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Top Forex Technical Indicators and their Real time accuracy analysis.

The truth you need to know!

With back tests results ( Can’t miss it )

 

When you embark on the journey of becoming an expert in trading the markets, you will most probably be bombarded with a swarm of different trading methodologies. Some of these trading methods will use technical analysis and indicators and some will be based on fundamental news.

In the beginning of trading, pit traders had to calculate pivot points, support and resistance levels on paper. This tedious process has since been replaced with technical indicators that come with most charting software.

Technical indicators are very popular amongst novice Forex traders. This is because they are very easy to interpret and to an inexperienced novice, they look accurate on a chart.  More on this later

In this article, I will present a non-biased review of some of the most popular forex technical indicators.

Understanding how and when to use them will propel you from a novice trader into a pro trader.

So, this article will present the following:

  1. A round up of the most popular forex technical indicators
  2. The distinction between leading and lagging technical indicators
  3. A list of the most popular forex technical indicators
  4. Their back tests results and reliability analysis
  5. Conclusion that wraps up the entire discussion

Our top listed Forex Technical Indicators include:

  1. Relative Strength Index (RSI)
  2. Stochastic Indicator
  3. Bollinger bands
  4. Ichimoku Cloud
  5. Moving Average Convergence Divergence (MACD) Indicator
  6. Commodity Channel Index (CCI) Indicator
  7. Moving Averages
  8. Pivot Points
  9. Support and Resistance

Are you ready?

Let’s jump right into it, shall we?

Forex Trading Indicators - jump in

So

What are Forex technical indicators?

Based on different mathematical calculations, forex technical indicators are statistics of past market data. Traders use them extensively in their technical analysis to predict currency trends.

The two major technical indicators are:

Trend following indicators

They reflect the direction and the strength of a current trend.  Traders may enter a position when the trend following indicators are showing the current trend in a strong momentum in either direction. The most common trend following indicators are moving averages and Bollinger bands.

Forex Technical Indicators - bollinger bands

Oscillators

are indicators banded between two extreme values that reflect short term overbought or oversold conditions.  The most common oscillators are RSI (relative strength index), MACD (moving average convergence difference) and stochastic oscillator.

Most charting packages usually include the common forex technical indicators, or you can find a charting package and add the indicators that you want if they aren’t included. These ones can be coded or developed by a trader or a programmer and be added in some charting software and used for trading.

Forex Technical Indicators - metatrader4 custom indicators

An example of a price chart bearing custom indicators

You will probably use a mix between the trend following indicators and the oscillators. Use whatever you are comfortable with.

Remember

Forex Technical indicators are calculated using historic price feeds.

They are all derivative of the same data – high, low, open, close

There is no other data in your trading platform other than these 4 pieces of data.

so

All technical indicators are being fed by the same data hence they are ALL the same ( REALLY )

 

What are Leading Vs. Lagging Indicators?

Based on how they respond in relation to price, technical indicators can be grouped as

  • leading
  • or lagging

Leading indicators give their signals BEFORE a new trend has started. They “project” the price levels into the future

while lagging indicators can only provide “today’s “value based on the historical data

Since these indicators lag the price of the asset, a significant move in the market generally occurs before the indicator can provide a signal.

Examples of leading indicators include

  1. Support and Resistance
  2. Trend lines
  3. Pivot Points

while lagging indicators include

  1. MACD,
  2. Moving Averages,
  3. Ichimoku Kinko Hyo,
  4. CCI, Stochastics,
  5. RSI among others.

It is really important for a trader to understand how the technical indicators work and how the data is compiled before incorporating them into trading strategies and risking capital on those strategies.

Most lagging indicators look very profitable on the chart AT FIRST GLANCE

This is because they lag and repaint. In real time, the signals generated by them are totally different.

This is because the real time data used for calculations is different.

Once the price moves along, past values are re-calculated and re-painted on your charts.

Remember

The price moves indicators – not the other way around.

This is why they are called lagging and this is why they repaint.

This is why they always look profitable when you look at them at the left hand side of the chart when the price action is already unfolded.

Leading indicators are different

By using leading indicators like support and resistance, trend Lines or Pivot Points, you can “project” important price levels into the future.

