How to Use Forex Indicators

Adam Lemon

With so many Forex indicators available to traders, it can be difficult to know when and how to use them successfully. Having a good grasp of the foundational forex indicators from the humble moving average to Ichimoku Kinko Hyo, can save you from a blind over-reliance on them which ruins so many Forex traders. This article will explain what indicators are, detail a selection of the most popular and best indicators, then explain why and how they can be useful, giving concrete tips on how to use indicators in your trading.

What is a Forex Indicator?

When people speak of a “Forex indicator” they usually mean a technical indicator used in Forex trading.

A technical indicator is just a formula, alternatively known as an algorithm, which calculates an indicated value by applying its formula to historical prices.

The basis of every Forex technical indicator is a historic price series: past prices. The user of the indicator can usually adjust how much historic price data should have the indictor formula applied to it to produce an output.

For example, if you apply the technical indicator average true range (ATR) with a setting of the last 15 days to a daily chart of the EUR/USD currency pair, the indicator will calculate and display the average daily volatility over the past few days in the EUR/USD. You can view the value displayed and use it to make trading decisions. An experienced trader might be able to roughly calculate this value just by looking at the price chart, without using an indicator, in the same way an experienced driver of a car might be able to guess the approximate speed of the vehicle without looking at the speedometer indictor that all cars have. Indicators just make things easier by quickly calculating accurate data for you as a trader to use.

Forex traders may use indicator data to anticipate future price movement, as the basis of technical analysis is the use of historic prices to calculate likely future price movements. 

These indicators are typically overlaid over a price chart (as in the case of a moving average), or underneath, making them easy to view, understand, and use.

The Best Forex Indicators

The list below includes some of the best and most popular Forex indicators for Forex traders of all types and are widely available as part of almost all charting packages. Let’s look at them one by one in more detail to understand what they do and how each can be used as part of an indicator-based trading strategy:

Moving Averages

Probably the most popular indicator is the moving average (which can be simple, exponential, or smoothed) which depicts the average change in price over a specified look back period. A moving average can be used to determine trend direction and momentum, as mobile support and resistance levels, and to determine entry and exit points (typically with multiple moving average crossovers). Moving averages are used as indicators within many successful trading strategies, sometimes as moving average crossovers.

200-Day Moving Average Sloping Up Suggests Bullish Trend

200-Day Moving Average Sloping Up Suggests Bullish Trend

Moving Average Convergence Divergence (MACD)

The MACD Forex indicator presents values representing the momentum and trend bias of a Forex pair to establish potential trading signals. The components of the MACD include two Exponential Moving Averages (EMAs) and a histogram representing the calculation, which is the subtraction of the longer period (slower) moving average from the shorter period (faster) one. The EMAs are split between a signal line (faster) and MACD line (slower). When the MACD is trading above the zero line then the market is said to be in an uptrend and vice versa. This further above or below the zero line, the stronger the momentum.

MACD in Lower Panel Shows Strong Bullish Divergence

MACD in Lower Panel Shows Strong Bullish Divergence

Relative Strength Index (RSI)

Used to identify overbought and oversold conditions, the RSI is a momentum indicator that is frequently applied to potential Forex trading setups as an additional or sole indicator. The RSI is calculated by comparing all price gains made during the look back period with all the price declines and relating them, so an even balance is at a value of 50. Therefore, a reading above 50 suggests bullish momentum and vice versa, and the further above or below 50, the stronger the momentum. Readings below 30 suggest oversold conditions while those above 70 suggest overbought conditions.

The RSI is an enormously powerful indicator, and if I were going to only use one or two indicators, I would pick the RSI and the average true range (ATR) indicator. The RSI can be used successfully as a standalone indicator on higher time frames on major Forex currency pairs and some other asset classes. There are very few other indicators that such a claim can be made for.

RSI in Lower Panel Shows Recent Bullish Crosses of 50 & 70 LevelsRSI in Lower Panel Shows Recent Bullish Crosses of 50 & 70 Levels

Parabolic SAR (Stop and Reversal)

Developed by the creator of the RSI, the parabolic SAR is used to indicate the likely start and end of price trends as well as potential changes in price direction. In its simplest form, when the parabolic SAR dots display below price data, we favour a buy signal and when dots display above price data, we favour a sell signal.

