How to Use Technical Indicators

By Rick Silver, of EverestForex.com

What are technical indicators?

Technical indicators are forms of trading analysis that allow us to follow the price and volume patterns of foreign exchange currencies. They are useful to us as traders as they help inform our trading decisions and help us judge when to enter and exit currency markets.

How important are technical indicators to a forex trader?

Technical indicators are a very important tool for your forex trading and ideally should be used in tandem with indicators of another kind, so that data is cross-referenced and optimized, giving the best and most reliable results. As each indicator is suitable for varying conditions in the market, they should be selected appropriately for particular types of market behavior.

How should I use them?

You should use them in conjunction with the skills and experience you develop as a confident forex trader and along with charts and other forms of data, such as news tickers, reports and the like. Technical indicators can offer useful market analysis, but they are not failsafe methods of prediction – don't rely solely on them for your trading decisions.

How many forms of technical indicator are there and what are they called?

There are 4 main forms of technical indicators: Number Theories, Trends, Waves and, the most common kind; price indicators. As these are the ones you are most likely to encounter and want to use, let's look in more detail at price indicators.

What are price indicators?

They aggregated forms of price data. An Oscillator is an example of a common price indicator. It has a fixed scope and values between price points. You may have come across some already; MACD, [M]ROC and RSI are popular price indicators.

What do all of these acronyms mean?!

[M]ROC = (Momentum) and Rate of Change

These are the least complex of the indicator oscillators and the simplest to understand. They depict the difference between today's price and the price of a closing trade N number of days ago in the past i.e. historically.

[M]ROC is an Oscillator showing the rate of price change. The range of the oscillation = the net difference of the current closing price and the historical closing price within the fixed timeframe.

You can apply it with this formula:

Momentum (i.e. the difference of price in a given direction) (M) = Current Closing Price (CCP) minus Historical Closing Price [HCP].

The Range of Change [ROC] will be a ratio, expressed as a percentage.

Word for the cautious: In a trending market, momentum oscillators may give preemptive exit signals, so use with care; better to use momentum oscillators to confirm trend indications from other indicators, instead of as a primary indicator.

MACD = Moving Average Convergence/Divergence

We calculate MACD by subtracting one moving average (a large one) from another (a smaller one), and then illustrating this with a trigger line; where the two converge, it indicates a possible change in the trend. Conversely, when they diverge, it is unlikely that the trend will change.

RSI = Relative Strength Index

This tracks relative upwards and downwards changes and it scaled to a ratio range of 0 to 100. What this means in a practical example is that it is able to indicate when a currency is both overbought and oversold.