Technical Indicators

There are literally hundreds of technical indicators out there in the market. And if you are not careful, they can easily distract you from the business of making money.

The novice trader litters his graph with a multitude of technical indicators, and in the process confuses himself trying to follow and act upon each indicator, many giving conflicting signals. The most successful trading strategies aim for simplicity, using just a few powerful indicators.

The original strategy we refined (to create our own unique trading strategy) uses just a few technical indicators:

• Relative Strength Index (RSI)
• Elliott Waves
• Fibonacci Numbers / Retracements

These may seem complex initially, but in reality they are quite simple to apply. Only a basic understanding of those indicators is required in order to use the original strategy. Your graphing software should automatically apply the indicators to your charts.

We'll take you through these three indicators and one other (Moving Averages) that we use with our own strategy.

We should indicate, at this stage, that our strategy does not require an understanding of RSI and Fibonacci Numbers / Retracement.

 

Relative Strength Index (RSI)

Relative Strength Index (RSI) measures the strength of all price increases against the strength of all price decreases in a specified time frame.

It is a tool available in most charting packages. You don't really need to understand how RSI is calculated. You only really need to know how to add it to your chart. Your charting software will let you do that quite easily.

Nonetheless, here is the formula:

RSI = 100 - [100 / (1+RS)]

RS = average of n day's up closes / average of n day's down closes

You only need input the RSI period and your graphing software will generate RSI.

The most common RSI period is 14. If you're looking at daily candlesticks, 14 would be equivalent to 14 trading days. If you're looking at hourly candlesticks, 14 would be equivalent to 14 hours, and so on.

RSI can range from 0-100. In the formula, if RS = 1, this means the average price increases equals the average of price decreases, i.e. RSI = 50. The market is having an equal strength of upward and downward force. In other words, the bulls and bears are equally matched.

If RSI > 50, this means the upward force is stronger than the downward force (bulls are in charge).

If RSI < 50, this means the downward force is stronger than the upward force (bears are in charge).

RSI is often used to detect overbought and oversold conditions

If RSI < 30, the market is considered oversold; prices are expected to rise. Traders will most likely buy at that point. ditions

If RSI > 70, the market is considered overbought; prices are expected to fall. Traders will most likely sell at that point.

Graphing software depicts RSI as an oscillating line at the bottom of the graph, as shown below:

 

Elliott Waves

Prices tend to move in waves. When a currency pair is on an up-trend, it will likely reach a top and then retrace – meaning pull back down – before resuming its initial trend. The same holds true for a currency pair in a down trend.

No matter how strong a long-term trend, the market never moves only in the direction of the long-term trend. There are always minor movements against the long-term trend. These movements usually don’t last very long and afterwards the market moves again in the direction of the long-term trend.

(This theory was first postulated by Ralph Nelson Elliott, a corporate accountant. Hence, the concept is referred to as Elliott Wave Theory).

The major market movements in the direction of the long-term trend are called impulsive waves. The major market movements against the long-term trend are called corrective waves.

Here is an example:

The red lines (impulsive waves) move in the direction of the long-term trend. The blue lines (corrective waves) move against the long-term trend.

Fibonacci Numbers / Retracement

Leonardo Fibonacci was a 12th-century Italian mathematician. He is known to have discovered the Fibonacci numbers, which are a sequence of numbers where each successive number is the sum of the two previous numbers.

e.g. 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, etc.

These numbers possess a number of interrelationships. For instance, any given number is approximately 1.618 times the preceding number. Fibonacci numbers are a phenomenon that has been observed in many walks of life, not least in technical trading.

In technical trading, Fibonacci numbers are used to anticipate price reversal points. This is because prices tend to reverse at or near lines created by the Fibonacci numbers.


Fibonacci Retracements are levels at which the market is expected to retrace to after a strong trend. It is also used to indicate when a corrective wave is likely to end and an impulsive wave begins.

Fibonacci retracements attempt to measure the likely price that a currency pair will retrace to, or pull back to. In forex trading, prices tend to retrace to 38.2%, 50%, or 61.8% of the initial trend.

This may seem complicated, but in reality, it couldn’t be simpler. Once you draw the trend line (on the graph), with the click of a mouse your graphing software will draw your Fibonacci (Fib) lines. The original e-book provides step-by-step instructions on how to apply the technique. With a little practice, the set up could take just a few seconds.

Here is an example of a Fibonacci retracement setup.

Moving AverageMoving averages are among the most popular tools used in technical analysis. It is very easy to use.

Moving averages smooth a data series making it easier to spot trends. This is particularly helpful in volatile markets.

This chart shows EUR/USD 1 hour 20-day chart with a 150 period moving average as a green line.

 

The two most popular types of moving averages are the Simple Moving Average (SMA) and the Exponential Moving Average (EMA).


The Simple Moving Average is the average price over a given time period. It is calculated by adding the closing prices of the currency pair for a number of time periods, and then dividing this total by the number of time periods. The nature of a simple average is such that an equal weighting is given to each price.


Generally, when you hear the term "moving average", it is in reference to a simple moving average.


The Exponential Moving Average is similar to a simple moving average, except that more weight is given to the latest (more recent) data. In other words, it gives more importance to recent price changes, than to older price changes. Consequently, this type of moving average reacts faster to recent price changes than a simple moving average.


Technical traders use moving averages in many ways to help them predict price movements. None of those approaches are relevant to our strategy. We incorporate a special moving average (EMA 150) on our chart merely to see the trend at any point in time.


Moving averages are available in most charting packages. No need to understand how they are calculated. You only need know how to add them to your charts within your charting software. Simple instructions in the software tell you how to do that.