The parabolic SAR indicator is calculated by examining the series of highs and lows within the look back period and determining whether the sequence is accelerating at an increasing or decreasing rate.

Parabolic SAR Stop Loss Indicator Would Keep You in Long TradeParabolic SAR Stop Loss Indicator Would Keep You in Long Trade

Stochastics

Stochastics are oscillators that aim to provide traders with possible buy and sell points based on changes in momentum. Readings range from 0 – 100. Prints above 80 signal overbought areas giving a selling bias, while prints below 20 signal an oversold market and a buying bias.

As an oscillator indicator, it is most useful in ranging conditions or in weak trends. It is calculated by comparing the current price with the range of closing prices within the look back period.

Average Directional Index (ADX)

The Average Directional Index (ADX) tries to indicate the intensity of a trend. The higher the ADX reading, the stronger the trend, while a lower reading shows a weaker trend. It is important to note that the ADX does not indicate trend direction, but only trend strength.

The ADX indicator is most useful in trend trading for filtering trends. For example, if you decide you only want to trade strong trends, then you would wait to enter a trade until you saw the ADX reach a certain minimum value (many traders use 30). On the other hand, some Forex traders prefer a strategy of entering before a trend gets overly strong, so these traders might want to see the value below 30.

The ADX indicator is calculated by determining the exponential moving average of upwards price thrusts minus downwards price thrusts over a look back period.

ADX Over 30 Shows Strong TrendADX Over 30 Shows Strong Trend

Bollinger Bands

Bollinger bands are commonly used to indicate not only trend but volatility. The more volatile a market gets, the further the bands widen. When the bands are very tightly bunched together, a volatility squeeze is indicated, giving a potential trade entry point. Trend is indicted by the angle of the bands. Bollinger bands do not only indicate which direction to trade, but also indicate opportune entry times and areas, and as such are one of the more versatile Forex indicators.

Bollinger Bands display around a moving average line with an upper and lower band representing a specified standard deviation away from the moving average. Settings for the standard deviations and moving average can be customised to preference: typical values are 1 standard deviation and a 20-period moving average.

Steep Slope Shows Strong Trend, Wide Bands Show High Increased VolatilitySteep Slope Shows Strong Trend, Wide Bands Show High Increased Volatility

Average True Range (ATR)

The Average True Range (ATR) simply indicates the average price range in pips per unit of time over the defined look back period. For example, applied to a daily chart with a 15-day look back setting, the indicator shows the trader by how much on average the price can be expected to move over the next unit of time. Used in this way, the ATR can be a powerful tool for determining trade exits, either by targets or used as a multiple for a trailing stop loss. Yet the ATR indicator can give an even better edge in another way which is often overlooked: when the price is moving firmly in one direction on above-average volatility, the price is a little more likely to move more in the same direction during the next period than against it, and this is enough to give a trader an edge. Changes in volatility regimes are often signals of imminent trend changes.

The ATR is a useful and very underrated indicator.

ATR Indicator Shows Rising or Falling Average VolatilityATR Indicator Shows Rising or Falling Average Volatility

Fibonacci

Fibonacci is a mathematical sequence that has been observed in natural architectures. Some technical analysts believe that human behaviour can mirror this sequence, so believe that when the sequence is applied to recent movements on a price chart, it can identify key levels which are more likely to become key support or resistance levels.

Some traders who use Fibonacci believe it is most useful for confirming suspected support or resistance levels which have already been confirmed by other indicators or analysis.

Fibonacci levels can be used for entries, stop losses, and take profit levels.

There are two types of Fibonacci levels:

  1. Retracements – these are percentages of the move from A to B, back towards A from B.

  2. Extensions – these are the percentages showing a future move from B to C.

Both types of levels are based upon the following percentages of a move from A to B:

23.6%, 38.2%, 50% 61.8%, 78.6%, 100%, 161.8%, 261.8%, and 423.6%

Pivot Points

Pivot points are prices which are calculated by a simple formula based on the previous period’s open, high, low, and closing prices. Pivot points can be used in the same way as Fibonacci levels to determine likely support, resistance, stop, limit, entry and exit points.

