1

Indicators
What is a Forex Indicator? A Forex indicator is a tool that notifies you of up and down trends
in the market; it gathers market information and with the information gathered it
represents the information to you in a graphical form that will help you gauge the future
market movement of whichever currency Pair that you are trading. Indicators give you a lot
of useful information that can be very helpful to one’s trading depending on how the
information is used; they reveal VOLUME, where the trend is heading; potential reversals
(where trend might stop and reverse) and many more useful information. So an indicator is
anything that can be used to predict future financial or economic trends.

Leading and Lagging indicators

Indicators are split up into two categories, Leading and Lagging indicators.
Leading indicators
Leading indicators are indicators that usually change before the economy as a whole
changes. Leading indicators are also called oscillators, they are therefore useful as short-
term predictors of the economy. Stock market returns are a leading indicator: the stock
market usually begins to decline before the economy as a whole declines and usually begins
to improve before the general economy begins to recover from a slump. Other leading
indicators include the index of consumer expectations, building permits, and the money
supply. A composite Leading Economic Index consisting of ten indicators is designed and
published to predict activity in the economy six to nine months in the future.
A leading indicator gives a signal before the new trend or reversal occurs.

Lagging Indicators

A lagging indicator gives a signal after the trend has started. Lagging indicators are
indicators that usually change after the economy as a whole changes. Typically, the lag is a
few quarters of a year. The unemployment rate is a lagging indicator: employment tends to
increase two or three quarters after an upturn in the general economy. In a performance
measuring system, profit earned by a business is a lagging indicator as it reflects a historical
performance; similarly, improved customer satisfaction is the result of initiatives taken in
the past. Lagging indicators are also trend-following indicators or momentum indicators.

1
Manqoba ndlovu
Trend Indicators
Trend indicators help you to determine where the overall trend is going, in trading we were
taught that the trend is your friend and whatever you do you need to follow the trend while
trading because that is where the money is. While the statement mentioned can be argued
the fact still remains that trading is about predicting the future movement of the market
and it is important to know where the current market is going because the probabilities are
very high that the trend will continue to go wherever it is going, so it is important to know
where the current trend is going. We can see where the current trend is heading by drawing
simple trend lines ( we hope that by now you know how to draw trend lines) or you can just
turn to your indicators and they can tell you.

MACD
MACD is one of the simplest and most reliable indicators used by many Forex traders.
MACD (Moving Average Convergence/Divergence) has in its base Moving Averages. It
calculates and displays the difference between the two moving averages at any time. As the
market moves, moving averages move with it, widening (diverging) when the market is
trending and moving closer (converging) when the market is slowing down and possibility of
a trend change arise.

Basics behind MACD indicator

MACD indicator is based on Moving Averages in their simplest form. MACD measures the
difference between faster and slower moving averages: 12 EMA and 26 EMA (standard).
MACD line is created when longer Moving Average is subtracted from shorter Moving
Average. As a result, a momentum oscillator is created that oscillates above and below zero
and has no lower or upper limits. MACD also has a Trigger line. Combined in a simple lines
crossover strategy, MACD line and trigger line crossover outperforms EMAs crossover.
Besides being early on crossovers, MACD is also able to display where the chart EMAs have
crossed: when MACD (12, 26, 9) flips over its zero line, if indicates that 12 EMA and 26 EMA

on the chart have crossed.

How does MACD indicator work

If you take the 26 EMA and imagine that it is a flat line, then the distance between this line
and 12 EMA would represent the distance from MACD line to indicator's zero line. The
further MACD line goes from zero line, the wider is the gap between 12EMA and 26 EMA on
the chart. The closer MACD moves to zero line, the closer are 12 and 26 EMA. MACD
histogram measures the distance between MACD line and MACD trigger line.
Trading MACD Divergence
MACD indicator is famous for its MACD Divergence trading method. Divergence is found by
comparing price shifts on the chart and MACD values.
MACD Divergence phenomenon occurs as a result of shifting forces in the Forex market. For
example, while Sellers may seem to be dominating the market at the moment and price
continues to trend down, there already might be signals for an overall weakening of Sellers
power. These key warning moments can be observed with MACD indicator. What Forex
traders would see is that despite price making new Lower Lows, MACD doesn't confirm that
and instead registers a Higher Low, signalling that Sellers are running out of steam and a
trend change is on its way. The opposite will be true for Buyers.

