Before learning all about major Technical Indicators, you must have a MT4 or MT5 account and installed the trading platform to your device.
If you haven’t, you can open one with one of the online Forex brokers from below.
1. Different Moving Averages Types and How to use them
The MetaTrader4 trading platform offers a variety of features and chart studies.
This only includes the Standard simple average, but also other more exotic versions such as the exponential smoothed and liner weighted averages.
Simple Moving Average
The Simple Moving Average (SMA) uses a very straightforward method to calculate the average line.
This calculation being the simple average calculated over X periods.
For example the SMA for 20 periods of closing prices is just that.
Take the closing price for the last consecutive periods, add them together and then divide by 20.
Exponential Moving Average
The Exponential Moving Average (EMA) are viewed by many traders and investors as being more reliable than a Simple Moving Average.
However both average types are very popular, the benefits of using one average over the other though has yet to be proven.
The reason why EMA’s are deemed as being more reliable is because greater weight is given to more recent price data outputs.
The more recent the data, the more relevant and therefore more useful.
The sum of weighting should always equal to 100.
An SMA on the other hand gives all values the same weighting.
SMA are deemed to have a problem which is referred to as ‘‘barking twice’’.
This is used when the SMA react at the start of the moving average period when a new data output is included in the equation, and once at the end when this same data output falls out of the equation.
An EMA slope can be recognized with greater ease.
This is because the slope EMA should point up when the price closes above the average and down when the price closes below the average.
This tendency usually follows the most recent price closely, which means that the EMA is much quicker to react when compared to an SMA and the nature of the price action.
Smoothed Moving Average
The Smoothed Moving Average (SMMA) similar to the EMA is a weighted average.
It is also very similar to the SMA.
The difference between the SMMA and the SMA is how it treats the oldest data output.
With the SMA, the oldest data output is simply subtracted from the SMA calculation.
However in the case of the SMMA the previous smoothed average value is subtracted.
Linear Weighted Moving Average
The Linear Weighted Moving Average (LWMA) gives higher weighting to more recent data outputs.
A data output is obtained by multiplying the closing prices by the position occupied in the data set.
The data output is then added together and then divided by the sum of the number of time periods.
2. “Moving Average” in general
A moving average is a technical indicator which is used to take away some of the volatility of raw price action.
This is achieved by calculating the average closing price over a set amount of periods.
This process is repeated over subsequent periods, with the net result being a line that shadows the price action.
Moving averages cannot be used to predict future price actions as they are a lagging indicator.
How to use Moving Average Indicator
The most common use of a moving average, is for reasons of quick visual identification of a trend.
For example if an instrument is trading above a 100 period moving average, over a set period, then it can be said that the price action is positive.
If a trader now adds the 50 period moving average to the chart, a variety of scenarios can be created based on the interaction of the price action and both averages.
If the shorter 50 period moving average crosses above the 100 period moving average then it is said to be bullish and is defined as a Golden Cross.
As moving averages are lagging indicators, the price action will almost certainly be above the 100 period average at the time the cross over takes place.
If the shorter 50 period moving average crosses below the 100 period moving average, then it is said to be bearish and is defined as a Black Cross.
As moving averages are lagging indicator the price action will almost certainly be below the 100 period average at the time the cross over takes place.
3. “Bollinger Bands”
The Bollinger Band chart overlay was created by John Bollinger.
Bollinger Bands work in conjunction with the moving average.
Bollinger Bands are designed to act as volatility bands which envelope a moving average above and below
Bollinger Bands are calculated by the use of a standard deviation.
The Bollinger Bands will expand as volatility increases and contract as volatility decreases.
The Bollinger Band overlay that can be found on the Metatrader 4 platform consists of three components.
A Simple 20 period moving average of closing prices.
An upper and lower band that uses a standard deviation of 2.
The bands use the same look back period of the average.
Bollinger Bands can also be used to provide trading signals in the form of double tops and double bottoms.
Furthermore Bollinger Band contraction can be used as a warning signal of a potential break out or break down.
4. “Parabolic SAR”
The Parabolic SAR (PSAR) system was created by Welles Wilder.
He referred to it as the “Parabolic Time/Price System.” SAR means “stop and reverse”.
Wilder is a well-respected writer on technical trading and wrote about the Parabolic SAR indicator in his book “New Concepts in Technical Trading Systems”, that was published in 1978.
This book also introduced other well-known technical indicators such as the RSI, ATR and Directional Movement Index.
How Parabolic SAR works
The indicator is actually a trading system
The indicator is designed to plot SAR points under the price action during an uptrend and above the price action during a down trend.
A signal to stop and reverse will be given if the current candle breaks below or above the Parabolic SAR indicator.
When this occurs a new SAR point will be painted in the opposite direction of what was the prevailing trend.
As the SAR follows the price action it is considered a trend following indicator
The SAR comes into its own as an indicator that allows a trader to stay in a trade during strong trending markets.
Without the PSAR indicator a trader maybe influenced to cut a trade early, due to psychological stress caused by normal market volatility.
The PSAR will continually rise during an uptrend and continually fall during a down trend.
Furthermore the PSAR will act as a trailing stop which stops a trader from increasing the stop value.
5. “Pivot Points”
Pivots Points and Pivot Point Analysis is a popular and well known technical trading tool.
The use of Pivot levels was first used as exchanges by pit traders.
Trading on the floors of major exchanges is typically very fast paced.
Traders on the floors did not have the use of technical charts and modern computer systems.
Therefore there was a requirement to create a leading indicator that would map out key daily levels for the floor traders.