Traders looking at the same support or resistance levels are likely to act when the price approaches these levels.

Forex Technical Indicators - support and resistance

 

By using support or resistance, the trader can “project” an important price level in the future where a lot of orders are likely to be placed and move the price

 

Forex Technical Indicators - trendlines

By using trend lines, traders can “project” an important price level in the future where a lot of orders are likely to be placed and move the price

This is self-fulfilling prophecy at work.

An Awesome List of the Most Popular Forex Technical Indicators

I guess you use some forex technical indicators in your trading?

Do you know how probable or accurate the indicators are that you use?

For example, lets take a classic stochastic indicator;

If the indicator goes

  • below the 30 line, we buy and
  • If it goes above the 70 line, we sell

This is a classic use of the stochastic indicator. It’s obvious to most traders, right?

Sadly, nobody is able to tell me how the indicator performs in real time.

What is the probability of a stochastic oscillator generating a winning trade?

Would you still use it if you knew that the probability is 50% or less?

You would be better off not to use it and pick the trade randomly, your probability would then increase to 50% (random coin flip).

so

I looked at 9 of the most common indicators;

I used the visual mode in MT4 strategy tester to mimic the real time behaviour of the indicators. As they are lagging indicators, it’s totally pointless to test it on a price action which has already unfolded.

Remember this is only a representation of some of the most common forex technical indicators.

Now let us review them one by one:

1.Relative Strength Index (RSI)

What is it?

Investopedia defines RSI as being a momentum indicator that is often used to measure the magnitude of historic price changes to determine overbought and oversold conditions in the price of any trade-able asset.

How is it calculated?

RSI can be calculated by following these steps:

  1. Pick the number of periods that you would like to base the study on. For example, period 14
  2. Pick a pair like EURUSD and compare today’s closing price with yesterdays
  3. Find the total of all upward movements in points between the two closing prices.
  4. Find the total of all downward movements in points between the two closing prices.
  5. Calculate the exponential moving average both for the upward and downward price movements
  6. Then calculate the relative strength (RS)

RS is given by EMA (for both upward and downward price movements)

Finally, the relative strength index (RSI)

RSI= 1/(1+RS)

Sounds confusing?

Worry not, you had to know how it is derived but you will not be expected to manually calculate this, thankfully, your trading platform will do this automatically for you

Is RSI a leading or lagging Indicator?

It gives its signal after the real move has happened, so it is a lagging indicator

How does it work?

RSI is used as a momentum indicator which enables traders to spot overbought (when the RSI goes above 70) and oversold (when RSI goes below 30) conditions in a trade-able asset.

Signals and strategies

Forex Technical Indicators - rsi indicator

Typically, you should be looking for buying opportunities when RSI crosses below 30 and look for selling opportunities when it crosses above 70. Here are some examples of RSI based trading strategies. You can try them out and let me know what you think.

Reliability after testing

From the results above, you can see how low the win rate is for this indicator. 45% is just too low, you would do better with a coin toss.

Biggest Advantage

It is smoothed because it uses exponential moving averages and as thus, it is more consistent that other oscillators.

It is very popular – many traders watch it, hence a lot of orders might go in at the RSI levels

Biggest Disadvantage

It is a lagging indicator which means it might not give you reliable signals in real time.

 

2.Stochastic Indicator

The Stochastic indicator is a momentum indicator which is often used by traders to compare the closing price of assets to its price range over a specific period of time.

Forex Technical Indicators - stochastic oscillator

So, how is it calculated?

The indicator is calculated using the formula

%K = 100 [(C – L14) / (H14 – L14)]

Where %K tracks the most recent market rate for the asset

C is the current closing price

H14 and L14 are the highest and the lowest price traded during 14 previous trading sessions respectively

%D is the 3-period simple moving average of %K. It is called “Stochastic slow” because it responds slower to changes in market price compared to %K.

Make sense?

No need to worry, your charting software will calculate it for you.

Is it a lagging or leading indicator?

Like its brother the RSI, stochastic is also a lagging indicator.  It gives its signal after the move has already happened and is not reliable in real time

How does it work?

