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FOREX INDICATORS
With the rise of the internet, Forex trading can be done
in a click of the mouse. Money travels through space and wires all the
time. The computers have done a big help in the growth of Forex trading,
transactions can now be done anytime anywhere. Since somebody is up
at a given time everyday anywhere in the world, you will never lose
someone to trade with.
There are two basic and fundamental ways to analyze and
evaluate foreign exchange trading. There is the technical analysis and
the fundamental analysis. There is a huge difference between the two.
In Fundamental analysis, Forex analyzers and brokers
watch out for causes to market fluctuation. These causes may include
the political condition of the country, their laws and legislations,
financial policies, their growth rate and other factors as well.
Technical analysis of Forex trading includes graphs,
charts and other method of measuring past data to see the indication
of the rise and fall of currencies. They get all the information they
need and use them to calculate and forecast the possible direction of
a certain currency.
Relative Strength Index (RSI)
What is RSI?
RSI is an indicator that falls under the category of oscillators, and
it is an extremely simple indicator to use. RSI works well in range-bound
markets, but it has limited value in trending or breakout markets.
What RSI Does
RSI offer indications of when a currency pair is overbought/oversold?
RSI essentially calculates the strength of all upward candles against
the strength of all downward candles over the course of the specified
time frame.
How to Use RSI in Trading
Can be used to determine overbought/oversold levels
Overbought/Oversold
If RSI is above 70, the pair is considered to be overbought. Some traders
enter short at this point, but this can be dangerous as the price may
still be rising. Enter short when the RSI crosses back under 70, as
this may indicate that the momentum has turned. If the RSI is below
30, the pair is considered to be oversold; enter when RSI crosses back
above 30. Like most oscillators, RSI works best when the market is range-bound
– in other words, when the market is expected to simply gravitate between
an upper and lower level
Simple Moving Average (SMA)
The average price of a currency pair over a given time
period, (15 minutes, 1 hour, 1 day, etc.) where each period in the average
is weighted equally. Since this indicator is widely used by day traders
and swing traders in many markets, it is important to understand how
it is calculated. A basic example to calculate the 4-day SMA will demonstrate
this.
Example (using closing prices of the EUR/USD):
Day 1 Close = 1.1210
Day 2 Close = 1.1250
Day 3 Close = 1.1220
Day 4 Close = 1.1240
SMA (4) = (1.1210 + 1.1250 + 1.1220 + 1.1240) / 4 = 1.1230
Consequently, the average price of the Euro - U.S. Dollar during the
four days shown above is 1.1230.
Exponential Moving Average (EMA)
Unlike the SMA that gives equal weight to all prices,
the exponential average gives more weight to the most recent currency
prices. The purpose of the exponential weight is to give more importance
to the most recent data in the determination of trend direction.
Moving Averages are one of the most popular and easy to use tools available
to the technical analyst. By using an average of prices, moving averages
smooth a data series and make it easier to spot trends. This can be
especially helpful in volatile markets.
The formula for an exponential moving average is:
X = (K x (C - P)) + P
X = Current EMA
C = Current Price
P = Previous period's EMA*
K = Smoothing constant
(*A SMA is used for first period's calculation)
The smoothing constant applies the appropriate weighting to the most
recent price relative to the previous exponential moving average. The
formula for the smoothing constant is:
K = 2/(1+N)
N = Number of periods for EMA
For a 10-period EMA, the smoothing constant would be .1818.
2/(TIME PERIOD+1)=2/(10+1)=.01818=18.18%
The EMA formula works by weighting the difference between the current
period's price and the previous period's EMA and adding the result to
the previous
period's EMA. There are two possible outcomes: the weighted difference
is either positive or negative.
If the current price (C) is higher than the previous period's EMA (P),
the difference will be positive (C - P). The positive difference is
weighted by multiplying it by the constant ((C - P) x K) and the answer
is added to the previous period's EMA, resulting in a new EMA that is
higher ((C - P) x K) + P.
If the current price is lower than the previous period's EMA, the difference
will be negative (C - P). The negative difference is weighted by multiplying
it by the constant ((C - P) x K) and the final result is added to the
previous period's EMA, resulting in a new EMA that is lower ((C - P)
x K) + P.
