How to trade Forex using a technical indicator strategy
When it comes to forex trading, there is a wide range of different strategies you can use to generate trading profits. But how do you trade forex? For example, you could pursue an event-focused strategy, where you make trades just after major market-changing macroeconomic or political events. Alternatively, you can make medium- to long-term trades based on your view of countries’ economic fundamentals and how they will affect their currencies over the next 6-12 months. You can also become an expert on selected specific currency pairs and focus your trading activities around these. On the other hand, you can also use a technical indicator-based approach to trading currencies, which recent research shows works particularly well in ‘hot’ markets. This is the strategy we will discuss in the article.
Popular technical indicators
There is a wide variety of technical indicators that focus on different areas, such as volume, momentum, volatility and trend following. However, it is important to note that using just a single indicator will not help you generate a trading profit. If you want to trade forex using chart analysis and technical indicators, you must always combine complimenting indicators to generate trading signals. Popular technical indicators include Moving Averages, MACD (Moving Average Convergence Divergence), RSI (Relative Strength Index), OBV (On Balance Volume), Bollinger Bands, Chaikin Oscillator and William %R. The list goes on as new indicators are created as the popularity of chart analysis tools increases. In fact, Mark Priest’s Head of Index & Equity Market Making at ETX Capital stated that “traders are increasingly demanding more sophisticated tools to trade forex and a big part of that is developing improved chart analysis tools to meet this demand.”
Combining indicators to create a trading strategy
As I mentioned above, if you want to trade forex using chart analysis, the key is to combine free technical indicators to generate strong trading signals. An example of a trading strategy that you could apply to your chosen currency pairs would be to combine the MACD (Moving Average Convergence Divergence), RSI (Relative Strength Indicator) and Bollinger Bands. By combining these three indicators, you can measure price movements based on moving averages, momentum, trend and volatility. The way to turn these three indicators into a trading strategy is to trade when three of the three indicators say buy (or sell) then buy (or sell). This would be a strong signal. If two of the three indicators give you a trade signal, you can also trade, but it would be a less strong trade signal. If only one or no indicator indicates that you should execute a trade, you do not trade. Let’s look at how these indicators work in combination. We will use EUR/USD as an example. On the chart below we can see the Bollinger Bands superimposed on the candle stick chart for EUR/USD and we can see the Relative Strength Index and MACD below the price chart. The three indicators used actually show a buy signal for EUR/USD in the medium term. The Bollinger Bands, which are volatility bands placed above and below a moving average, show the price moving through the moving average from the bottom to the top during a low volatility phase (as indicated by the tight bands around the moving average). This would indicate a price increase. The RSI, which shows the speed of the price movement, is close to penetrating the center line, indicating a trend change towards a price increase.
Finally, the MACD shows three, albeit weak, buy signals. First, it shows a signal line crossing of the fast moving average through the slow moving average (the black line crosses the red line). Secondly, it shows the trend line moving towards the zero line and thirdly, it shows that the divergence between the two signal lines is increasing. Judging by the trading signals from these three indicators, we should buy EUR/USD. However, the trading signals, especially from the MACD, are not as strong as they could be so it would now depend on your risk profile whether you would want to buy EUR/USD or wait and wait for clearer trading signals from this strategy. In addition, it is important to test technical indicator-based trading strategies using historical data. This way, you can check how accurate your chosen indicator combination is in order to determine profitable trading signals for your chosen currency pairs.
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