Analysing the Forex market can be tough for traders who are new to the market or who don’t have enough trading experience. Most beginners start by applying too many technical indicators to their charts, which usually leads to costly trading mistakes. In the end, those traders dismiss technical indicators as a viable tool to analyse the market, but the truth is that they can generate successful trading signals if you know how to use and interpret them correctly. That’s why we’ll cover the most important Forex technical indicators in this article, and show you how to read them to find great trading opportunities.
Understanding Forex indicators
Forex indicators are computer scripts that execute directly inside your trading platform, and usually plot lines or other graphical objects on your price chart. They perform mathematical algorithms on historical price data to forecast where the price might go in the future. Since technical indicators are based on historical prices, all of them tend to lag a little bit, which makes it even more important to carefully interpret their values before placing a trade.
In general, Forex technical indicators can be grouped into:
- Trend-following indicators: These indicators are used to determine the overall trend of a currency pair. Trends can be either upwards or downwards, and trend indicators change their value based on the strength of the underlying trend. Examples of trend-following indicators are moving averages (both simple and exponential), MACD (Moving Average Convergence Divergence), Parabolic SAR, and the ADX (Average Directional Movement Index), to name a few. Out of these, the best trend indicator in Forex depends on your trading style and strategy, so you might want to try a few of them out first.
- Momentum indicators: Forex market indicators that follow the speed of a price change during a certain period of time are called momentum indicators. Momentum indicators are Forex useful indicators for breakout traders, since they want to catch the initial price move with high momentum following the breakout of important technical levels. Examples of momentum indicators are the Relative Strength Index (RSI), Stochastics, Commodity Channel Index (CCI) and so on. Some of you may already be familiar with those names, as they are among the most used indicators in Forex trading.
- Volatility indicators: Finally, volatility indicators measure the volatility, or the relative rate of price moves of a market. If the price moves quickly up or down in a short period of time, that market is considered very volatile. On the other hand, if the price moves slowly, we’re talking about non-volatile markets. Bollinger Bands and the ATR (Average True Range) are examples of popular Forex trading indicators that measure the volatility of a currency pair.
Forex indicators and how to use them
Before we move on and list the best Forex indicators to use, let’s cover some basics on how they’re applied to the chart and how to change their settings.
Generally, there are two types of technical indicators depending on where they appear on the chart. The first group is applied directly to the price chart itself (moving averages, Fibonaccis…), while the second group appears in a separate indicator window just below the price chart (RSI, Stochastics, ADX…).
Once you apply an indicator to the chart or indicator window, you can easily change its properties in the Indicator Settings window. If you’re using MetaTrader 4, simply right-click on the indicator and select Properties from the drop-down menu. In the case of moving averages, the menu looks like this:
Try to play with a few different settings to see how the indicator’s behaviour changes. Usually, traders change the period-setting of an indicator to make it more volatile to fresh price action, as shorter periods put more weight on the most recent prices.
In the following lines, we’ll list the best Forex chart indicators, show you how to use Forex indicators, and try to answer which indicator is best for Forex trading.
Forex chart indicators explained
Moving averages are among the best technical indicators for Forex trading. As their name suggests, moving averages show the average price over a pre-specified number of trading sessions and plot it directly on the chart. For example, a 10-day moving average would plot the average price over the last ten trading days, while a 20-period moving average on a 4-hour timeframe would plot the average price of the last twenty 4-hour bars. Given their simplicity, moving averages are probably the best Forex chart indicators for day traders.
There are two main types of moving averages: simple moving averages (SMA), and exponential moving averages (EMA). The main difference between them is the way they calculate the average price. Since EMAs use an exponential approach and put more weight on recent price action, they tend to react more quickly to price changes than SMAs.
In addition to being a trend-following indicators (moving averages point up in uptrends, and down in downtrends), they can also be used to identify dynamic support and resistance zones. In this regard, the 50-day, 100-day and 200-day moving averages are extremely popular and the price might find it challenging to break through these lines.
Moving averages also form one of the basic technical trading strategies in Forex, called the Moving Average Crossover. In this strategy, traders apply two MAs to their chart, one slower MA (higher period-setting) and one faster MA (shorter period-setting). A bug signal occurs when the faster MA crosses the slower MA from below, while a sell signal occurs when the faster MA crosses the slower MA from above. This is shown on the following chart, using two EMAs – one with a 5-period setting (the fast EMA), and one with a 50-period setting (the slow EMA).
Whether you use EMAs or SMAs in your trading, moving averages are one of the top Forex indicators for all trading styles, so make sure to incorporate them into your trading strategy.
Fibonacci tools are also some of the best technical indicators for Forex. Named after famous Italian mathematician Leonardo Fibonacci, who discovered the Fibonacci sequence of numbers (1,1,2,3,5,8,13…), Fibonacci tools are used to measure the extent of a correction during an uptrend or downtrend.