The Stochastic indicator DOES NOT show overbought and oversold conditions. It is a momentum indicator.

When the indicator crosses above 80 that does not mean that the asset is overbought.  When it crosses below 30 that does not mean it is oversold.

Please take note, this is where most traders mess up and blow their accounts.

Don’t rush to sell the market when you see the indicator crossing above 80.

Remember an overbought market can be bought further.

Only sell that market once the indicator crosses below the 80 line and is confirmed by a leading indicator.

Note: Stochastic works best in a TRENDING MARKET

Signals and Strategies Generated by Stochastic Indicator

  • Buy if: Oscillator is under the 20 line and crossed upwards
  • Sell if: Oscillator is above the 80 line and crossed downwards

You can set your stop loss at 50 pips from entry and take profit at 50 pips

Is it reliable?

We will gauge its reliability by considering these 20 trades. Anything above 50% is considered to be reliable. The higher the accuracy the more reliable it is.

Looking at the results above you can see that the win rate stands at 50% thus not reliable

Biggest advantage: Used with price action and support and resistance levels, it can help a trader catch a good trade

Biggest disadvantage: It is a lagging indicator meaning that it shoots its signal after the move has happened.

3.Bollinger bands

A Bollinger band is a very popular indicator that is often used by traders to trade. It is a momentum indicator which can be used to check if the market is trending or ranging.

Forex Technical Indicators =- bollinger bands indicator

Bollinger bands comprise three lines- a simple moving average (often called the middle band) and two lines (outer bands) plotting two standard deviations (positive and negatively away from the middle band).

Note: Settings for the Bollinger bands can be changed in line with the preference of the user

How is it calculated

  • The middle band is calculated by taking 20 previous periods to get the simple moving average
  • The outer bands are calculated by taking 2 standard deviation positive and negative to get the upper and lower band respectively

Is it a lagging or leading indicator?

Bollinger bands are lagging indicators because they give their signal long after the move has happened.

How does it work?

Traders use the Bollinger bands in different ways:

 

  • Some look for a squeeze then take the trade in the direction of the breakout.
  • Some look for a bounce off the outer bands and buy or sell until the price comes to the middle or opposite band.
  • Others wait for the price to break past the outer bands

Signals and strategies

As mentioned, there are many ways of trading using the Bollinger bands. Personally, I trade it as follows:

Buy if a full candle completes above the simple moving average (middle band) with stop loss below the high of the previous candle

Sell if a full candle completes below the simple moving average (middle band) with stop loss above the high of the previous candle

Note: Bollinger bands work best in trending markets but can be used with a leading indicator to trend both ranging and trending markets.

Reliability:

As you can see from the results above, the accuracy for this indicator stands at 50%

Biggest Advantage: Can be used with leading indicators to catch nice moves in the market

Biggest disadvantage: It is a lagging indicator and thus, it should not be traded alone.

4.Ichimoku Cloud

The Ichimoku cloud also known as the Ichimoku Kinko Hyo indicator can be used to determine support and resistance, trend direction and momentum for an asset.

The indicator has five different components:

  • Tenkan-Sen – the conversion line
  • Kijun-Sen – the baseline
  • Chikou Span- lagging span
  • Senkou Span A- leading span A
  • Senkou Span B – leading span B

Forex Technical Indicators - ichomuku cloud

Note: The cloud (Komu) is formed by Senkou span A and Senkou span B

How is it calculated?

It involves 5 calculations as shown under:

  • Kijun-sen = (26-day high + 26-day low) / 2
  • Tenkan-sen = (9-day high + 9-day low) / 2
  • Senkou Span B = (52-day high + 52-day low) / 2
  • Senkou Span A = (Tenkan-sen + Kijun-sen) / 2
  • Chikou Span = Close plotted 26 days in the past

Complicated yes? No need to scratch your head doing all these. Your charting platform will do it for you.

Is it a lagging or leading indicator?

Similar to all the other indicators discussed above, the Ichimoku Cloud is a lagging indicator.

How does it work?

