Forex Trading Indicators

What Are All Those Strange Lines And What Do They Mean?

Indicators are mathematical perspectives that are applied to a currency pair’s chart.

Different indicators have been created through the years by mathematicians and analytical investors, and are designed to illustrate different aspects of the currency pair’s movement.

They calculate important variables related to the graph, for example, all high prices for the last nine days, or buying pressure versus selling pressure—and then apply them to the graph, to give traders some idea of what’s going on in the market.

For example, some indicators show if a trend is weakening and preparing to reverse, which helps you time the closing of any active trades. Some can also show whether a currency pair has been overbought or oversold, and when to enter the market to capitalize on that fact. Others can give hints when a big breakout from a price channel might be coming.

Indicators are categorized in several different ways. Because some indicators show where the price has been, while others show where the price might be going, these are sometimes referred to as lagging and leading indicators.

Some indicators measure price, others momentum. (When momentum changes, so might the direction of the trend.)

Different indicators are useful in different market situations. Some work well in trending markets, others in range-bound or momentum markets.

Many indicators are oscillators, which work on the statistical principle of regression to a mean. Put simply, in any given sample of numbers, many of the members of the group should be numerically close to the mean of the group. If the price (which is what this sample is usually based upon) strays beyond that point, then it should revert back toward that mean.

Oscillators aren’t splashed across the chart itself, but displayed in a band along the bottom of the chart, because they’re based on a different set of numbers than the chart itself.

Other indicators are moving averages, which find the average of a currency pair’s price over a given number of days then plot that line atop the chart. Moving averages smooth out fluctuations, making intermediate- and short-term trends easier to spot. Some moving averages give more weight to recent prices than distant ones; these are called exponential moving averages (EMA).

A third variety of indicator is the price envelope, which is actually two moving averages, one above the price and the other below the price, graphed atop the chart.

Price envelopes are similar to the lines drawn on a chart, connecting support and resistance points (as discussed in the article on technical analysis and chart interpretation), in that they help to identify trends and define the limits of a price channel. The price bounces from the top of the price envelope to the bottom, indicating where to buy and sell.

There are hundreds of different indicators out there, practically one for every broker, and forex software packages for traders that allow you to create your own. But when using indicators, generally less is better.

Too much information can lead to “analysis paralysis” and cause confusion rather than clarity. Practice trading with one or two indicators of different sorts and get to know them well, and study what they say about your favorite currency pairs.