Bollinger Bands
The theory behind Bollinger Bands is that currency prices
tend to stay within the upper and lower bands. Bollinger Bands are plotted
a number of standard deviations above and below a moving average (SMA).
The default values used in the software are a 20-period simple moving
average and 2 standard deviations, which are commonly used values in
the industry. A common use of bollinger bands when trading currencies
is to sell when the price is close to the upper band and buy when the
price is close to the lower band. A distinctive characteristic of Bollinger
Bands is that the spacing between the bands varies with price volatility.
During periods of extreme changes in foreign exchange rates (high volatility),
the bands widen to become more forgiving. On the other hand, the bands
become narrower during periods of low volatility, containing currency
prices. Some forex traders use the band in combination with other indicators
such as RSI (Relative Strength), MACD (Moving Average Convergence/Divergence),
and Rate of Change, which are also available with the trading platform.
Bollinger bands are Curves plotted above and below a moving average
of prices using a standard deviation offset. You specify where the bands
should be placed in relation to the average.
Rate of Change
A momentum oscillator in which the most recent price
is divided by the oldest price. For example, to construct a 9 day rate
of change oscillator, the latest closing price is divided by the close
nine days ago and the result is multiplied by 100. ROC has a horizontal
median called equilibrium. It is this median that tells us everything
we need to know about rate of change.
The normal time frame for ROC measurement is 10 days. The ratio to build
the ROC indicator is as follows:
Rate of Change = 100 (Y/Yx)
"Y" represents the most recent closing price, and Yx represents
the closing price a specific number of days ago
Momentum
Measures the rate of change in currency prices (not the
actual price levels). Ten (10) is a commonly used period for the momentum
calculation. The momentum oscillator consists of the difference between
the current closing price and the oldest closing price in a given number
of periods; for example, the 10-day momentum is calculated by taking
the current closing price, subtracting the price 10 days ago, and plotting
the results around the zero line. The results plotted can be negative
(current price is lower than oldest price) or positive (current price
is greater than the oldest price). This indicator can be used as either
a trend-following oscillator (similar to the MACD) or as a leading indicator.
The Momentum Technical Indicator measures the amount that a security's
price has changed over a given time span.
There are basically two ways to use the Momentum indicator:
You can use the Momentum indicator as a trend-following oscillator similar
to the Moving Average Convergence/Divergence (MACD). Buy when the indicator
bottoms and turns up and sell when the indicator peaks and turns down.
You may want to plot a short-term moving average of the indicator to
determine when it is bottoming or peaking.
If the Momentum indicator reaches extremely high or low values (relative
to its historical values), you should assume a continuation of the current
trend. For example, if the Momentum indicator reaches extremely high
values and then turns down, you should assume prices will probably go
still higher. In either case, only trade after prices confirm the signal
generated by the indicator ( e.g., if prices peak and turn down, wait
for prices to begin to fall before selling).
You can also use the Momentum indicator as a leading indicator. This
method assumes that market tops are typically identified by a rapid
price increase (when everyone expects prices to go higher) and that
market bottoms typically end with rapid price declines (when everyone
wants to get out). This is often the case, but it is also a broad generalization.
As a market peaks, the Momentum indicator will climb sharply and then
fall off — diverging from the continued upward or sideways movement
of the price. Similarly, at a market bottom, Momentum will drop sharply
and then begin to climb well ahead of prices. Both of these situations
result in divergences between the indicator and prices.
MACD (Moving Average Convergence/Divergence)
Consists of two lines. The first line (MACD line) is
obtained by subtracting a 26-day exponential moving average (EMA) of
a currency from its 12-day EMA. The second line (signal line) is usually
a 9 period EMA of the MACD line. The result is an oscillator that fluctuates
above and below zero (0). Currency traders have different ways to trade
the MACD. One way is to buy when the MACD line goes above zero and sell
when it goes below zero. When the MACD crosses over the zero line, it
means the 12-day moving average went higher (crosses over) than the
26-day moving average. This is nothing more than a bullish moving average
crossover. When the MACD falls below zero, it means that the 12-day
moving average crossed under the 26-day moving average, implying a bearish
shift in the currency. Some traders also trade off the crosses of the
MACD line and the signal line (its moving average); that is, when the
MACD crosses over the signal line, it generates a buy signal and when
it crosses below it, a sell signal is generated. Divergences between
the MACD and the currency rate can also be traded .
