Some economic theories argue that forex trading is akin to gambling based on the fact that market behavior can be totally irrational and profitable returns are never guaranteed. However, despite this irrational behavior, there is, nonetheless, a logic to the forex markets.
We only have to look at historical data charts to see this; there are clearly identifiable ‘patterns’ to the way forex market prices move over time. Forex markets tend to behave in very specific ways depending on various market conditions. As such, we see the same price patterns repeat themselves over and over again. Which is where forex trading indicators come in.
Forex trading indicators attempt to identify these price patterns and the conditions that cause them. Forex traders can then look at these indicators to work out the direction the market is likely to move in based on certain patterns and use this to inform their trading strategy. Below, you’ll find an overview of three of the most popular of these trading indicators.
1. Simple Moving Average
The SMA (Simple Moving Average) indicator is one of the first trading indicators that traders come across and is one of the most simple. In a nutshell, it shows the average price of a currency pair for a time period based on historical data.
A 50-day SMA would show the ‘average’ price based on the closing prices for the last 50 days. A 10-day SMA would calculate the same average price based on the closing price for the last 10 days.
As it calculates the average over time, it ‘smooths out’ price movements in order to better reflect the trend over time. The downside of this is that it also reacts more slowly to changes in the market as it only provides a signal after the trend has already begun.
SMA indicators usually look at two data sets: one with a shorter SMA (e.g. a 10-day SMA) and one with a longer SMA (e.g. a 100-day SMA). These two data sets are plotted together on a chart. When the long-term average line crosses over the short-term average, it indicates that there is a new trend.
2. Exponential Moving Average
Unlike the SMA, which reacts slowly to trends, the EMA is designed to respond very quickly to price changes and is weighted more heavily towards recent prices.
There are various strategies for using the EMA price indicator. One simple strategy is to plot two EMAs of different terms on a 15-minute chart (such as a 5-period EMA and a 20-period EMA) and then buy when the shorter MA crosses over the longer MA, and sell when the reverse happens.
There are many more sophisticated forex trading strategies that use EMA, and you should endeavor to learn these before using this indicator.
3. Bears and Bulls Power
Bears Power and Bulls Power are more technical and sophisticated indicators that are used to evaluate the strength behind a market price. Bulls Power is an indicator that measures the strength of buyers in the market to lift prices, whereas Bears Power measures the strength of sellers to drag prices down.
We can use both these indicators together to assess good entry and exit points by applying them to trading systems such as the Elder-Ray Index, which is designed to gauge both bullish and bearish momentum based on market indicators.