The pivot points indicator draws three price levels below the opening price and three above it.

Ichimoku Kinko Hyo

Also known as Ichimoku or IKH in trading circles, this Japanese indicator is avoided by many traders due to its complex appearance. The Ichimoku has several components but if you break down each aspect, the Ichimoku can be extremely insightful in some areas. The indicator is believed by some to have the ability to anticipate future price movements as well as reveal support and resistance zones.

One part of the Ichimoku, the line, is remarkably like the MACD indicator. The most unique part of the Ichimoku is its Cloud, which predicts future areas through which the price will struggle to move – a particularly useful indicator to traders when correct.

Ichimoku Kinko Hyo IndicatorIchimoku Kinko Hyo Indicator

Non-Repainting Indicators in Forex Trading

Unlike repainting indicators which are often used to mislead individuals to purchase trading algorithms and programs through their accuracy, non-repainting indicators cannot be faked.

Non-repainting indicators utilise price data from prior price data and cannot alter their values to appear more profitable once the price bar is closed. Some Forex indicators can be built to work in either repainting or non-repainting formats, and anyone using such an indicator really needs to know what version it is. Repainting indicators always appear to be more successful than they really were. A quick way to check if an indicator is repainting is to monitor whether the indicator continues to change a historic value once a candlestick has closed.

The Forex indicator which is most typically used in both non-repainting and repainting formats is Bollinger Bands, but there are many other minor Forex indicators based on standard deviation which are also used in both formats. There is nothing wrong in using either format if you are aware of which format you are using, and how different the same readings look in the other format.

How to Use Forex Indicators for Exits/Profit Taking Signals

Trade exits are, for most traders, one of the most challenging aspects of trading. Exit too soon and you might miss huge further profits, too late, and you might watch a winning trade turn into a loser.

Some traders use profit targets which they set as take profit before walking away from the trade and letting it play out. It can be very challenging to use this method successfully as part of profitable trading.

Traders looking to hit set profit targets will typically try to identify key support or resistance levels to be used as targets, and the indicators that are usually used in identifying such levels are:

  1. Fibonacci extensions

  2. Pivot points

  3. Moving Averages, either as a cross or as mobile support/resistance

Most traders find that a better approach is to let the trade keep advancing into profit as long as it is moving in the right direction over time. This tends to be a better approach, especially when used in momentum or trend trading. One approach to manage this process is to use a trailing stop, which is typically based upon volatility or the initial stop loss, which may also be based on volatility. This is one reason why the ATR indicator can be so useful.

Other traders may use a variety of indicators to judge when a trade has run out of positive momentum, and to execute a trade exit at that point. For example:

  1. ATR – when the price makes a huge directional move in favour of the trade, on far above-average volatility, and then begins to reverse, this is often a sign of climax and exhaustion signifying that the price will not make a better price.

  2. RSI – momentum stops increasing and begins to fall towards or even below the 50 level.

  3. Bollinger Bands – the price falls back into the mid-zone of the bands.

Personally, I like to use a trailing stop based upon volatility at the entry point, applied to closing prices. For example, if I am entering a long breakout trade in USD/JPY, my initial stop loss will be the 15-day ATR, and for every higher closing price, I will move the soft stop loss up by the same amount. When I get a daily close below that soft stop loss, I exit the trade.

It is worth remembering that you cannot realistically hope to get exits exactly right all or even most of the time. The best you can achieve is to reach a balance between sticking with winners and not staying too long with losers. You will never get even close to exiting in all the optimal places in all your trade, so it is best not to try too hard at that.

The important thing about determining trade exits is to make a method which ensures you participate well in the big winners.

What are Leading Forex Indicators and Why are They Useful?

Forex indicators can be divided into two types, leading and lagging.

A lagging indicator tells you something that has already happened. For example, if a momentum indicator such as the RSI calculated at the close of every candlestick shows that its value has dropped considerably, this means that momentum has already slowed significantly.