MACD measures the difference between two moving averages. A positive
MACD indicates that the 12-day EMA is trading above the 26-day EMA.
A negative MACD indicates that the 12-day EMA is trading below the 26-day
EMA. If MACD is positive and rising, then the gap between the 12-day
EMA and the 26-day EMA is widening. This indicates that the rate-of-change
of the faster moving average is higher than the rate-of-change for the
slower moving average. Positive momentum is increasing and this would
be considered bullish. If MACD is negative and declining further, then
the negative gap between the faster moving average (green) and the slower
moving average (blue) is expanding. Downward momentum is accelerating
and this would be considered bearish. MACD centerline crossovers occur
when the faster moving average crosses the slower moving average.
Parabolic SAR
SAR stands for "stop and reverse." The Parabolic
SAR is a time/price stop-loss system that can be used in conjunction
with other technical oscillators and studies. The name of this system
is derived from the parabolic shape of the dots that appear above and
below the currency price. This indicator is commonly used to exit (sell)
a long position when the price of a currency falls below the SAR dots
and to exit (buy) a short position when the price rises above the SAR.
Thus, the Parabolic SAR indicator can be thought of as a "trailing
stop." When the price of a currency is above the SAR dotted line
and the currency keeps going up, the dots keep rising just below the
lows of the current uptrend. When the price falls through the trailing
SAR dots, a sell signal is generated. Conversely, when a currency trader
initiates a short position and the price of the currency keeps falling,
the SAR dots will fall as well trailing the highs of the bars on the
current downtrend. When the price of the currency rises above the SAR
ceiling, a buy signal is generated to close the position. The SAR works
best in trending markets.
ADX (Average Directional Index)
ADX is an oscillator that fluctuates between 0 and 100.
Even though the scale is from 0 to 100, readings above 60 are relatively
rare. Low readings, below 20, indicate a weak trend and high readings,
above 40, indicates a strong trend. The indicator does not grade the
trend as bullish or bearish, but merely assesses the strength of the
current trend. A reading above 40 can indicate a strong downtrend as
well as a strong uptrend.
ADX can also be used to identify potential changes in a market from
trending to non-trending. When ADX begins to strengthen from below 20
and/or moves above 20, it is a sign that the trading range is ending
and a trend could be developing.
When ADX begins to weaken from above 40 and/or moves below 40, it is
a sign that the current trend is losing strength and a trading range
could develop.
Accumulation/Distribution:
Accumulation/Distribution Technical Indicator is determined by the changes
in price and volume. The volume acts as a weighting coefficient at the
change of price — the higher the coefficient (the volume) is, the greater
the contribution of the price change (for this period of time) will
be in the value of the indicator.
In fact, this indicator is a variant of the more commonly used indicator
On Balance Volume. They are both used to confirm price changes by means
of measuring the respective volume of sales.
When the Accumulation/Distribution indicator grows, it means accumulation
(buying) of a particular security, as the overwhelming share of the
sales volume is related to an upward trend of prices. When the indicator
drops, it means distribution (selling) of the security, as most of sales
take place during the downward price movement.
Divergences between the Accumulation/Distribution indicator and the
price of the security indicate the upcoming change of prices. As a rule,
in case of such divergences, the price tendency moves in the direction
in which the indicator moves. Thus, if the indicator is growing, and
the price of the security is dropping, a turnaround of price should
be expected.
Bulls and Bears Power Indexes are calculated by the formulas :
Bulls Power Index = High – EMA(Price)
Bears Power Index = Low – EMA(Price)
Bullish divergence occurs when price makes a new low which is not confirmed
by Bears Power, bearish divergence occurs when price makes a new high
while Bulls Power fails to make a new high. Bullish divergence produce
buy signal, bearish divergence produce sell signal.
