Five effective forex indicators you should know

Stochastic oscillator

Alternatives: RSI, CCI, MACD

The stochastic oscillator is a popular example of an indicator that gives you an idea of the underlying momentum behind the price, hence the tag ‘momentum indicator.' The stochastic will oscillate within a boundary of 0-100, with a reading below 20 denoting an ‘oversold’ market, whereas a reading above 80 would denote an ‘overbought’ market.

However, this indicator is more complex than it may seem, with different ways to use the tool dependent on the form of the market. For instance, the overbought/oversold readings are more useful in a range-bound market than in a highly-trending one. Conversely, for a trending market you can utilise methodologies such as pattern recognition (double tops, head and shoulders etc.), trendlines, and divergences between price and momentum.

Bollinger bands

Alternatives: envelope, Donchian channel, Keltner channel

The Bollinger band is a very useful tool for recognising when the price is outside of its comfort zone, with the tool used for both breakouts and reversions to the mean. The indicator provides a band within which the price typically trades. The width of the band increases and decreases to reflect recent volatility.

When the price moves outside of the Bollinger band, it is a signal that it is extraordinary and thus it could mean we are about to break out, or else return back into a more ‘normal’ range of prices. This can be useful for a range, where a rally into horizontal resistance is accompanied by the Bollinger band, thus providing a good shorting opportunity.

Often when the price engages with the Bollinger band it will be fleeting, and subsequently moving away from it. The ability of the price to maintain and post a closed candle outside of the Bollinger band (above the upper or below the lower Bollinger) can signal a potential breakout in that direction.

Fibonacci retracements

Alternatives: pivot points

The Fibonacci tool can be applied in a number of ways. Firstly, the tool provides support and resistance, particularly within a trending market. Remember that a trending market will take a breather every once in a while.

This tool is useful for measuring those breathers and providing support or resistance within that trend. It is possible to utilise these levels as entry points when seeking to trade with the trend.

Average true range (ATR)

The ATR indicator is a measure of volatility, which when used properly can provide important information which can aid your position sizing and risk management. The ATR will rise and fall in tandem with volatility, providing traders with a tool that allows us to decide whether we should take higher or lower risk.

If the ATR is high, then we are likely to see wider swings, thus dictating a larger stop loss and smaller position size. Conversely, a market of lower volatility would necessitate a larger position size and closer stop to account for the lower volatility. Some traders will apply this indicator as a means to set their stop loss by using a multiple of the ATR to determine their stop.