Foreign exchange (“forex”) traders need to see information that cannot be obtained from standard price charts. They use technical analysis tools to gain additional insights, and although the indicators for these tools may appear to be a mysterious language for beginners, they are simple enough when explained.
01 of 05: Session Highlight Indicator
The forex market is open 24 hours a day during the week, with a major market always open somewhere in the world. The European market opens daily, followed by New York, then Sydney, and finally Tokyo. London opens again before Tokyo closes. Several smaller markets open and close throughout the day and night.
These global markets vary in size, in terms of the volume of foreign exchange operations and the number of currency traders. This means that each session in each market has different characteristics in its currency pairs, or the comparison of the local currency value against another currency.
For example, the EUR/USD currency pair is most active during the London and New York sessions because these currencies are tied to Europe and the United States. However, the USD/JPY pair sees continuous activity throughout the day, as traders in Tokyo, London, and the U.S. actively trade this pair.
Many forex traders find it useful to separate the different sessions on their charts. The session highlight indicator displays the price movements that occurred during the various sessions, whether by minute or hour.
Note: Session highlight indicators can be integrated into forex trading platforms.
02 of 05: Forex Volatility Tools
The forex volatility tool shows how much a currency pair generally moves. A trader may want to look at the average daily movement over a 30-day period, for example. The tool can show how much the pair moves overall during each hour of the day, how volatile it is on a specific day of the week, and how its volatility changes over time.
These tools provide insights into what to expect on a specific day or at a particular hour. This information helps the trader assess whether there is a good chance of reaching a profit target in a specific trade.
A price volatility tool cannot tell the trader which direction the price will go, but it indicates the potential amount of price movement in either direction. Forex volatility tools vary in complexity and format. For instance, a trader can specify a time frame, and the tool will calculate the confidence level in the likelihood that the price will remain within the typical movement range for that time frame.
03 of 05: Forex Position Summaries and COT Data
Some forex brokers provide updated summaries of their clients’ positions. A position summary might reveal that 60% of clients hold the EUR/USD pair, while 40% of clients hold the pair.
Individual comparisons like this may not be of great benefit, but monitoring how the ratio changes as the price changes can provide insight into how the price might move in the future. Ultimately, traders must exit these positions, regardless of whether they are realizing a profit or a loss. The current trader position can predict future positions and thus price movement.
Traders can also look at position summaries through the Commitment of Traders (COT) report. Myfxbook provides a source that delivers COT reports dating back to 2006, allowing traders to see how different traders were positioned at major market turning points. This data can be used to predict future turning points in price.
04
05: Forex Correlation Tool
Some currency pairs tend to move together, while others tend to move in opposite directions. When two pairs tend to move similarly, it is referred to as “positive correlation.” When two pairs tend to move in opposite directions, it is referred to as “negative correlation.”
Understanding the correlation between forex currency pairs is important. Traders often trade multiple currencies. If their purchases all have a positive correlation with each other, the risk is compounded, as is the potential reward opportunity. If you are positioned in two currency pairs that have a negative correlation, you have achieved risk and potential reward.
Note: Pairs that move independently are “uncorrelated.”
Note that correlation refers to direction, not magnitude, of price movement. There can be correlation between two currency pairs, but one may move significantly more than the other. In other words, the pair that moves more can have greater volatility. Therefore, studying correlation should also include studying volatility.
Many online resources provide free forex correlation tables. Correlation changes over time and can be measured across different timeframes. Check correlation regularly and look for correlation on the timeframe you are trading on. For example, if you are trading intraday on a one-minute chart, check correlation on one-minute and hourly timeframes if you are trading more than one pair. If you are trading a swing pattern on a daily chart, check daily correlation regularly.
05 of 05: Technical Indicators
There are many technical indicators that forex traders can add to forex charts. Common indicators include the MACD indicator, RSI, and moving averages. There are also less common tools, such as the Zigzag, envelope moving averages, and the TTM Trend indicator.
Zigzag: The Zigzag indicator draws lines over price waves only when they meet a certain minimum movement threshold. By highlighting only the main movements, this indicator helps filter out the noise of small movements so traders can focus on significant price movements, where the biggest profits lie. The Zigzag can be customized to show how much the price has moved (in points or percentages), which can highlight trends in price action.
Envelope Moving Averages: Envelope moving averages consist of three lines drawn directly over price action. The middle line is a moving average, and the other two are drawn above and below the moving average at equal distances chosen by the trader. For example, a trader might use a 20-day moving average as the middle line, drawing the upper and lower lines at 5% above and below the middle line.
When the envelope is set for a specific pair, it can provide insight into potential trend changes and whether the trend is strong or weak. When the price moves near the upper band, it highlights a bullish trend. When the price breaks the band, it can indicate an overbought or oversold level that precedes a trend change. The moving average in the middle can act as a support or resistance area – it’s a rough point where the price usually stops.
TTM Trend: The TTM Trend indicator changes the color of the price bars on the chart depending on whether the short-term momentum is bullish or bearish. This tool can be used in conjunction with other trend-following strategies to capture large price movements. For example, if the trend is bullish, stay in a long position while the bar is blue. When the trend is bearish, stay in a short position while the bar is red.
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Most people hear the term “technical analysis,” and they usually think of technical indicators like MACD or RSI. However, technical analysis also involves extracting information from price formations, statistics, and other information.
The technical tools described here can be integrated to make better and more creative trading decisions. No one needs to use all these tools. Your best bet is to review the tools and practice trading with them in a demo account. You’ll find the tools you need and discard those that you find unhelpful.
The Balance does not offer tax, investment, or financial advice. Information is provided without regard to the investment objectives or risk tolerance or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risks, including the risk of losing capital.
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Sources:
Myfxbook. “Commitment of Traders (COT) Data.”
TD Ameritrade. “ZigZagHighLow.”
Fidelity. “Moving Average Envelope (MAE).”
TD Ameritrade. “TTM_Trend.”
Source: https://www.thebalancemoney.com/forex-traders-technical-analysis-tools-4127157
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