Commodity channel index
the Commodity Channel Index (CCI) was designed to identify
cyclical turns in commodities. The assumption behind the indicator is
that commodities (or stocks or bonds) move in cycles, with highs and
lows coming at periodic intervals. Lambert recommended using 1/3 of
a complete cycle (low to low or high to high) as a time frame for the
CCI. (Note: Determination of the cycle's length is independent of the
CCI.) If the cycle runs 60 days (a low about every 60 days), then a
20-day CCI would be recommended. For the purpose of this example, a
20-day CCI is used.
Calculation : There are 4 steps involved in the calculation of the CCI;
Calculate the last period's Typical Price (TP) = (H+L+C)/3 where H =
high, L = low, and C = close.
Calculate the 20-period Simple Moving Average of the Typical Price (SMATP).
Calculate the Mean Deviation. First, calculate the absolute value of
the difference between the last period's SMATP and the typical price
for each of the past 20 periods. Add all of these absolute values together
and divide by 20 to find the Mean Deviation.
The final step is to apply the Typical Price (TP), the Simple Moving
Average of the Typical Price (SMATP), the Mean Deviation and a Constant
(.015) to the following formula:
CCI= (TYPICAL PRICE - SMATP )/(0.15 * MEAN DEVIATION)
For scaling purposes, Lambert set the constant at .015 to ensure that
approximately 70 to 80 percent of CCI values would fall between -100
and +100. The CCI fluctuates above and below zero. The percentage of
CCI values that fall between +100 and -100 will depend on the number
of periods used. A shorter CCI will be more volatile with a smaller
percentage of values between +100 and -100. Conversely, the more periods
used to calculate the CCI, the higher the percentage of values between
+100 and -100.
Lambert's trading guidelines for the CCI focused on movements above
+100 and below -100 to generate buy and sell signals. Because about
70 to 80 percent of the CCI values.
Between +100 and -100, a buy or sell signal will be in force only 20
to 30 percent of the time. When the CCI moves above +100, a security
is considered to be entering into a strong uptrend and a buy signal
is given. The position should be closed when the CCI moves back below
+100. When the CCI moves below -100, the security is considered to be
in a strong downtrend and a sell signal is given. The position should
be closed when the CCI moves back above -100.
Since Lambert's original guidelines, traders have also found the CCI
valuable for identifying reversals. The CCI is a versatile indicator
capable of producing a wide array of buy and sell signals.
CCI can be used to identify overbought and oversold levels. A security
would be deemed oversold when the CCI dips below -100 and overbought
when it exceeds +100. From oversold levels, a buy signal might be given
when the CCI moves back above -100. From overbought levels, a sell signal
might be given when the CCI moved back below +100.
As with most oscillators, divergences can also be applied to increase
the robustness of signals. A positive divergence below -100 would increase
the robustness of a signal based on a move back above -100. A negative
divergence above +100 would increase the robustness of a signal based
on a move back below +100.
Trend line breaks can be used to generate signals. Trend lines can be
drawn connecting the peaks and troughs. From oversold levels, an advance
above -100 and trend line breakout could be considered bullish. From
overbought levels, a decline below +100 and a trend line break could
be considered bearish.
Traders and investors use the CCI to help identify price
reversals, price extremes and trend strength. As with most indicators,
the CCI should be used in conjunction with other aspects of technical
analysis. CCI fits into the momentum category of oscillators. In addition
to momentum, volume indicators and the price chart may also influence
a technical assessment.
Recomended reading:
Getting Started in Currency Trading:
Winning in Todays Hottest Marketplace
Getting Started in Currency Trading is both an introduction and reference
tool for beginning and intermediate foreign exchange (Forex) traders.
This information-packed resource opens with a description of the Forex
market and a section of clearly defined Forex terms with examples. You'll
learn how to open your own trading account by following step-by-step
instructions and numerous screen shots that show you whats inside a
dealer's trading platform. You'll walk through the physical process
of placing and liquidating currency orders. Later chapters introduce
various trading strategies and tactics in detail, along with some fundamental
and technical analysis that will help you win in the exploding foreign
exchange trading market.
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