Forex trading strategies indicators
A moving average, for example, is simply an average of a security's price over a particular period. The time period is specified in the type of moving average; for instance, a day moving average. This moving average will average the prior 50 days of price activity, usually using the security's closing price in its calculation though other price points, such as the open, high or low can be used. The user defines the length of the moving average as well as the price point that will be used in the calculation.
To learn more, see our Moving Averages Tutorial. Strategies A strategy is a set of objective, absolute rules defining when a trader will take action. Typically, strategies include both trade filters and triggers, both of which are often based on indicators. Trade filters identify the setup conditions; trade triggers identify exactly when a particular action should be taken.
A trade filter, for example, might be a price that has closed above its day moving average. This sets the stage for the trade trigger, which is the actual condition that prompts the trader to act — AKA, the line in the sand.
A trade trigger might be when price reaches one tick above the bar that breached the day moving average. Figure 2 shows a strategy utilizing a period moving average with confirmation from the RSI.
Trade entries and exits are illustrated with small black arrows. To be clear, a strategy is not simply "Buy when price moves above the moving average. Here are examples of some questions that need to be answered to create an objective strategy:. An indicator can help traders identify market conditions; a strategy is a trader's rulebook: How the indicators are interpreted and applied in order to make educated guesses about future market activity.
There are many different categories of technical trading tools, including trend, volume, volatility and momentum indicators. Often, traders will use multiple indicators to form a strategy, though different types of indicators are recommended when using more than one. Using three different indicators of the same type - momentum, for example - results in the multiple counting of the same information, a statistical term referred to as multicollinearity.
Multicollinearity should be avoided since it produces redundant results and can make other variables appear less important. Instead, traders should select indicators from different categories, such as one momentum indicator and one trend indicator.
Frequently, one of the indicators is used for confirmation; that is, to confirm that another indicator is producing an accurate signal. A moving average strategy, for example, might employ the use of a momentum indicator for confirmation that the trading signal is valid.
One momentum indicator is the Relative Strength Index RSI which compares the average price change of advancing periods with the average price change of declining periods. Like other technical indicators, the RSI has user-defined variable inputs, including determining what levels will represent overbought and oversold conditions.
The RSI, therefore, can be used to confirm any signals that the moving average produces. Opposing signals might indicate that the signal is less reliable and that the trade should be avoided.
Each indicator and indicator combination requires research to determine the most suitable application with respect to the trader's style and risk tolerance. One advantage to quantifying trading rules into a strategy is that it allows traders to apply the strategy to historical data to evaluate how the strategy would have performed in the past, a process known as backtesting. Of course, this does not guarantee future results, but it can certainly help in the development of a profitable trading strategy.
Learn more about the benefits and drawbacks of backtesting. Read Backtesting And Forward Testing: The Importance Of Correlation. Regardless of which indicators are used, a strategy must identify exactly how the indicators will be interpreted and precisely what action will be taken.
Indicators are tools that traders use to develop strategies; they do not create trading signals on their own.
Any ambiguity can lead to trouble. Choosing Indicators to Develop a Strategy What type of indicator a trader uses to develop a strategy depends on what type of strategy he or she intends on building. This relates to trading style and risk tolerance. A trader who seeks long-term moves with large profits might focus on a trend-following strategy, and, therefore, utilize a trend-following indicator such as a moving average. A trader interested in small moves with frequent small gains might be more interested in a strategy based on volatility.
Or you will at least be able to reduce it to the basics such as Fibs, divergence, and a moving average. Then look at the market. When a trader looks long enough at the charts, they start to build up intuition. But if you like at the charts often enough, you will see the impulse in the market.
You will start to see energy and momentum in the charts. The best traders observe small little clues that seem meaningless to others but remind the chart watcher of imminent danger and opportunity. Or remind them of previous experiences that help aid the current analysis and decision-making process. The best traders are in rhythm with the market. The market makes impulses, corrections, then again impulse, correction, impulse, correction, etc. This is the heartbeat of the market. So if this pattern is the basic mechanism of the market, why not capitalize on it?
Forex trading using chart patterns and price action signals is tremendously powerful. There are a ton of links on price action at the Winners Edge Trading website so we will focus this article more on Forex trading with chart patterns. Patterns are so great simply because they mark the start and end of a correction. But also mark the start and end of an impulse! And the impulse is the gravy of Forex trading. Impulses are great because Forex trader reaches their profits and their take profit targets quickly without too much hassle and sideways chop.
And because impulses are more easily identified and caught in trends than in ranges, Forex traders usually to focus primarily on trading trends. And that makes sense. Trends have many price action areas with impulses. That is why trading with the trend is so important to Forex traders.
But in fact trading with the impulse is the real name of the games. Chart patterns help us with identifying corrective periods. That is why trading breakouts are such a great, if not the best, the method for trading using no indicators.
There are tons of different chart patterns. Here is a list:. The downtrend is weakening, potential upside. As you can see, there are tons of them. On any time frame. As you see in these charts, a Forex trader can accomplish a ton of analysis with just simple chart pattern recognition. A triangle usually breaks in the same direction as the impulse prior to the triangle. So downside and then a triangle is usually followed by a continuation lower. Of course, it does take a trained eye to capitalizing on them.
That is why paper trading and back testing will always remain vital elements for the trader. We must practice, practice, practice… and then practice even more.
A Forex tool that you definitely want to your disposal is the ability to capitalize on Forex chart patterns. They happen so often and so regularly that you really want to make sure you are well equipped for that. In our room, we do use a couple of indicators, like Fibs.
And you will see how we are able to identify breakouts, and how we filter out bad setups.