Technical Analysis – The Most Important Trend Indicators
Chasing a trend or riding a trend is every Forex trader’s dream. Strong trends forming on bigger time frames, like the daily chart and above, can result in tremendous profits in the trading account. There is a saying when trading the Forex market, and that is: “the trend is your friend”. It cannot be truer! Unfortunately, the market is mostly in corrective waves or spends more time in consolidation rather than in a trend. This sounds like the Elliott Waves traders that are waiting for most of their time for the third wave in an impulsive move to form, only to realize that they are rare patterns. Nevertheless, a trend is defined by a strong and consistent market move and that is what Forex traders want: to see volatility, to see the market consistently moving. Trends, of course, can be either bullish or bearish, but this should not matter for traders. A Forex trader will adapt to both bullish and bearish conditions and should always keep an objective eye, without being influenced by the market moves. Easy to say than done, though!
The Most Important Trend Indicators
Spotting a trend can be an easy thing and trend indicators are part of a set of trading tools designed for conservative traders. Aggressive traders will always try to catch a bottom in a bearish trend or sell a top in a bullish one, even though this is a risky endeavor. Conservative traders, on the other hand, like to see the trend reversing, a pullback/spike being bought, the previous highs/lows being broken, and the new trend to start picking up steam. Then, and only then, trend indicators will start to be plotted on the screen. Trading platforms offered by all Forex brokers are having a “trend indicators” category. Even if the indicators are not called exactly trend indicators, the fact that they are attached to an actual chart is telling us they are, in fact, designed to chase a trend. The MetaTrader 4 platform, under the standard or default settings, is offering the following trend indicators: Moving Averages, the Bollinger Bands, the Average Directional Moving Index, Envelopes, Ichimoku Kinko Hyo, Parabolic SAR and the Standard Deviation.
We will not treat all of them in this article, but the most important one. It should be mentioned here that there are other custom trend indicators that can be bought, or created, and imported in the trading platform, but the ones listed as the default ones should be considered as the most relevant ones.
Like the name suggests, a moving average considers multiple candles back in time to plot the average on the screen at current prices. Therefore, the current price is compared with the moving average. As a rule of thumb, if the price is above the moving average, it is said it is in a bullish territory. If the price, on the other hand, is below the moving average, a bearish environment is in place. If the price stays below/above a moving average, the market is trending. In the first instance, it is in a bearish trend, and in the second one, in a bullish trend. The bigger the moving average is, the stronger the implications for the bullish or bearish market. Moreover, the bigger the time frame the moving average is applied on, the stronger the implications for the overall trend.
Moving averages can be interpreted and used as single indicators, but also combined with other moving averages that take a bigger period into account. A moving average used as a trend indicator is offering strong support (in a bearish trend) when the current price is reaching the average and resistance (in a bullish trend) when the current price is reaching the average as well. In the case of multiple averages on a chart, if they are intersecting in the same place, it is said that a confluence area is forming. This is giving a stronger support or resistance level.
The Bollinger Bands Indicator
The Bollinger Bands indicator is famous through its upper and lower bands, as the formula used to plot them is quite unique. To this day, John Bollinger is saying that the two bands have the power to predict a breakout from current prices. This may be very well true, but the trading platform is listing the Bollinger Bands indicator as being a trend one. It goes without saying that the standard interpretation is that a trend is valid as long as the price is staying within the rising or falling bands. Moreover, a stronger trend will always stay on the upper side of the bands (in a bullish market) or the lower side of the bands (in a bearish market). The middle line in the Bollinger Bands indicator is called the SMA (Simple Moving Average) or the EMA (Exponential Moving Average). This line is being used as a buying opportunity in a bullish trend and a selling opportunity when the price is a bearish one. The chart below shows the AUDUSD pair being in a strong bearish trend and the EMA as the middle line with the Bollinger Bands indicator is acting as a perfect place to sell spikes.
Ichimoku Kinko Hyo
The Ichimoku indicator, or the Ichimoku cloud, as it is being also called, is the most famous Japanese technical analysis indicator. It has multiple advantages on top of other Western-based indicators, and one of the biggest advantages is the fact that it projects future price levels forward in time. In other words, with the Ichimoku cloud, traders will know twenty-six periods ahead (using the default settings) what the future resistance or support levels will be. This represents a great competitive advantage when chasing a trend as it gives the opportunity for traders to incorporate the time element in their analysis.
The chart above shows the AUDUSD pair hitting the cloud and this is a strong support level in a bullish trend. You must imagine that this cloud has been projected at this place twenty-six periods earlier. Considering that this is the daily time frame, it means that traders knew in advance twenty-six days earlier that the price is going to find a support first time the cloud is going to be tested. So powerful the Ichimoku cloud is, that it is extremely popular among traders. I won’t insist on the other trend indicators listed at the start of this article as the overall idea is the same: traders are looking to buy dips in bullish trends and sell spikes in bearish ones to add to an already opened position or to start riding a trend. Conservative traders are finding trend indicators appealing and the ones treated in this article are the most famous ones. However, there are multiple other types of moving averages and other trend indicators but they are all showing, in the end, the same thing. Aggressive traders, on the other hand, will enjoy riskier approaches, but more rewarding ones. They’re trying to pick a top or a bottom and, to do that, oscillators are being used.
Recommended Further Readings
- Forex Trading – Explaining the Concept
– What is forex trading, generalities about trading the currency market.
- Forex Trading Sessions and Their Importance
– Explaining the differences between the three Forex trading sessions, what are their importance, ranking, etc.
- Forex Brokers Types – ECN or STP?
– What is ECN, STP, how d- brokers deal with client’s orders, advantages, and disadvantages of the tw- types.
Other Educational Materials
- The use of fundamental and technical analyses by foreign exchange dealers: Hong Kong evidence. Lui, Y.H. and Mole, D., 1998. Journal of International Money and Finance, 17(3), pp.535-545.
- “Forecast forex with ANN using fundamental data.” Eng, Ming Hao, Yang Li, Qing-Guo Wang, and Tong Heng Lee. In Information Management, Innovation Management and Industrial Engineering, 2008. ICIII’08. International Conference on, vol. 1, pp. 279-282. IEEE, 2008.