  • When price is above the cloud, this indicates an uptrend
  • When price is below the cloud, this indicates a downtrend
  • When Senkou span A crosses above Senkou span B the trend is up and getting stronger, the cloud is positive
  • When Senkou span A crosses below Senkou span B the trend is down and getting stronger, the cloud is negative

Signals and Strategies generated

To buy wait for the following:

  1. Price to break and close above the cloud
  2. Conversion line to cross above baseline
  3. Buy at the open of the next candle after the crossover, set your stop loss below the breakout candle

Note: You can use the same rules as above for SELL but in reverse

Also remember: Ichimoku cloud works best with a trending market

Reliability

Based on the results above, you can clearly see that this indicator gives more losing trades than winning trades

Biggest advantage: Ichimoku cloud is an all-in-one technical indicator meaning that it can be used alone to make trading decisions

Biggest disadvantage: Ichimoku Cloud gives its signal long after the real move has happened.

5.Moving Average Convergence Divergence (MACD) Indicator

MACD is a powerful indicator that is often used by traders to check for price momentum, price trend and direction. This awesome indicator has three components, two moving averages (signal line and MACD line) and a histogram.

Forex Technical Indicators - macd indicator

How is it calculated?

MACD is calculated by taking the 12-day Exponential Moving Average (EMA) and subtracting 26-day EMA from it. This calculation uses the closing prices for the two EMAs. Then a 9-day EMA is added to give the signal line.

MACD is a lagging indicator meaning that it gives its signals long after the real move has already happened.

How does it work?

The various components of this versatile indicator can be used to gauge price momentum, price trend and direction.

Signals and Strategies Generated

There are many different MACD trading strategies. Let us look at an example of such strategies

MACD Divergence

Divergence happens when price action is doing the exact opposite of what the MACD is doing.  For example, if price is forming lower lows and MACD is forming higher lows, this indicates the formation of a strong bullish signal and the opposite can be considered for a bearish signal.

The chart above shows an example of a bearish divergence which yielded that sweet bear move

Take note: MACD works best in a TRENDING MARKET environment

Reliability

MACD appears to be more reliable than the indicators that we have back tested before

Biggest advantage: It can be used either as a standalone indicator or be used with other leading and lagging indicators.

Biggest disadvantage: MACD shares the disadvantage of being a lagging indicator with all the other lagging indicators. This means that it usually generates signals long after the real move has happened.

6.Commodity Channel Index (CCI) Indicator

This versatile indicator can be used to help you, the trader to identify a new trend or beware of extreme condition. Initially, the CCI indicator was developed for use in trading commodities but today it can be used for trading equities, indices, currencies and other assets.

Forex Technical Indicators - commodity channel index

How is it calculated?

The CCI is calculated using the formula below:

CCI= (Typical price (TP)- 20-period SMA of TP)/ (0.015 X Mean Deviation)

Where TP is typical price and is given as = (High + Low + Close)/3 and 0.015 is a constant

The mean deviation is calculated as follows:

  1. Find the most recent 20- period average of TP and subtract it from each period’s TP
  2. Find the absolute values of these numbers
  • Find the sum total of these absolute values
  1. Divide the total by the number of periods which in our case it is 20.

How does it work?

CCI is an oscillator which moves to the upside of the baseline marked 0 or the downside. Traders use it to spot buying and selling opportunities

Signals and Strategies

  • When CCI crosses above +100, a new and strong uptrend is beginning which signals a buy
  • When CCI crosses below -100, a new and strong downtrend is beginning – look for a sell setup.

Forex Technical Indicators - cci

Here are some examples of trading strategies  that are based on the CCI. Try them out.

Take note: CCI is a lagging indicator and as thus it will most definitely give signals after the move has already happened. For best results, use CCI in a trending market environment

Reliability

As seen from the results, 55% is just above average. So, we can say it is somewhat reliable

Biggest Advantage: CCI is very easy to use with very simple rules that anyone can follow

Biggest Disadvantage: It can produce multiple false signals when the market is choppy leading to losses.

7.Moving Averages

Moving averages are some of the most popular technical indicators used by traders to analyse the markets and take a trading decision.

