Forex Is About Learning» Forex Indicators

The Moving Average Chart Indicator – part 2

Tantalus — Sun, 03 Jan 2010 06:23:25 +0000

In the previous post of this series I discussed what a Moving Average is and how it’s calculated. Now let’s get to the good stuff and talk about how to trade using it.

The first way we’ll discuss is to simply view the moving average as a general trend direction indicator. This is one of the very first methods of MA trading to become popular. With this method the trader compares the current price to the Moving Average trace to see which is higher. Because the Moving Average lags behind the price (see the previous post) it will always be below the price during times when the price is rising (an up trend) and it will always be above the price during times when the price is falling (a down trend). That’s the basic principle, but there are some other things to consider.

First, you need to be sure that you’re trading trends that are longer than the period of your Moving Average by at least a factor of two. For instance, if you are using a Moving Average that is calculated using the most recent 20 bars (Period = 20) you need to be looking for trending moves that will last at least 40 bars. Shorter moves than that will not be detected by the Moving Average because it’s filtering them out – remember that a Moving Average smooths out rapid price movements to expose the longer term trends.

Second, you must have a clear idea of what it means to say that the price is ‘above the Moving Average’ or below it. Most traders use the Close price of the bar as their point of comparison, but others use measures such as the average price ((Close + Open + High + Low) / 4) or the midrange price ((High + Low) / 2). Pick the price value you wish to work with and stick to it. Then consider that short term, spiky movements can make the price jump back and forth across the Moving Average trace instead of clearly crossing it in one direction or another. Try to develop a rule for determining when the price has truly crossed the Moving Average trace – such as requiring the an entire bar is on one side or the other, or waiting until the Close price is at least X pips beyond the MA line.

Third, you must consider the slope of the price line, that is, how steeply it is moving up or down. As a general rule, you should prefer to trade when the price is moving more steeply, as this will often indicate a strong, rather than a weak and uncertain trend.

Then finally bear in mind that the best time to catch a trend is early, so if the price crossed the MA many bars ago, you may have missed most or all of the movement, and you should consider waiting until the next crossing.

Watching to see which side of the MA trace the price is on has been a winning strategy for over 100 years, but it must be applied intelligently, and as always, with a healthy dose of good money management.

The Moving Average Chart Indicator

Tantalus — Tue, 29 Dec 2009 18:25:57 +0000

The oldest and most commonly used of all forex indicators is the Moving Average. A moving average provides a modified view of price movement with smaller, less important price actions filtered out. It is designed to let the trader see the underlying trend of prices without being distracted by momentary spikes or chops which often occur. It is easy to understand and to calculate and can be interpreted in several different ways, which we will explore in later installments.

First, let’s talk about what a moving average is and how it is calculated. A moving average line is simply the average price value for some number of bars in the past, for instance if you create a moving average with a period of 10, that means that each point in the moving average trace is actually the average calculated from the 10 most recent price bars. The moving average (MA) is therefore a new version of the price line which has been filtered (smoothed) by combining the current bar price with the prices of the previous 9 bars. Since the MA value is based on the combined values of 10 bar values, it is said to have a period of 10. Any number of bars can be used as the period. Let’s look at a calculation example:

Moving Average Example (Period = 4)

This is an example of a 4 bar moving average (Period = 4). Because it uses data from 4 bars, the values for the first three bars cannot be calculated – there aren’t enough data points for the formula. The MA for Bar4 is calculated by adding Bar4 to the three previous bars, then dividing by the Period (4). This creates the average price value for the first four bars.

The MA for Bar5 is calculated in the same way, but in this case the value for Bar1 is left out (it’s too far in the past) and the value for Bar5 is included. We continue calculating each bar value in this way, creating a smoothed line which represents the movement of the price with much of the unstable action removed. There is also a delay in the price line that is introduced by the smoothing which can cause problems but can also be used to your advantage. We will discuss this more in a future installment.

The type of moving average chart indicator described here is the simplest type, and is usually called a Simple Moving Average (SMA). We will cover other, more advanced types in future articles.

Read the next installment

The Stochastic Trading Method

Aster MacInnerney — Wed, 09 Dec 2009 19:12:24 +0000

This article was reprinted with permission of the author. Links have been preserved per author’s request.

What is the stochastics indicator?

Stochastics is an oscillating indicator very commonly used in technical analysis for Trading in Forex. George Lane, the developer of this indicator, applied it for the first time in the late year 1950s and early 1960s.

This indicator is measured on a scale from 0% to 100% and determines the deviation of the closing price on the Forex market, compared with normal levels of a period set by the trader. It is important that you know that this indicator is not recommended to be used in trending markets, since it is less effective in this kind of market.

Using the stochastic trading method

The main idea of how the stochastics indicator works is that you need to see clearly how this indicator determines what’s going to happen in the market; if it can be an upward or downward trend, by looking specifically at the cross of the two indicator lines.

You can use this metric to calculate the levels of overbought / oversold levels (using the RSI indicator), also for finding points of entry at the intersection of lines and moving averages of the market direction and to identify points of divergence, with the aim of providing some weakness in the market.

This indicator is composed of two lines:

1. The main line is called: % K
In the main fluctuation line (% K) tends to be more distinguished than the secondary line (% D), since it is more sensible. This is represented in the graphs as a compact line.

2. The secondary line is called: % D
% D is the moving average line of % K line. It is represented in the graphs as a dotted line.

There are 3 types of stochastics: Slow, fast and full.

1. Fast Stochastics: Line % K is not uniform, so it will not show any moving average. This type tends to provide an early indication of a turnaround in Forex.

2. Slow Stochastics: Contrary to the fast % K line it is a bit more uniform, using three periods moving averages of the values of the line % K, so it is called a Fast Stochastics derivative. This type of stochastics indicator provides more reliable trading signals.

