Over the years, traders have devised various tools to try and help them successfully trade the markets. Of the hundreds that have been invented so far, only a few have stood the test of time, and that is because they have continued to prove effective in many market conditions. These are the most important ones every trader should know about, and even the software developers know it. That is why the most popular forex trading platforms, including those developed by SpotOption will have them pre-installed. In fact, I doubt you will find any trading platform that doesn’t have all of these available.
There are two types of moving averages – simple and exponential moving averages (SMA and EMA). Moving averages are calculated by dividing the sum of closing prices for a given period by the period over which the sum has been calculated. The SMA is calculated just this way, and is considered ‘simple’. Meanwhile, the EMA has a similar method of calculation, except more emphasis is placed on the more recent closing prices.
As a result, the EMA reacts a lot more quicker to price movements than the SMA. The choice between the SMA and EMA will depend on your trading strategy, where the SMA is more suitable to a long-term strategy and the EMA, a short-term strategy.
The moving averages are important for one main reason – establishing trend direction. Whenever prices are trending above the moving average, then the trend is considered bullish, and vice versa. The cross between the moving averages and prices also indicates a change in market trend, which is also a very important trading signal.
Moving Average Convergence Divergence (MACD)
Instead of just sticking to a single moving average, the MACD makes use of 3 EMAs. The first two EMAs are used to create a histogram, while the third generates the signal line. A trading signal is generated at the point where the signal line crosses the histogram bars. A cross by the signal line outside the bars to the downside is a bullish signal and vice versa.
Besides this, the positioning and height of the histogram bars are used to show the strength of the current trend. The bars radiate from the central line and move either downwards or upwards. Upward movement shows that the trend is bullish and vice versa. Meanwhile, the height of the bars shows how strong the trend is, helping you decide whether or not to enter the trade.
The MACD is a much more reliable indicator than just moving averages alone, and it is a very widely used indicator by traders in all industries from stocks, commodities, forex, futures, etc.
Relative strength index (RSI)
Calculated by measuring how fast the price reacts, the RSI indicator is important in determining whether market trends may be close to a reversal. For example, if there has been a sudden interest in buying a particular currency within a short period of time, then the RSI indicator will move quickly upwards. It works on the principle that market prices always correct themselves to reflect the actual value of an asset. Therefore, after a quick movement of the RSI upwards, it indicates that market prices may come back down, reversing the prevailing uptrend.
To measure the likelihood of this reversal, the RSI is measured in values ranging from 0 to 100. Readings closer to zero indicate a possible reversal to the upside while readings closer to 100 indicate the opposite.
Why are these the most important indicators?
The fact that these are the most popular technical indicators also makes them the most important. You see, their popularity makes them have a self-fulfilling property. For example, traders are likely to initiate long positions when the moving average moves below the candlesticks. Since the markets react to the trade volumes, these popular indicators generate the most trading volume. That is why trading software developers like SpotOption and others always make sure to include them in all their trading software, whether online, mobile or desktop based.