Technical analysis is one of the two most common strategies in forex trading. The other one is fundamental analysis. The difference between the two is that while technical analysis uses mathematical calculations, the latter uses economic data. For example, if inflation data shows growth, the interpretation is that the underlying currency will move up. In technical analysis, traders use a number of indicators to make informed decisions about the performance of the securities.

There are hundreds of indicators that are commonly used in the market. These indicators are divided into three main categories. The trend indicators are used to identify a trend while oscillators are used to show specific levels of a trend. The volumes indicators are used to confirm the occurrence of a trend or reversal.

 

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Moving Averages

This is an indicator calculated by adding the closing price of a security and dividing it with the number of periods under consideration. The goal is to see whether the price is currently above or below that period’s average. There are three most common types of moving averages and they are: Simple Moving Average, Exponential Moving Average, and Smoothing Moving Average. The chart below shows a currency pair with a double EMA applied.

Bollinger Bands

This is an indicator made up of three bands. The middle line is usually the moving average of the pair while the two outer lines are the standard deviations of the pair. The interpretation is that in a downward trend, the price of the security is likely to be along the lower band. In an upward trend, the price is along the upper band as shown below.

Parabolic SAR

This is an indicator that is usually represented by dots. It is derived by a complicated mathematics that factors in the acceleration factor, extreme point, and the previous SAR. The indicator is used to show the direction of the trend and when a reversal is likely to happen. The idea is to buy when the dot is at the lower side and sell when the dot is on the opposite side. The chart below shows the indicator applied in a chart.

Relative Strength Index (RSI)

The RSI indicator is used mostly to show when the security is at an overbought or oversold position. The idea is to buy when the security is in the oversold zone and sell when it is in the overbought zone as shown below. It is therefore an important indicator for showing extreme levels.

MACD

MACD is the short form of the Moving Average Convergence Divergence. It is an oscillator indicator made up of the MACD line, the signal line, and the histogram. It turns two moving averages into a momentum oscillator. It does this by subtracting the longer MA from the shorter MA. As a result, it offers a good view of the trend by focusing on the trends and the momentum.

Money Flow Index

This is a volumes based indicator commonly referred to as the MFI. It uses the price and volume to measure the buying and selling pressure of the securities. It is also known as the volume weighted RSI. Money flow is usually positive when the buying pressure is high and negative when the pressure is low. It is usually interpreted in a similar way to the RSI only that it brings volume to the mix. A good example of it is shown in the chart below.

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