Other Indicators To Open A Forex Trade
Most brokers provide plenty of other indicators to open a forex trade in their charting tools. We will look here at three of the most common, and how they can be used.
Open up your demo account and look at these indicators as they are shown in your own system as we go through the different kinds.
Bollinger bands are made up of three lines or bands. Mathematically, the central band is a simple moving average over a certain number of time periods, typically 20. The upper and lower lines are at a certain number (usually 2) of standard deviations calculated with reference to the number of periods used for the center band.
Bollinger bands were invented by John Bollinger in the 1980s. His theory was that prices will normally remain within 2 standard deviations of the moving average used to plot the central line. This means that as prices reach the upper and lower band lines, Bollinger’s theory is that they will probably turn back in the other direction to keep the prices within the bands.
They are also an indicator of volatility (how unstable the prices are). Wider bands indicate a more volatile, wider swinging market than narrow bands. Here are two of the ways that traders use Bollinger bands:
- Identification of overbought and oversold markets
On the basis that prices are likely to remain within the bands, some traders will use Bollinger bands as an indicator to sell when the price closes above the upper line and buy when it closes below the lower line. Typically they will plan to close their trade when the price returns to the central line. Caution is required here, however, as these movements outside of the bands may simply indicate a strong trend forming in that direction. So you could be caught on the wrong side of a strong trend in some cases. John Bollinger himself recommended always checking against another indicator.
Probably the best for this purpose are non-oscillating indicators such as trend lines or chart patterns.
- Identification of contraction, predicting breakout.
As we have seen, the bands will diverge and converge according to the volatility of the market over the measured past periods. When they converge so that their area becomes narrow, this is called contraction.
Some traders will act on the basis that this contraction is an indicator of a large breakout and they will place both buy and sell orders outside the bands, as in the triangle pattern that we saw on our candlestick chart in the last section.
The danger here is that there can often be a false break where the prices will stretch outside the bands briefly before reversing. For this reason some traders prefer not to act on the first move outside the bands, but wait for a second break. Again it is a good idea to check with another indicator.
Next Page: Stochastic Indicator