What are Best Indicators For Forex Trading?

Forex indicators are among the most misunderstood tools in finance. For many traders who plunge headfirst into this world, they represent an unavoidable concept akin to a lighthouse—without it, they believe they’d run their accounts aground.

Yet, forex indicators are not essential. They only show what is already on the chart and not some hidden, otherwise unobservable data. Their main task is to present a certain amount of data in a simplified form. They serve as tools for identifying trends, potential entry or exit points, and other important price levels on the market.

By mastering a range of technical indicators and learning how to combine them, traders can make more informed decisions, enhance their market timing, and improve their overall performance in Forex trading. Still, it is essential to note that less is often more in the world of indicators.

Essential Technical Indicators for Forex Traders

Moving Averages

Moving averages are among the most popular and widely used technical indicators in Forex trading. They help smooth price data over a specified period, making it easier to identify trends and potential reversal points.

• Simple Moving Average (SMA): The Simple Moving Average calculates the average price of an asset over a set number of periods. For example, a 50-day SMA sums up the closing prices of the last 50 days and divides it by 50. The SMA is a lagging indicator that reacts slower to price changes, making it ideal for identifying long-term trends.
• Exponential Moving Average (EMA): The Exponential Moving Average places more weight on recent prices, making it more sensitive to price fluctuations. Traders often use the EMA to identify short-term trends or reversals because it reacts quicker than the SMA. The 20-day EMA is a common tool for identifying short-term momentum.

Moving averages can be used to identify trends and potential reversal points. For instance, when a shorter-term moving average (e.g., the 20-day EMA) crosses above a longer-term moving average (e.g., the 50-day SMA), it may signal an uptrend (aka Golden Cross). Conversely, when the shorter-term moving average crosses below the longer-term one, it can indicate a potential downtrend (aka Death Cross).

Bollinger Bands

Invented by financial analyst John Bollinger in the 1980s, Bollinger Bands are a volatility indicator consisting of three lines: a middle line (SMA) and two outer bands representing the price's standard deviation.

Bollinger Bands on EUR/USD, Source: TradingView

• Calculation and Interpretation: Bollinger Bands measure the volatility of an asset. The middle band is typically a 20-day SMA, while the upper and lower bands are two standard deviations away from the middle band. When the bands expand, it indicates high volatility, and when they contract, it signals low volatility.
• Identifying Overbought and Oversold Conditions: When the price touches or moves beyond the upper band, the market may be considered overbought, indicating a potential sell signal. Conversely, when the price touches or falls below the lower band, the market may be oversold, suggesting a potential buy opportunity.
• Combining Bollinger Bands with Other Indicators: Bollinger Bands are often used with other indicators, such as the RSI, to confirm signals. For example, if the price reaches the upper band while the RSI indicates overbought conditions, it may strengthen the case for a reversal.

Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. It is used to assess whether an asset is overbought or oversold.

• Calculation and Interpretation: The RSI ranges from 0 to 100 and is calculated based on the average gains and losses over a specified period (usually 14 periods). When the RSI is above 70, it indicates that the market is overbought, while a reading below 30 suggests the market is oversold.
• RSI Divergence: RSI divergence occurs when the price of an asset moves in the opposite direction of the RSI. This can signal a potential reversal. For example, if the price is making higher highs while the RSI is making lower highs, it may indicate that the upward momentum is weakening, and a reversal could be imminent.

RSI on EUR/USD with bearish divergence, Source: TradingView

Stochastic Oscillator

The Stochastic Oscillator is another momentum indicator that compares an asset’s closing price to its price range over a specified period. It helps traders identify overbought and oversold conditions.

• Calculation and Interpretation: The Stochastic Oscillator consists of two lines: %K (the main line) and %D (a moving average of %K). The oscillator ranges from 0 to 100. A reading above 80 indicates the market is overbought, while a reading below 20 suggests it is oversold.
• Combining the Stochastic Oscillator with Other Indicators: The Stochastic Oscillator is often used alongside trend indicators like moving averages. For example, if the Stochastic indicates an overbought condition while the price is nearing a resistance level based on a moving average, it may signal a potential sell opportunity.