Simple Pivot Points
Simple pivot point levels are calculated by taking the previous day’s high, low and close and by use of a simple arithmetic equation which helps create predictive levels for the day ahead.
The calculation is shown below:
- Pivot Point (P) = (High + Low + Close) / 3
- Support 1 (S1) = (P X 2) – High
- Support 2 (S2) = P – (High – Low)
- Resistance 1 (R1) = (P X 2) – Low
- Resistance 2 (R2) = P + (High – Low)
As the Pivot Point is based on the previous day’s data, the levels created are set in place for the whole days trading.
A day trader would look to buy a financial instrument and keep the position up to R1.
At R1 the day trader has three decisions to take:
- Close long positions and book profits
- Close long positions and enter a short again R1
- Allow the price action to break above R1 and hold the position until it tests R2
Shorts will mirror longs with the trader looking for tests and fades of S1 and S2.
There are other more exotic versions of the pivot point.
These include the following.
Fibonacci Pivot Points
Fibonacci Pivot Points are similar to Simple Pivot Points.
The Fibonacci Pivots use the same high, low and close levels; however they include a Fibonacci element into the calculation.
The calculation is shown below:
- Pivot point (P) = (High + Low + Close) / 3
- Support 1 (S1) = P – {.382 * (High – Low)}
- Support 2 (S2) = P – {.618 * (High – Low)}
- Support 3 (S3) = P – {1 * (High – Low)}
- Resistance 1 (R1) = P + {.382 * (High – Low)}
- Resistance 2 (R2) = P + {.618 * (High – Low)}
- Resistance 3 (R3) = P + {1 * (High – Low)}
6. “Moving Average Convergence Divergence (MACD)”
The Moving Average Convergence Divergence (MACD) was created by Gerald Appel in the late 1970s.
The MACD is a very simple but at the same time one of the most useful indicators that is available to traders.
The MACD makes use of two trend following Moving Averages and creates a momentum indicator, by simply subtracting one average from the other.
The end product of creating the MACD oscillator is an indicator that can be used for both trend following and momentum analysis.
The MACD oscillates around a zero line with the moving averages converging, crossing or diverging around this level.
The calculation of the MACD is as follows:
- MACD LINE: (12-DAY EMA – 26-DAY EMA)
- SIGNAL LINE: 9-DAY EMA OF MACD LINE
- MACD HISTOGRAM: MACD LINE – SIGNAL LINE
How to interpret the MACD
As the name implies the MACD highlights the degree of convergence and divergence between moving averages.
According to Appel’s interpretation of the MACD, convergence happens as the two averages move closer together.
Conversely divergence occurs as the two averages move apart from each other.
The shorter length moving average is more responsive than the longer period moving average.
Center Line Cross Overs
The center-line is placed at the zero value.
The MACD will oscillate above the centerline.
Crossovers of the centreline will also indicate that the short length average is above or beneath the longer average.
If the MACD crosses above the zero line, then the short moving average should be above the long moving average.
If the MACD crosses below the zero line, then the short moving average should be below the long moving average.
Positive and negative crossovers will also give an indication of the current trend; a positive cross indicating an uptrend and a negative cross indicating a down trend.
Furthermore the separation of the moving averages from each other, can be interpreted as an increase in positive or negative momentum depending on the direction the crossover took place.
Signal Line CrossOvers
Signal line crossover occurs when the fast EMA crosses the slow EMA.
A positive cross over happens when the short length moving average crosses the long length moving average from below.
A negative crossover occurs when the short length moving average crosses the long length moving average from above.
Divergences
Divergences typically occur when both moving averages converge with each other.
The convergence signifies a decrease of positive or negative directional momentum.
Whereas the divergence signifies a lack of commitment to push prices higher or lower.
During an uptrend one would expect to see the MACD in step with the price action.
As the financial instrument proceeds to print new highs, the MACD will also reach higher levels.
However during the exhaustion phase of the trend, the MACD could come out of gear with the underlying price action and consequently stop printing higher values.
This is a warning sign that the trend is reaching levels of exhaustion which could lead to a corrective pullback.
A similar scenario could occur during a down trend.
As the financial instrument proceeds to print new lows the MACD will also reach lower levels.
However during the exhaustion phase of the trend, the MACD could come out of gear with the underlying price action and stop printing lower values.
This is a warning sign that the down trend is reaching levels of exhaustion which could lead to a corrective pullback.
7. “Relative Strength Index (RSI)”
The Relative Strength Index (RSI) was developed by J. Welles Wilder.
The RSI is classed as a momentum oscillator.
Its function is to measure the speed and change in price movements.
The RSI has a range of 0 to 100.
Traditionally and according to Wilder levels above 70 are considered overbought and levels beneath 30 oversold.
However these levels can be adapted to suit the investors trading strategy.
The calculation of the RSI is:
RSI = 100 – (100 / 1 + RS)
RS = Average Gain / Average Loss
How to use RSI (Relative Strength Index)
The RSI can print multiple false signals during very strong trending markets.
There can also be times when the RSI remains in overbought and oversold areas for a considerable time.
This phenomenon can occur when the momentum oscillator becomes embedded in extreme areas during strong trending markets.
The use of RSI divergences are extremely useful when used as a filter to identify valid and non-valid overbought and oversold trade set ups.
As discussed in the section that focussed on MACD divergences, very similar set ups occur when using the RSI.
Furthermore although RSI could signal profitable trade sets off extreme overbought and oversold levels, divergences on the whole can offer safe trade set ups that lead to much larger corrective moves in the price action.
As with all indicator based trading, the paramount importance is once the oscillator moves into an extreme area; entry should only be taken if the price action begins to show signs of exhaustion.
IronFX
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March 26, 2024
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