A leading indicator gives you a forecast that something which has not happened yet has some chance of happening. For example, suppose that the price of EUR/USD has risen strongly from $1.0900 to $1.1000, breakout out cleanly beyond a key resistance level at $1.0990. The Fibonacci extension indicator would suggest that the price is now likely to reach at least as high as $1.1023.

Leading indicators are generally those which predict support and resistance levels. However, there are other leading indicators such as economic data prints, breakouts, or seasonality, all of which forecast that the price will move more in one direction than the other over the near term.

Although they are potentially extremely useful to traders, leading indicators should be approached with caution, as they are used to predict events that have not yet unfolded so any market changing news or inputs could alter the initial trajectory and render the trade unprofitable. Generally, it is a good idea not to rely solely upon leading indicators in your trading, but instead to use them as confirmations where appropriate.

Final Thoughts

Using Forex indicators can be a daunting task for traders beginning their journey but taking the time to understand their functions will go a long way towards helping you choose the most suitable indicators for your type and style of trading. More is not always better in trading so be discerning. Many Forex beginners make the mistake of using too many indicators and blindly relying upon entering and exiting trades as soon as certain values are displayed. This can lead to overtrading, big losses, and a loss of confidence, because the trader who is over-reliant on indicators never learns how to read the market themselves.

You should probably not be using more than two indicators, at the very most three, applied at the same time to a single Forex price chart.

When you use indicators in Forex, you should be aiming to get to a place where you can just glance at a naked price chart, without indicators, and tell approximately what the values of your favourite indicators will be. This will help you use indicators better, and to realise that all indicators do is a paint you a picture of the technical situation, and that they will not give you bullet-proof entries and exits based on supposedly magical look-back settings.

Study the diverse types of indicators and know what they do and how their output values are calculated, before using any in your trading.

Finally, remember that you will get much better results applying indicators to higher or multiple time frames than you will by doing anything else with them.

FAQs

Which indicator is best for Forex?

The best indicator for Forex depends upon your trading strategy and style. For example, a momentum trader may find the RSI most useful, while a short-term day trader might get better results relying on moving average crossovers for entry and exit points.

What are the 4 types of indicators?

Within the realm of trading indicators there are four subcategories including:

  1. Momentum Indicators

  • Relative Strength Index (RSI)
  • Commodity Channel Index (CCI)
  • Moving Average Convergence Divergence (MACD)
  • Average Directional Index (ADX)
  • Stochastic
  1. Volume Indicators

  • Volume Rate of Change
  • Chaikin Oscillator
  1. Volatility Indicators
  • Standard Deviation
  • Bollinger Bands
  • Average True Range (ATR)
  1. Trend Indicators

  • Parabolic SAR
  • Moving Averages
  • Moving Average Convergence Divergence (MACD)

What are indicators in the Forex market?

A Forex indicator is an algorithm, based on historic price or economic data, which gives a value as an output that can then be used by a Forex trader to predict whether the price will rise, fall, or stay the same. Most Forex indicators use historic prices, not economic data, as input.

Adam Lemon

Adam Lemon began his role at DailyForex in 2013 when he was brought in as an in-house Chief Analyst. Adam trades Forex, stocks and other instruments in his own account. Adam believes that it is very possible for retail traders/investors to secure a positive return over time provided they limit their risks, follow trends, and persevere through short-term losing streaks – provided only reputable brokerages are used. He has previously worked within financial markets over a 12-year period, including 6 years with Merrill Lynch.
Learn more from Adam in his free lessons at FX Academy

Did you like what you read? Let us know what you think!

exclamation mark

Please make sure your comments are appropriate and that they do not promote services or products, political parties, campaign material or ballot propositions. Comments that contain abusive, vulgar, offensive, threatening or harassing language, or personal attacks of any kind will be deleted. Comments including inappropriate will also be removed.

0 User comments

exclamation mark

Please make sure your comments are appropriate and that they do not promote services or products, political parties, campaign material or ballot propositions. Comments that contain abusive, vulgar, offensive, threatening or harassing language, or personal attacks of any kind will be deleted. Comments including inappropriate will also be removed.

Read more
Add new comment
This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.