A technical indicator is a mathematical calculation using price( and volume) history and is primary used to build mechanical and automated fx trading systems. A forex trading system is defined by a common set of rules developed around technical indicators that signal entry and exit points for a given currency pair.
For instance, a forex trader might have a set of rules stating that he will take a long position whenever the currency price closes above its 20-day simple moving average, and shorting it whenever it drops below.
Basically, technical indicators used in forex technical analysis can be arranged in three main categories:
Trend-following - used to spot new trends
Trend-confirming - used to confirm new trends
Momentum Oscillators- used to indicate overbought or oversold market conditions
1) Trend-following indicators
Determine the direction of the current trend and react much more smoothly to price action than oscillators. They look deeply into past price data and often have internal smoothing to filter out market noise and minor volatility to evaluate the overall direction of the “time frame” been studied.
The most common trend indicators include moving averages and bollinger bands.
2) Trend-confirming indicators
Help to confirm the new trend and are very helpful in avoiding false breakouts and whipsaws because they measure the strength of the trend.
The most common trend-confirming indicators include MACD and ADX.
3) Momentum Oscillators
React very quickly to short-term changes in price, flipping back and forth between overbought and oversold levels. Oscillators are very useful in both rangebound and trending currency markets. Forex traders may enter a long-trade under rangebound markets conditions when the oscillator shows the current price is in an oversold condition, or they can enter a short-trade when the oscillator signals overbought market conditions.
The most common momentum oscillators include Relative Strength Index (RSI), CCI and Stochastic Oscillator.
Building a forex trading system using technical indicators
Later on in this forex tutorial you will learn how to build a complete trading system using technical indicators.
Summary
Nowadays, many different technical indicators are available to currency traders, as you become more familiar with various technical indicators, you will find ones that you prefer to use over others, and can incorporate those into your favored trading system or strategy.
There is no such a thing as "the right indicator ", you have to feel comfortable with the indicators you use. Best is to experiment with a number of different technical indicators until you find those that fit your needs and trading style.
Technical indicators used in forex technical analysis can be arranged in three main categories:
