Understanding Forex Price Charts
Basic technical indicators
Besides using forex price charts, you can also use some other price indicators to understand the market direction. Indicators are simply mathematical manipulations of the raw price data. You don’t need to calculate these yourself – they will be built into your forex charting package (even the basic packages supplied by brokers).
Typically, these lag price action, and should not form the only basis of your trading system. The main limitation is the lags inherent in the smoothing used, which can be overcome with understanding of other smoothing approaches.
Here are some of the popular indicators used by forex traders:
Moving Average
A moving average is simply the average price of a currency pair over a specified time period. There are two types, simple moving averages (SMA), and exponential moving averages (EMA). Simple moving averages weight all periods equally, while exponential moving averages give more value to recent results. Moving averages with different time periods can be used to indicate entry points (refer to the MACD indicator discussed below). Moving averages are simply overlaid over the price chart.
One approach is to use a shorter term and longer term moving average and use the crossings as trading signals. When the shorter term average crosses down through the longer term average, that is a sell signal, while when it crosses up through the longer term average, that is a buy signal.
Moving averages are a simple filter. The longer the period of the moving average, the smoother the line, but the more it will lag. The lag is roughly half the period of the moving average.
Moving Average Convergence/Divergence (MACD)
Moving Average Convergence/Divergence (MACD) indicates the price velocity of a currency. MACD simply shows the mathematical difference between a short term moving average and a long term moving average, and this is further smoothed by another moving average, which is called the signal line. MACD is not overlaid over a price chart as moving averages are, but it is displayed underneath the chart. The MACD signal line and the difference between the moving averages are shown as lines, while the difference between them is displayed as as a histogram.
If MACD lines crosses up through the signal line, it is a buy signal, while crossing below the signal line is a sell signal.
Since it is based on moving averages, it is again a lagging indicator. This makes it of limited usefulness except for very long term traders.
Relative Strength Indicator (RSI)
The Relative Strength Indicator (RSI) uses a scale divided into 100 units is used to evaluate the strength of the price action of a currency. If the RSI of the currency exceeds 70 then it means that currency is overbought (which is a sell indicator) and if the RSI falls below 30 it means the currency is oversold (which is a buy indicator). This signal should be confirmed by the actual movement of the currency – that is if the RSI falls below 30, then the currency should move upward before a buy signal is generated.
Stochastic Oscillator
Stochastic Oscillator evaluates the strength of a market by comparing the closing price of a currency with the price range in a given time. The idea is that the rate of price movement will change near a turning point. That is what this indicator shows.
If your indicator represents a high stochastic for a currency then it points to the currency being overbought (a selling opportunity) and it may be oversold ( a buying opportunity) when the Stochastic Oscillator illustrates a low stochastic.
Conclusion
If you are new to forex trading then understanding the price charts and indicators may seem difficult at first. But there is no need to get frustrated. There are many trading resources to help new traders. It is useful to experiment with the different indicators on your broker’s trading platform.
Gradually you will start understanding the language of the forex charts. When you can understand the price action shown on the charts, it will become the key of your trading success. You will be able to execute a lot of profitable trades by interpreting the market trends with the help of the price charts and supplementary indicators.
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Tags: Bar, Candlestick, Forex Chart, Indicators, Line, Price Movements, technical indicators