Chapter 10: Types Of Indicators
Indicators are the vision mechanisms for traders and today we are going to look at 4 very important types of indicators. Each of them provides valuable information to traders that often has a direct impact on his/her output account balance.
If you are going to trade the Forex market, you need to have at least one good trend indicator that will provide you with information about the current trend in the market. Trading without a trend indicator would be similar to driving with your eyes closed hoping to stay on the road.
There are many trend indicators developed, most of which, will show you the direction of the trend (up or down) and the strength of that trend.
The most popular and the most used trend indicators are, unsurprisingly, Moving Averages (MA). Many variations of moving averages can be created. However, keep in mind that the ones that most professional traders pay attention to are the 50, 100 and 200-day moving averages. That means the moving averages are calculated based on daily closes on the daily chart. The basic implication behind these 3 is simple. If price is above the moving average then the trend is up and if price is below it then the trend is down.
Other very popular trend indicators include MACD, ADX and Parabolic SAR.
They are designed to measure the rate of change of price, or with other words the acceleration or deceleration of price.
The basic concept behind why they work is that price tends to accelerate at the beginning of a trend and they will decelerate towards the end of the trend, right before a reversal takes place. Momentum oscillators show this by flattening or turning before price changes direction.
The other things oscillators are used extensively for is:
Determining overbought and oversold levels of a currency pair. An overbought oscillator indicates that a market top may be forming. Conversely, oversold levels on the indicator signals a market that is unlikely to continue moving further down. One very important thing to keep in mind is that oscillators are only Mathematical formulas derived from price and they do not reflect the real order flow from in market.
Divergence between price and the oscillator. If the price makes a swing higher but the oscillator swing is lower than its previous swing high, then that is called bearish divergence and it indicates a market top. On the flipside, a bullish divergence is when price makes a lower swing and the indicator fails to do so.
Volume shows the number of orders for a given trading period. This can be used to interpret the size behind a move in the market. For this purpose, indicators derived from volume and price have been developed to make it easier for traders to understand all the data.
Volume and volume indicators are usually used as a confirmation tool because any price move on large volume is more likely to be a genuine move. Whereas a thin low liquidity market usually produces choppy small price moves, which are useless to technical traders.
Examples of volume indicators include the Price and Volume Trend, Chaikin Money Flow, the Klinger Volume Oscillator, Ease Of Movement and the Money Flow Index.
Volatility indicators are a very valuable component to any Forex trading strategy. It is crucial that you as a trader pay attention to volatility. Chart patterns and trading tactics work differently under different market volatility. Low and high volatility market environments require different position size management. Also, when deciding on the price level of your stop loss, you have to take volatility into account, because otherwise there is a higher chance to be stopped out in a fakeout.
So here are some good tools to help you judge volatility:
Bollinger bands are a wonderful trading tool because they indicate extremely well where price will trade for a given period. This can help you decide on where to enter and where to exit a trade. It also shows when price has reached an extreme level, thus you know whether it is a good time to enter a trade or it is better to hold on.
Average True Range (ATR) is a simple indicator that shows the average number of pips that a pair has moved. When the ATR is going up, it means that volatility is increasing and when the indicator is down then there is a so-called “quiet” market.
So try out the different types of indicators and see what works for you. It is always a sound strategy to learn and understand these indicators, and also, to be aware of the signals these indicators are generating.