How to Use Technical Indicators to Increase Profits in Trading Forex & Commodities
Do the colored lines in the stock market charts confuse you? What value can these wild lines add to your chart analysis, and how can you use these indicators to forecast the market? This is what you will learn in this article. We are going to explore the most important technical indicators for better trading results in forex & commodities!
You might also be interested in our online trading courses and a beginner’s guide to trading commodities.
I. What Are Technical Indicators?
The 7 technical indicators for Forex are mathematical tools that analyze one or more of the following values:
- Opening price (OPEN)
- High point (HIGH)
- Low point (LOW)
- Closing price (CLOSE)
- Volatility
- Volume
Technical indicators are recorded as chart patterns. Sometimes they are drawn directly into your chart and sometimes into a separate window. There are thousands of technical indicators, as anyone with programming experience can create their own. But you do not need to master all of them. In this article we will focus on only the most important technical indicators for forex trading.
The goal of this article? You should understand the logic behind the main technical indicators, know about the strengths and weaknesses of technical analysis indicators and learn how to put them together to help you become a successful trader in the most efficient way. In some cases, we will also briefly explain the basic calculations of these trading indicators. We will discuss the fundamental analysis for forex traders in our next blog.
Note: If you are just starting in forex trading, you should always keep in mind that there is no holy grail that leads to success. This also applies to the use of various technical indicators. To trade forex and commodities successfully, you must follow the same path that all other successful traders have followed. Your primary goals must always be to protect and preserve your capital!
II. The 7 Most Important Technical Indicators
1. Simple Moving Average (SMA)
The Simple Moving Average (SMA) was already popular in the past because it could be calculated easily without the use of a computer. It is still very popular today – and despite the possibilities of powerful charting software, it continues to attract traders due to its simplicity alone.
The SMA is calculated by adding the average closing prices of X price bars or candlesticks over a certain period. These values are then divided by the corresponding period X. The basic approach of this trend-following indicator is to compare prices with the SMA to capture the market sentiment.
- Prices above the moving average → bullish
- Prices below the moving average → bearish
You can also view the slope of the SMA:
- The line of the moving average slopes upwards → bullish
- The line of the moving average slopes down → bearish
You can also use it as a support and resistance level by placing the moving average on the price chart.
2. The Exponential Moving Average (EMA)
In the past, there was only the Simple Moving Average (SMA). But as time went by, traders were no longer satisfied with this simple indicator and started experimenting with the SMA. As a result of these experiments they called the original average “simple average” to distinguish it from the new complex methods. One of these complex versions is the Exponential Moving Average (EMA).
Like the SMA, the EMA is based on the addition of the closing prices – whereby the sum is divided by the X price bars of the corresponding period. However, this is not a simple average, but a weighted average. In this version, the current or younger prices are weighted more heavily than the more recent or older prices. This exponentially smoothed moving average, therefore, reacts more strongly to current prices.
The aim is to capture the interplay between SMA and EMA. Since the exponential average reacts more strongly to current prices, it generates more trading signals from bullish to bearish market events or vice versa. However, the more signals a moving average produces, the less reliable the respective signal is. This is an inevitable conflict that occurs with all technical indicators.
3. The Stochastic Oscillator (SO)
The Stochastic Oscillator by George C. Lane has been one of the classic oscillators since its invention decades ago. The “stochastic” is composed of two (exponential) average lines, called the %K line and %D line, oscillating between 0 and 100.
If extreme prices (high or low) develop in a certain trading range, there is a strong price movement in one direction. But the momentum may not be sustainable. This is why so-called overbought and oversold areas arise:
- Stochastic value above 80 → overbought (search for selling or short opportunity)
- Stochastic value at 20 → oversold (search for buying or long opportunity)
Also, the combination of %K and %D produces accurate signals:
- %K line falls below %D line → Sell signal
- %K-line crosses %D-line → Buy signal
4. Relative Strength Index (RSI)
When we talk about technical indicators, there is one person we cannot get past – J. Welles Wilder. The RSI is a tool among many indicators that Welles Wilder invented. The Relative Strength Index measures the speed and extent of current price movements. It compares average price increases with average price losses to locate situations when a product is overbought or oversold.
If the average increase exceeds the average decrease on a sustained basis, prices will probably fall. If the average decline outweighs the average decline, this indicates that prices will soon rise. That means:
- RSI value above 70 or turns close to it in opposite direction (down) → overbought (search for selling opportunity)
- RSI value below 30 or turns close to it in opposite direction (up) → oversold (search for buying opportunity)
The sensitive and fast-reacting RSI-Indicator is especially popular for the determination of exit and re-entry signals in trading positions. Day traders also like to use it to open counter positions.
5. Bollinger Bands (BB)
A Bollinger Band (or band in short) indicates the upper and lower limits of common price movements. It is usually plotted against an SMA at two standard deviations. 95% of price movements should be within the bands if prices follow a Gaussian bell curve.
Why are Bollinger Bands important? They are used to measure volatility and provide strong support and resistance zones when the market does not show a clear trend.
The Bollinger Bands can be used as a rough indicator of subsequent price movements, as the price usually tends to move within the bands. If there is a price movement to the upper border, a downward trend is likely to follow soon. If the price is moving towards the lower band, this indicates a subsequent upward trend. At the lower Bollinger Band is bought, at the top is sold.
However, the evaluation and interpretation of the Bollinger Bands only serves as a rough guide and not as a clear trading signal, as additional parameters (oscillators & indicators) must be considered.
Tip: In a trend market, the bands move away from the SMA. A wider range of Bollinger Bands indicates a strong trend. As soon as the distance between the two shells becomes smaller, the trend loses strength.
6. Support & Resistance Lines
Support & Resistance lines are an important cornerstone of technical analysis. If you compare historical charts and price trends, you will find different points at which the price could not rise or fall any further. If you connect these points, you get support (price cannot fall further) and resistance (price cannot rise higher) lines.
If the price should come back into the areas of these lines, you can assume that the course of the price will turn again. Of course, this does not always happen, but it is an important indicator. The more often such a line is confirmed, the more reliable it is. Naturally, one should always keep in mind that other traders know this too – and that the line will only hold as long as the majority of traders see it that way.
Tip: If the price is significantly above or below the resistance or support line, then it is often very likely that the price will continue its course and not turn.
7. Commodity Channel Index (CCI)
The CCI was developed by Donald R. Lambert. Although this indicator was originally intended for trading in the commodity markets, it is also used for other financial instruments. Here, the difference between the price and its moving average is used to capture momentum. That is why we compare the difference between the current observation period and the average difference of the past X periods.
Unlike the Stochastic Oscillator and the RSI, the values of the CCI are not limited. But in practice, due to its construction, the CCI moves between -100 and +100. As the name suggests, the CCI assumes that prices are normally within an invisible channel around the moving average. If you trust that this invisible channel will hold, follow these rules:
- CCI values above +100 → Overbought (search for sales opportunity)
- CCI values at -100 → Over-sold (search for buying opportunity)
I trust that this article helped you to understand seven of the most fundamental technical indicators for forex and commodities trading – now it’s your turn. Go and implement these indicators in your daily trading opportunities and watch your profits potentially increase. We wish you all the best and lots of trading success! Read Jesse Livermore’s stock trading tips to further improve your trading skills
