Forex trading tips – understanding the indicators

Reader's Digest Editors

The past decade has seen everyday savers and investors seeking out new alternatives to make their money work harder. At the same time, the growth of online tutorials and resources has helped us all to become a more knowledgeable about financial tools and opportunities that used to be the domain of specialist investment bankers.

 

Nowhere is this more evident than in the rise amateur Forex traders. Anyone can install an app on their phone and start dabbling in the money markets. But whether you treat it as a fun way to make a little extra money, or you are looking to take up trading full time as your main income, the Forex market is not a beast to be taken on lightly. Those who make money are the ones who put in the time and effort into truly understanding the market, learning to read the indicators to choose what trades to make and when.

Download a trading platform such as MetaTrader and you will be greeted with dozens of these indicators. It takes time, practice and dedication to understand how they all work, and the correlations between them. The point is that everyone has to start somewhere, and diving in with a complex strategy with dozens of moving parts before you are ready is little better than blindly trading on the basis of guesswork.

Here, we run through a handful of the fundamental indicators that you need to be able to read and interpret that will be sufficient to get you started.

Moving average

The moving average indicator is the basis on which everything else is built. It measures the average price of the currency pair under evaluation over a set period of time, whether that’s a week, a month or a year. It’s important because it smooths out the short-term fluctuations and allows you to see the overall trend of how the pair is behaving. And that’s the first consideration when deciding whether it is time to buy or sell.

The moving average is certainly important, but it only provides the first piece of information in the jigsaw puzzle, describing how the currency pair has behaved over a set time period. In itself, that’s useful but we need more information to understand how good an indication that is of how the currencies will behave in the future.

Average true range

You hear the word volatility a lot in Forex trading. It describes the price variation over a set period of time, and how much the price deviates from the overall trend. Those who paid attention in school will be thinking standard deviation here, and while that is a metric that is often used, the most popular tool to measure volatility in Forex trading is the average true range indicator.

The true range is calculated by taking the highest price in the period under evaluation and subtracting from that the lowest price. The Average True Range (ATR) indicator then performs this same calculation over multiple trading periods (14 is typical) to arrive at the average true range.

High ATR implies high volatility, and can be used to guide your trading activity in a number of ways. For novices, just seeing a high ATR might be sufficient to make you think twice about going near a particular currency pair. Alternatively, you can use the ATR data to help you decide where to position your stops (your buy and sell limits) as part of your risk mitigation strategy.

Relative Strength Index

RSI is probably among the first indicators you will learn about, and rightly so. Its role is to look beyond what’s happened in the past and to try to find some clues as to future behavior among currency pairs. Get this right and you can steal a march on other traders by spotting when a particular trend is about to change.

The relative strength indicator assesses whether a particular currency pair is being either oversold or overbought. Clearly when this happens, it can lead to either a bursting bubble or a sudden boom. Either way, you need to know about it, as the alternative is to get caught up in the hype and simply join all the other traders in leaping off the cliff.

MACD

Every fast food lover’s favourite indicator, the Moving Average Convergence Divergence, better known as MACD, is the final basic tool that you need in order to get started in trading. The MACD does not bring any new metrics to the table, but what it does is to take “averages of the averages” in your currency pairs to provide an additional level of confidence that the trends you are relying on are genuinely there.

Use MACD as your final “sense check.” If it arrives at the same conclusion as the other indicators, it makes sense to proceed. If it casts doubt, then go back to the drawing board.