MACD (Moving Average Convergence Divergence)

The MACD is a trend-following momentum indicator that shows the relationship between two moving averages of an asset's price.

• Calculation and Interpretation: The MACD is calculated by subtracting the 26-period EMA from the 12-period EMA. The result is plotted alongside a 9-period EMA, known as the signal line. When the MACD line crosses above the signal line, it may indicate a bullish trend, while a cross below may suggest a bearish trend.
• MACD Crossover and Histogram Signals: Traders also pay attention to the MACD histogram, representing the difference between the MACD and the signal line. A shrinking histogram can signal weakening momentum, while a growing histogram indicates increasing momentum.

Advanced Technical Indicators for Forex Traders

Fibonacci Retracements and Extensions

Fibonacci levels are based on the Fibonacci sequence and are used to predict potential support and resistance levels.

Fibonacci drawn on EUR/USD, Source: TradingView

• Calculation and Interpretation: Common Fibonacci retracement levels are 23.6%, 38.2%, 50%, 61.8%, and 100%. Traders use these levels to identify where the price might retrace to during a correction in a larger trend.
• Using Fibonacci Levels: These levels help traders determine potential areas where the price might find support or resistance. Fibonacci extensions are also used to identify where the price might move after a breakout.

Ichimoku Cloud

The Ichimoku Cloud is a comprehensive indicator that provides insights into support, resistance, trend direction, and momentum.

Ichimoku on EUR/USD, Source: TradingView

• Components of the Ichimoku Cloud: The indicator consists of five lines: Tenkan-sen (conversion line), Kijun-sen (base line), Senkou Span A and B (cloud boundaries), and Chikou Span (lagging line). The cloud (Kumo) is formed between Senkou Span A and B, indicating potential support or resistance zones.
• Using Ichimoku Cloud: When the price is above the cloud, it indicates an uptrend, and when it is below, it signals a downtrend. The cloud’s thickness can also provide information about the strength of the trend.

Parabolic SAR

The Parabolic SAR (Stop and Reverse) is used to identify potential trend reversals.

Parabolic SAR on EUR/USD, Source:TradingView

• Calculation and Interpretation: The Parabolic SAR is plotted as dots above or below the price. When the dots are below the price, it signals a bullish trend; when they are above, it signals a bearish trend.
• Using Parabolic SAR for Trend Reversals: Traders often use the Parabolic SAR to set stop-loss levels, as a reversal in the dots can indicate a change in trend direction.

Combining Technical Indicators for Effective Trading

Combining multiple indicators is one of the most effective ways to enhance trading accuracy. Combining trend-following indicators like moving averages with momentum indicators like RSI or the Stochastic Oscillator can help confirm signals and avoid false entries.

However, it is important to avoid indicator overload, where too many indicators are used, leading to conflicting signals. Instead, traders should focus on complementary indicators that suit their trading style.

Practical Tips for Using Technical Indicators

Consider the following approach when designing an indicator-based system.

• Backtesting: Before relying on any indicator in live trading, it is crucial to backtest it using historical data to evaluate its effectiveness.
• Avoiding Over-Reliance: While technical indicators are powerful tools, they should not be relied upon exclusively. Incorporating fundamental analysis (such as economic reports and central bank policies) can provide a more complete market view.
• Setting Realistic Expectations: No indicator guarantees success. The key is to use indicators to manage risk and increase the probability of successful trades.

Best Forex Indicators For Singapore Forex Traders

For forex traders based in Singapore, indicator selection will first depend on their personal trading style and then on the time they plan to trade.

As Singapore's regular working hours fall into an Asian trading session, it makes sense to focus on indicators that are more useful in ranging markets—oscillators like RSI and Stochastic are useful for this purpose. Bollinger Bands are also a good choice for traders trading a ranging market with recurring mean reversion.

 

 

Frequently Asked Questions

What indicator do most traders use?

The moving average is probably the most used indicator among forex traders. It is a price derivative that shows the average price over a certain period, and its main purpose is to identify the trend.

How many indicators should I use in forex trading?

There is no set number of indicators that should be used for trading, as it depends on the individual trader. Still, a general practice says that less is more, and cluttering charts with numerous indicators does more harm than good.