Whenever a market makes a strong upwards or downwards move, market participants who lock in their profits and buyers/sellers who perceive the new price as too low/high start to enter the market, creating a short-term price correction in the opposite direction of the underlying trend. That’s why you see the price on a chart fluctuating and zig-zagging from highs and lows.
The Fibonacci retracement tool measures the extent of the correction from the recent low to a recent high using ratios based on the Fibonacci sequence of numbers. Since a price correction usually reaches 50% of the previous move, Fibonacci retracement levels of 38.2% and 61.8% (also called the Golden Ratio) are followed by traders worldwide and can host a large number of market orders, basically acting as support or resistance for the price. The following chart shows how the price respects the 61.8% Fibonacci retracement level, after which the price returns to its previous uptrend.
Once the price shows to respect a Fibonacci retracement level, another tool called Fibonacci extension levels is used to determine where the price might go in the future. By combining these two Fibonacci indicators, traders get one of the most reliable technical indicators in Forex and one of the best Forex indicators to use together.
Fibonacci levels are one of the top indicators for Forex trading, and many trend-following strategies can be built around them making it one of the best Forex trading strategy indicator.
Average directional movement index
The Average Directional Movement Index (ADX) is a technical indicator that measures the strength of an uptrend or downtrend. When applied to the chart, the ADX appears below the main price chart in a separate indicator window, and consists of three lines: the +DI and –DI directional indicators, and the Average Directional Index. By combining all three lines, traders can determine both the strength and the direction of a trend.
In general, when the +DI line crosses above the –DI line, an uptrend is present in the market. Similarly, when the –DI line crosses above the +DI line, we have a downtrend. The strength of the trend is determined by the value of the ADX, with readings above 25 suggesting that the market is trending. Readings above 50 show a strong trend, and above 75 an extremely strong trend. On the following chart, you can see how the ADX can be used to generate trading signals. A cross of the –DI and +DI lines, combined with an ADX reading of above 25 (meaning the market is trending), can be used to enter the market.
However, don’t base your trading decisions solely on the ADX or any other technical indicator. Since they are based on historical prices, technical indicators tend to lag and you may miss a good part of the move before they trigger a trading signal. Also, pay attention that the ADX, just like other indicators, can generate false and losing signals from time to time.
If you learn to interpret the ADX indicator correctly, it can be combined with other trend-following Forex trading technical indicators to form a complete technical trading strategy.
Oscillators – Relative Strength Index (RSI) and Stochastics
Oscillators, or momentum indicators, are another group of good indicators for Forex trading. They include indicators such as the Relative Strength Index (RSI) and Stochastics, which are proven Forex indicators that work.
The Relative Strength Index (RSI) measures the momentum of a price move relative to time, and can return a value between 0 and 100. Developed by Mr. Wilders, the RSI is popularly used to determine overbought and oversold market conditions. An RSI value above 70 signals an overbought market where the price may soon reverse and fall down, while an RSI value below 30 signals an oversold market where the price may soon go up. However, you should note that markets can stay oversold and overbought for a long period of time, so you shouldn’t base your trading decisions solely on the value of the RSI indicator. Also, trading oversold and overbought market conditions is generally considered as a counter-trend trading approach, which can be riskier than a trend-following approach. Trading RSI levels that are overbought and oversold is shown on the following chart. Pay attention to the fake signals that the indicator may generate from time to time.
Similar to the RSI, the Stochastics is also an oscillator which can range between 0 and 100. Unlike the RSI where the 30 and 70 levels are considered as thresholds for oversold/overbought market conditions, in the case of Stochastics those levels are 20 and 80. Since both indicators are oscillators, they return similar results when applied to a chart. The following chart shows how to use the Stochastics indicator to trade overbought and oversold levels in a ranging market (the ADX could be used to determine whether a market is ranging or trending).
Whether you go with the RSI or Stochastics, you can rest assured that both are top-rated Forex indicators that work.
What is the best indicator for Forex trading?
Picking the best indicator for Forex trading is not an easy task. All of the mentioned indicators are good indicators for Forex trading, and they’re used in different market conditions and cater to different trading styles. Since all indicators lag the current price, you should be cautious when using them as Forex trading forecasting indicators. Alternatively, try to avoid placing trades based solely on technical indicators, and try to use them as confirmation tools instead.
Moving averages are probably the most popular technical indicator on our list, and traders around the world use them as a trend-following tool or as dynamic support/resistance lines. Fibonaccis also have a proven track record, just like the RSI, ADX, and Stochastics. So if you’re asking what the best Forex indicator is, all of them could be a winner depending on your preferred trading style.