3. Full stochastics: Allows you to use the two lines: % K and % D.

As in other indicators, it is suggested that you make reference to the two lines between 20 and 80. These lines will serve to highlight potential overbought levels (above 80%) and oversold levels (below 20% to trade in Forex.

The stochastics indicator provides 3 types of signals for trading in the Forex market:

1. Overbought/ Oversold: This signal occurs if the line passes over stochastics line of 80% and then the indicator goes back to the middle zone; the market should move in the same direction, which means a movement downwards. The same occur when the stochastics line passes below the line of 20% and then the indicator goes back to the middle zone; the market should move in the same direction which is an upward movement.

What to do? You must wait until the crossing is given between the lines to confirm the signal to trade.

2. Crosses: This signal occurs if the two lines cross the upper zone (above 80% mark) and then, the indicator goes back to the middle zone; the market should move in the same direction, which means a movement downwards. The same thing happens when the two lines crosses the lower zone (below 20% mark) and after the indicator goes back to the middle zone; the market should move in the same direction which is an upward movement. These moments are regarded for traders as the strongest signals.

What traders should do? In this case you should sell at the intersection of the lines % K and % D when they are above the mark of 80% and buy at the intersection of the lines % K and % D, when it is below the line of 20%.

3. Divergences: It is considered the most important signal because it can be useful for confirming signals.

It is divided into:

• Bearish Divergence: This signal occurs when new high levels or new maxim levels appear and tend to go higher in the market and their corresponding peaks are progressively smaller. This is a potential sell signal. I.e. Price continues to move up but stochastic indicator fails to do so

• Bullish Divergence: The bullish divergence occurs when the market shows new consecutive and new low levels, and the corresponding minima are progressively larger. This is a possible buy signal. I.e. Price continues to move lower, but stochastics indicator fails to do so.

What traders should do? For these cases, you sell a bearish divergence and you buy if it is a bullish divergence.

What you should NEVER do?

• Never buy or sell unless both lines cross.

• Never buy or sell, if you find crosses in the boundary lines marked or in the middle of the two limits.

• Do not use this indicator in markets with heavy trends.

Remember that no investment is risk free and a stochastics indicator in Forex will help you most effectively when it is used in conjunction with other tools and indicators.

If you would like to have more information about this Indicator, Please click here: Forex Indicators

Forex Trading Indicators – Repainting the Past

Tantalus — Sat, 28 Nov 2009 00:24:38 +0000

Technical indicators by their very nature are designed to give you some idea of the likely price movement in the future by performing calculations on the price movement of the past. Since past price movement is fixed and cannot change, the information an indicator derives from it should also be fixed. For most trading indicators this is true, but some indicators redraw past analysis data as new data comes in. Called ‘Repainting the past’, this is usually considered a sign of a fraudulent indicator; one that tries to convince you it does a better job of creating trading signals than it actually does. In some cases, though, it’s actually a useful technique for highlighting market movement features that might not be evident without ‘repainting’.

First, let’s be clear on what exactly repainting is. All Forex indicators use data from previously occurring price bars. Typically, for each bar that has occurred, there will be a data point in the indicator trace. For instance, in a Simple Moving Average (SMA) the data point for a given bar is equal to the average of a certain number of past data bars (typically only the Close of each data bar is used). If the Close of each bar used is already fixed – as will be the case when the bar has closed – then the value of the SMA at that point will be fixed, and cannot change as the result of further price movement. However, the current data point – that is, the data point for the current bar – will change slightly (and sometimes considerably) as the data of that bar changes. This is because the bar is not yet closed, and therefore the Close price is considered to be the current price as of the latest tick. Obviously, if this ever-changing price value is part of the SMA data point calculation, the data point will not be stable but will fluctuate. This, however is not repainting. This is typical behavior of any indicator, and cannot be avoided unless the code for the indicator prevents any data for the current bar from being plotted. This can be done but seldom is. Most traders understand that the current indicator data point fluctuates, so masking it is not necessary.

True repainting is seen when past data points – those which are ostensibly based on price bars that have indeed closed – are seen to change. A moving average of any kind, a digital filter or an oscillator would generally be rendered useless by repainting as these indicators are designed to provide accurate trading signals. It’s important when assessing indicators of these kinds to be able to scan visually over past price action and see what the action of the indicator was relative to price movements. This way a trader can get a sense of the accuracy of the trades signals the indicator has given as well as the tendency to whipsaw or otherwise create false signals. An indicator that repaints the past does not allow this type of assessment because the past history of the indicator trace tends to change even though the price data on which it should be based does not. A good example of this is the indicator called ‘Solar Wind’, which appears to make incredibly accurate signals, but in fact is falsifying the past through repainting.

There are, however, indicators which repaint for a specific purpose, and in fact which would not be useful if they didn’t repaint. Indicators like this are what I call analytic indicators. They do not generate usable trade signals and should never be expected to do so. Instead, they tell you something useful about the nature of market movement in general over a given period of time. This type of information can be very helpful when it’s used along with signal generating indicators – usually as a filtering mechanism to help avoid bad signals. Examples of this type of indicator are ZigZag, which shows local high and low points and displays both the spacing and height of price waves, and Linear Regression Line, which gives a graphic display of the overall slope of price action for a period of time. Neither of these calculations is possible without repainting behavior, but nonetheless they are very valuable indicators when they are properly understood and used.

So, in summary, if an indicator is intended to provide trading signals it must not be the type that repaints. Make sure that the data points for already closed bars never changes as a result of future price movements. Analytic indicators, however, may be very beneficial despite the fact that they sometimes repaint the past and in fact these indicators may be impossible to calculate without repainting.