There are two main types of moving averages:

  1. Simple moving average (SMA)
  2. Exponential moving average (EMA)

How are they calculated

Assuming that we are looking at a 5 period SMA applied to an asset like EURUSD, we will calculate the SMA by using its 5 previous closes:

1.13373 + 1.13193 + 1.13359 + 1.13410 + 1.13427 = 5.66762

Then we divide the total by the number of periods = 5.66762/5= 1.133524

Some popular SMAs include 5 SMA, 10 SMA, 20 SMA, 50 SMA and 200 SMA.

 

Forex Technical Indicators - moving averages

Take note: SMAs are lagging indicators and they work best in combination with leading indicators in a TRENDING MARKET environment

What does an SMA do?

SMAs can be used to determine trend direction and to take trades when two SMAs crossover each other. The SMAs are also used as dynamic support and resistance

Strategies and Signals

An example of an SMA trading strategy has been captured here. The rules are pretty simple. The trader uses two SMAs

  1. 200 SMA is used to determine trend direction, if price is above it its bullish, if below it is bearish. Look for buys in a bullish market and look for sells in a bearish market.
  2. 50 SMA is used to pick the trades, when the market closes above it for the first time wait for the market to come back and retest it then take your buy.

So, here are the rules

  • Buy if the price is above 200 SMA and it has touched or bounced off from 50 SMA. You can set your stop loss at 25 pips from entry and Take profit at 50 pips from entry
  • Sell if the price is below 200 SMA and it has bounced off 50 SMA. You can set you stop loss at 25 pips from entry and Take profit at 50 pips from entry

Looks good yes? Well, why don’t you head over to your charting platform and plot the SMAs.  Try and identify potential trades.

Remember: SMAs are lagging indicators and should be used together with a leading indicator for better results. SMAs work best in TRENDING MARKETS.

Reliability

Its reliability stands at 60%

Biggest Advantage: It is one of the simplest trading systems out there.

Biggest Disadvantage: It lags and if used inappropriately can lead to fake trades and late entries.

Up to this point we have been looking at LAGGING INDICATORS

Let us now shift gears and look at two examples of LEADING INDICATORS

Are you ready?

Let’s go

8.Pivot Points

Pivot points are the first example of leading indicators. They represent support and resistance levels where the direction of price movement can potentially change.

How to calculate Pivot Points

Pivot point are calculated as shown below:

Pivot point (PP) is given by taking the sum of (High + Low+ Close)/3

The value of the PP is used to calculate support and resistance levels

R1 which is first resistance= (2 X PP) – Low

SI which is first support= (2 X PP) – High

R2 which is second resistance= PP + (High – Low)

S2 which is the second support= PP- (High – Low)

R3 which is the third resistance= High + 2 (PP – Low)

S3 which is the third support= Low – 2 (High – PP)

Take note: Some charting platforms can plot intermediate levels called mid-point levels

Forex Technical Indicators - Pivot Points

How does it work?

Being a leading indicator, you can use it to anticipate a bounce when the price hits it. See the chart posted above.

Use Monthly pivot to trade signals on H4 or Weekly pivot to trade signals on H1

Signals and Strategies

Pivot Bounce

 

  1. Open a 4-hour chart for EURUSD
  2. Apply the monthly pivot
  • Wait for the price to hit and fail to close below or above a PP or a mid-PP
  • Buy when it fails to close below and set a stop loss of 50 pips and a Take profit of 100 pips.
  • Sell when it fails to close above and set a stop loss of 50 pips and a Take profit of 100 pips.

Point to note: Pivot points work best in RANGING MARKETS

Reliability 

forex trading indicators - pivot points

From the results we can see that pivot points have a high accuracy rate

Biggest advantage: Pivot points are leading indicators meaning that traders can catch the main move as it happens.

Biggest disadvantage: Pivot points are not 100% accurate

9.Support and Resistance

Support is defined as an AREA on your chart where there is substantial buying pressure while resistance is an AREA on your chart with a potential selling pressure. In some places, you will hear people referring to support as floor and resistance as roof.

Forex Technical Indicators - support and resistance indicator

How does it work

For you to understand how support and resistance works, you first need to understand that markets are either in a trend or a range at any given time. With that in mind, you can go on and plot your support and resistance levels.