How to trade MACD Divergence

When MACD line (on our screenshot it is a blue line) crosses Signal line (red dotted line) - we
have a point (top or bottom) to evaluate. With two most recent MACD line tops or bottoms
find corresponding tops/bottoms on the price chart. Connect MACD tops/bottoms and chart
tops/bottoms. Evaluate the lines received, as shown on the larger screenshot (click on the
small picture to enlarge).

With MACD divergence spotted, enter the market when MACD line crosses over its zero
point. Another entry strategy is to find 2 most recent swings high or low on the chart and
draw a trend line through them; and then set an Entry order on the breakout of that trend
line. MACD divergence trading method used not only to predict trend turning points, but
also for trend confirmation. A current trend has high potentials to continue unchanged in
case no divergence between MACD and price was established after most recent
tops/bottoms evaluation.

Moving Averages: EMA and SMA

Moving Averages (MAs) are among the most commonly used indicators in Forex. They are
easy to set and easy to interpret. Speaking simply, moving averages simply measure the
average move of the price during a given time period. It smooth’s out the price data,
allowing to see market trends and tendencies.

How to use Moving Averages

Moving Average is a trend indicator.

Besides its obvious simple function, a Moving Average has much more to tell:
In Forex, moving average is used to determine:
1. Price direction - up, down or sideways.
2. Price location - trading bias: above Moving average - buy, below Moving average - sell.
3. Price momentum - the angle of the Moving average: rising angle - momentum holds,
falling angle – momentum pauses or stops.
4. Price support/resistance levels.
There are 2 types of moving averages that we will be focusing on, they are:
SMA - Simple Moving Average - shows the average price for a given period of time.
EMA - Exponential Moving average - gives priority to most recent data, thus reacts to price
changes quicker than Simple Moving Average.

Most common settings for Moving Averages in Forex

200 EMA and 200 SMA
100 SMA
50 SMA
34 SMA
20 EMA and 20 SMA
10 EMA and 10 SMA
Try and test and then choose your favourite set of Moving Averages.

Stochastic Indicator
Trading with Stochastic indicator involves the following signals:
Stochastic lines cross — indicates trend change.
Stochastic readings above 80 level — currency pair is overbought,
Stochastic staying above 80 level — uptrend is running strong.
Stochastic exiting 80 level downwards — expect a correction down or beginning of a
downtrend.
Same for readings below 20 level — currency pair is oversold,
staying below 20 — downtrend is running strong, exiting upwards above 20 — expect an
upward correction or a beginning of an uptrend.
Stochastic is a momentum oscillator, which consists of two lines: %K - fast line, and %D -
slow line. Stochastic is plotted on the scale between 1 and 100. There are also so called
"trigger levels" that are added to the Stochastic chart at 20 and 80 levels. Those lines
suggest when the market is oversold or overbought once Stochastic lines pass over them.

Let’s look at three methods of trading with Stochastic indicator.

