oscillator crosses the zero line. The more responsive the momentum oscillator will be to the short term price fluctuations, the shorter the number of days included in the calculations.
Another important technical indicator is the Relative Strength Index (RSI). It indicates a markets current strength or weaknesses depending on where the prices close during a given period. RSI is plotted on a scale of 01-100. A buy signal is triggered when RSI moves up from the lower band above 30. Similarly, a sell signal is triggered when RSI moves down from the upper band and comes down below a level usually set at 70.
Rate of Change (ROC) is another version of momentum oscillator is calculated by dividing the current closing price with the oldest closing price instead of subtracting the oldest closing price from the current closing price as in the momentum oscillator. It is sometimes used.
The Volume Indicator is used to show the strength of an up or down movement. A movement accompanied by an increasing volume is more likely to continue with strength than a movement accompanied with decreasing volume. Many traders use volume indicator as their only tool in trading. Others use it in conjunction with charts, economic news and geopolitical news.
The Volume Indicator is a great source of confirmation, entry and exit signals and overall trading decisions. Learn to use these technical indicators. Become comfortable in using them and discerning trends on different currency pairs and time intervals.
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