Market indicators are the basis for a decision taken by the trader to buy or sell a currency. According to the basics of technical analysis, it is known that the market may be submitted in one of two states: trend or flat. On this basis, the indicators are conventionally divided into 2 types:
- Trend indicators - those that indicate the presence of a direction (downward or upward).
- Oscillators – they have a high level of efficiency in the absence of a pronounced trend.
In this article you will learn about 2 trend indicators (Moving Average and Bollinger Bands) and 2 oscillators (Stochastic and MACD). So let’s start with trend ones:
Moving Average
The technical indicator – Moving Average (MA) shows the average price of an instrument over a certain period of time. When Moving Average is calculated, there is performed a mathematical averaging of the currency pair price during a period. As the price changes, its moving averaging either increases or decreases.
When using the MA, traders should keep in mind that:
- The greater the period of the moving average, the less sensitive to changes in price it becomes;
- Moving average with a very small period will generate a lot of false signals;
- Moving Average with a very large period is constantly delayed;
- When there is a sideways trend, it is necessary to use moving averages with higher period.
There are 4 types of moving averages:
• Simple Moving Average (SMA) - simple moving average is calculated by summing the prices of closure over a certain number of time periods (for example 34 hours) and then dividing the sum by the number of periods.
• Exponential Moving Average (EMA) - is calculated by adding to the previous value of the moving average, a certain share of the current closing price. When using an exponential moving average, there is more weight on recent prices.
• Smoothed Moving Average (SMMA) - smoothed moving average is calculated on the basis of a simple MA, but it is more resistant to price fluctuations.
• Linear Weighted Moving Average (LWMA) – when it is calculated, the latest data has a greater weight, while oldest data earlier has lower importance. Weighted moving average is calculated by multiplying each of the closing prices within the considered series, by a certain weight coefficient.
In the analysis of the chart, moving averages can form 2 main signals:
- When the chart price crosses the moving average from bottom up, it generates a signal for a long position; if the price crosses the MA from up downward, it is a sign that you should sell.
- The general direction of the moving average indicates the current trend at the moment, so the opening of a position is recommended only in the direction of the current trend.
Bollinger Bands
The author of the technical indicator called Bollinger Bands is John Bollinger. This indicator is inserted on the chart and shows the range and rate of changes in prices.
The indicator consists of three bands:
- The average band - this is a common moving average
- Upper band - this moving average + 2 standard deviations
- Lower band - this moving average - 2 standard deviations
The trader can choose the moving average period at its discretion, in the same way as the number of standard deviations (standard values of 20 and 2, respectively).
Interpretation of Bollinger Bands is based on the fact that prices tend to stay within the upper and lower limit of the bands. At a time when the market prices has high volatility (significant price changes) Bollinger Bands expand. In a period of low volatility the Bollinger bands narrow and keep prices within its borders.
There are the following features of this indicator:
- After bands get narrow, you should expect sharp price changes
- When prices move outside the bands, there should be a continuation of the current trend.
- If the peaks and lows outside the bands are followed by peaks and lows inside, a reversal trend may come.
- When the price starts to move from one of the band's lines to another, it usually reaches the opposite band and thus help to predict price targets.
Stochastic
Stochastic Oscillator shows the position of each closing price in the previous interval of peaks and lows. This indicator consists of two lines: the fast, called %K, and slow, called %D. The second is the most significant since it is possible to judge based on it the dynamics of major developments in the market. Analysis by Stochastic oscillator sets the location of the closing price on the price range over a given period of time. The most common calculation period of the oscillator is five days.
If you set a short period with Stochastic Oscillator, you can detect more turning points, and if the period is longer, you can identify the most important turning points.
Stochastic oscillator allows you to observe in percentage (0 - 100%) the place of the last closing price in the general range of prices for a certain period of time. If it is greater than 80, the closing price is near the upper limit of the range, and if it is below 20, then respectively, it’s near the bottom.
The second curve (D %) is a three-day smoothed modification of the %K curve. K is represented by a continuous line and D by a dashed line.
Stochastic Oscillator generates three types of signals, arranged in descending order of importance:
- Divergence
- Stochastic oscillator line level
- The direction of the lines Stochastic Oscillator.
With these 3 signals, you can assess the market tendency, like bullish or bearish.
MACD indicator
MACD stands for moving average convergence/divergence. In MetaTrader 4 MACD indicator is shown in the form of bar graphs. MACD histogram helps the trader to understand the balance of power between bulls and bears, in addition, the MACD histogram indicates if one or another market sentiment is improving or worsening.
According to many traders, MACD histogram is one of the best indicators for technical analysis.
MACD histogram is the difference between two exponential moving averages (EMA) with periods set by the trader (the default is 12 and 26). To determine the best time to buy or sell, on the MACD histogram there is applied the so-called signal line, a 9-period moving average indicator.
When MACD-histogram rises, it shows that bulls are stronger than they were before, and it is reasonable to buy, and when it falls, it indicates that the bears are becoming stronger and it is better to sell.
The basic rule of trade using MACD histogram is built at the intersection of the indicator with its signal line: when the MACD falls below the signal line, it is necessary to sell, and when it rises above the signal line – you should buy. Also you can buy/sell when the MACD is crossing its zero line up/down.
Each indicator has its own pros and cons, so you should exercise them on your demo account and see what is suitable for you. Enjoy trading!