As a beginner in the forex market, you must keep in mind that each type of indicator has a unique configuration to bring out the most conscientious signals. Just like a task which can be done by a screwdriver cannot be accomplished by a spade, you cannot analyze the high point of a currency with the technical tool developed for analyzing a trend.
There are two important rules that every forex trader has to keep in mind while getting trading signals using technical analysis:
- Keep everything simple.
- Be disciplined and strict with your money management.
Technical tools are designed in such a way that it leaves a little scope for any uncertainty. The primary use of this analysis is to identify and act instantly when the currency value hits the correct point. A trader should take all the vital steps to control the risk of loss. Even a tiny mistake can take the account downwards in a spiral mode. Once all the necessary measures related to the risk management are taken, a trader is then ready to go on a journey to become wealthy and prosperous.
Following are the tools used by the most successful forex traders to analyze the price action:
The movement of a price can be from zero to any number on the charts. Although there is always an upper limit price of currency, it is tough to estimate how up it will go.
Let’s take an example, the price of currency pair EUR/USD is 1.10. We can consider 1.30 as a very high price. If we see logically, there could be other high prices such as 1.25 or 1.35; it is tough to place a stop loss or take a decision to close the position at a particular price and bag the profit.
From this example, it must be clear that you need something using which it becomes easy to confine the price action into more practical range. Using this range, you can easily interpret where to buy and where to sell to make maximum profits.
But how to decide the range?
Well, this can be easily done with the help of a very powerful technical tool called “oscillators”. This tool can overcome all the obstacles that lead to a lack of precision in defining the highs and lows of currency. Different types of oscillators with different formulas were developed in the past decade with a similar aim i.e. readjusting the price data in such a way that it can provide a designation of overbought and oversold levels. Overbought value means that the trader has pushed the price too high in comparison to what it has been in the past. On the other hand, an oversold value indicates that the trader has kept the price too low as compared to where it hit in the past. In both cases, the best option is to do a contrarian trade to make good profits.
There is a predefined upper and lower values in the oscillator beyond which the oversold and overbought designation is hit. In the case of an overbought level, the trader will consider closing the position by selling the currency. On the other hand, when an oversold price hits, the trader opens the position by buying a currency pair. Different oscillators work according to the different price patterns of the market. Some are good in trending market while other works well in the periodic market. For Example, Stochastic and RSI are best when the market is in a periodic mode while the MACD and Williams provide their most useful indicators in a trending market.
Even under the best circumstances, many traders doubt the oversold and overbought readings of an oscillator. Oscillators are useful when you want to reduce the confusion of how high should be high and how low should be low, but still sometimes market acts in a weird way. Suppose the RSI reading at 80 is considered as an overbought value, but in some cases, the price even shoots up to 95 without taking a u-turn.
This problem can be avoided by making use of the concept of convergence/divergence between the price and the indicator. Although rarely used, this concept has a greater significance attached to it. Let’s have a look….
A bullish convergence/divergence occurs when the oscillator is indicating a lower low, but the actual price is further on the lower side. This means the price is now going to break the downtrend momentum. A bearish convergence occurs when the oscillator is indicating a high, but the actual price is going much higher. This is an indicator that the uptrend is running out of power. It is recommended that in both the cases you should go for contrarian trade.
Some of the highly recommended oscillators by the successful traders are Stochastic, RSI, Williams Oscillator, Average True Range, Force Index and MACD.