How are they calculated

These can be calculated in two ways

  1. Based on the calculation of the tool/indicator used to locate support and resistance. If you use pivot points or moving average, use the formulas we have already discussed above.
  2. You can also draw support and resistance using the horizontal line and trendline tools found on your charting software.

Are they leading or lagging indicators?

Support and resistance are leading indicators because you can see them long before price hits them allowing you to plan your trades in advance.

Also note:

Support and resistance work best in both trending and ranging market conditions

Signals and strategies

  • Combine the support and resistance strategy with multi time frame analysis
  • Spot the potential support and resistance areas on your charts
  • Wait for the price to come to the area and break it or bounce from it
  • Enter your trade and set your stop loss a few pips (we use 25-50 pips) away from entry and take profit at 2 times your stop loss

Check out how I trade support and resistance here

Reliability

A strategy with a win rate of 70% is quite accurate and worth trying out

Biggest Advantage: Support and Resistance are easy to spot and can be very profitable if combined with multi time frame analysis and price action

Biggest disadvantage: Support and resistance does not hold forever and can lead to losing trades if not traded cautiously. It is subjective in nature and hard to pin down in real time trading.

Conclusion

The point to drive home is that a trader needs to use statistics and numbers to figure out what works and what doesn’t.

Use maths and statistics to recognise and dump things that look OK on the surface but are in fact dragging you and your money down the drain.

I use only a few indicators, mainly leading ones as an addition to my price driven strategy.

The starting point for me is always the Fundamental analysis measured by Commitments of Traders and Risk Events Calendar

Before even thinking about entering a trend trade, I want to know where is the price is likely to go in the long term and what big institutional traders are doing in the market

The only indicators I would recommend to you are

Multi-Time-Frame Stochastic 

Momentum indicator. This indicator draws me higher time frame stochastic on lower time frame, ( daily stochastic on 4 hrs time frame). I CONSIDER only long entries when the daily stochastic is oversold on lower time frames and short entries if the daily stochastic is overbought on lower time frame

DOWNLOAD IT HERE ( Metatrader4 only)



Pivot Points 

Over sold/bought indicator. Probably the oldest indicator on the planet.

Draws the future levels based on the average price in the past.

I exit my long positions around high pivot points and exit my short positions on low Pivot Points.

I also use central Pivot Point as a reversal signal on lower time frames.

DOWNLOAD IT HERE (Metatrader4 only)



Single Currency Strength Index 

This is a weighted index of the single currency.

This allows me to see if the currency is strong or weak against the basket of other currencies rather than comparing in to another single currency

DOWNLOAD IT HERE (Metatrader4 only)



Support and Resistance

Supply and Demand indicator. Any successful trader has to have a thorough knowledge of support and resistance.

I NEVER sell the support or buy the resistance.

Only buy support in a rising market or resistance in falling markets



Fibonacci Retrecements

Retrecement indicator. Measures potential retrecement size. Markets tend to get exhausted around 38%-50% retrecement zones most of the time.

I consider 38%-50% retrecement as a mature support zone and look to buy the rising markets.



Candlesticks

Supply and Demand indicator. Shows the sentiment and a struggle between bears and bulls. Best used on daily charts.Engulfing candles show the sudden sentiment change on the market and often follows with lower or high prices.



You should do two exercises:

#1 If you have a strategy at the moment, do you know:

  • What is the accuracy of your strategy?
  • What is your risk and reward ratio?
  • What is your pay-out?
  • How can you make the above metrics better?

#2 Go through all indicators you use today and calculate how accurate they are.

  • Do they really help you to achieve results or they are only clouding your perception?
  • Dump those that don’t work, replace them with those that do.

Indicators should not be traded in isolation, use them to build and trade your strategy.

Indicators are price driven and not the other way around.

Used in the right context, indicators can help you determine entries, exits and lower your risk.

Take caution not to be too dependent on indicators. Spend some time learning how the markets work.

Interested in testing out some free to use indicators, go here

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Bonginkosi Mbanjwa

I wish to get that special lndicator for doing a Trade and lmprove my self

ronnie fulscher
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ronnie fulscher

Thanks.

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