Method 1. Trading Stochastic lines crossover

This is the simplest and most common method of reading signals from Stochastic lines as
they cross each other. Stochastic %K and %D lines work similar to moving averages and:
when %K line forms above and crosses %D line downwards, traders open Sell orders.
when %K line forms below and crosses %D line upwards, traders open Buy orders.
Stochastic lines crossovers that happen above 80% level and below 20% level are treated as
strongest signals, compare to crossovers outside those levels. Traders may choose
sensitivity of their Stochastics. The smaller the Stochastic parameters, the faster it will react
to market changes, the more crossovers will be shown. Sensitive Stochastic (for example 5,
3, 3) is useful for observing rapidly changing market trends. But because it is too choppy it
should be traded in combination with other indicators to filter out Stochastic signals.
Method 2. Trading Stochastic oversold/overbought zones
Stochastic by default has 80% level, above which market is treated as overbought, and 20%
level, below which market is considered oversold.
It is important to remember that while in sideways moving market a single Stochastic lines
crossover that occur above 80% or below 20% will most of the time result in a fast
predictable trend change, in trending market could mean just nothing. When price is
trending well, Stochastic lines may easily remain in overbought/oversold zone for a long
period of time while crossing there multiple times. That’s why a method of trading
overbought/oversold zones stands up. The rules here are to wait until Stochastic lines after
being in overbought/oversold zone come out from it. E.g. When stochastic was trading for
some time in overbought zone – above 80% level, traders wait for the lines to slide down
and eventually cross 80% level downwards before considering to take Short
positions. Opposite for Long positions: wait till Stochastic lines come into the oversold zone
(below 20% level); wait further until Stochastic lines eventually cross 20% level upwards;
initiate a buy order once Stochastic lines are firmly set, e.g. a trading bar is closed and
Stochastic lines cross over 20% mark is fixed.
Method 3. Trading Stochastic divergence
Traders are looking for a divergence between Stochastic and the price itself. At times when
the price is making new lows while Stochastic produces higher lows, this creates dissonance
(lack of harmony) in the picture. It is called divergence. Divergence between price and
Stochastic readings suggest a forming weakness of the main trend and therefore its possible
correction.
RSI (Relative Strength Index) indicator
Relative Strength Index (RSI) - is another great momentum indicator developed by Welles
Wilder. Standard period settings for RSI are 14 periods, which can be applied to any time
frame. RSI indicator compares the average of up and down closes for a specific period of
time.

Trading with RSI indicator involves the following signals:

• RSI moving above 50 level — uptrend is confirmed, below 50 — downtrend is confirmed.
• RSI peaking above 70 level — market is overbought.
• RSI staying above 70 level — uptrend is running strong.
• RSI exiting 70 level — downtrend is underway, or at least a correction down is due.
(Opposite for RSI falling below 30.)
• RSI trend line breakout - early warning about chart trend line breakout.
• RSI diverging from price on the chart — an early warning of a possible trend change.
RSI indicator is often referred as an overbought/oversold indicator, however, this is not
exactly accurate. RSI doesn't provide Buy/Sell signals upon reaching oversold/overbought
areas, there are certain rules, which help to identify the right timing for entries and exits.
Readings above 70 indicate an overbought market, while readings below 30 indicate an
oversold market. However, once RSI advances above 70 it is not yet a signal for an
immediate Sell, since RSI may stay in overbought area for a long-long time. In fact, when a
strong uptrend develops, readings above 70 are just a beginning of a great upward move; an
opposite is true for a downtrend and readings below 30.
In order to enter at the right moment (on the true market reversal) Forex traders should
wait for RSI to leave its overbought/oversold area. For example, when RSI goes above 70,
Forex traders would prepare to Sell, but the actual trade will take place only when RSI
crosses down below 70. Opposite true for an oversold RSI: once RSI goes below 30, traders
wait for the indicator to come out of an oversold area and rise above 30 before placing a
Buy order.
Forex traders also use 50 level of the RSI indicator, which separates buying forces from
selling forces on the market. Certain trading strategies use RSI 50 level to confirm Long and
Short entries by looking at a positioning of the RSI in relation to its 50 level.

RSI trend lines

RSI indicator has got another handy feature: Forex traders use RSI to draw trend lines. While
RSI's trend line stays intact, it confirms that a trend holds well.

With RSI trend lines Forex traders are able to receive a much earlier warning about
upcoming trend changes since RSI trend lines witness a breakout few candles earlier than
chart trend lines. RSI trend lines are especially useful on large time frames.
***************************************************************************
***************************************************************************
***************************************************END Of LESSON
3**************************************************************************
***************************************************************************
***************************************************************************
*************************************************************************