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The Three Most Popular Indicators for Day-Trading


by James Stanley , Currency Strategist

Price action and Macro.

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  • This article is an extension of our previous two on the topic of short-term trading.
  • Price action is an extremely common tool for day-traders’ (scalpers) risk management approaches.
  • Moving averages and psychological support and resistance can assist with entry and trade management.

In our previous two articles, we took a detailed look at a short-term (day-trader) approach for trading in the forex market.

In How to Trade Short-Term we shared a simple strategy that traders can look to execute when a market may offer momentum opportunities.

In The Three Keys to Day-Trading , we took a look at some of the finer points of executing such a short-term approach.

In this article, we’re going to look specifically at indicators that are commonly used with a short-term strategy.

The first indicator is more than an indicator, and closer to a ‘field-of-study’ within technical analysis. Because trading on short-term time frames exposes traders to the complexity of ‘lag’ within a market, price action is one of the more popular ways of performing technical analysis with a short-term approach.

The reason this is so popular is because price action removes technical indicators from the equation and instead focuses on price and price alone. Price action can be used to grade trends, identify support and resistance levels, and to show traders potential entry opportunities in markets .

We outlined a simple structure for traders to become more familiar with the study of price action in the article Four Simple Ways to Become a Better Price Action Trader .

Where price action can come in as especially valuable for a short-term trader is in the realm of trade and risk and trade management. By noting price levels with which reversals or changes in market direction have taken place in the past, traders can look to place stops on positions so that if the market breaks against them (if a new low is put in while in a long position, or a new high while in a short position), the trade can be closed in an effort to mitigate the loss.

Price action can be a valuable tool for risk and trade management

We discussed this specific application of price action in the article How to Identify Positive Risk-R e ward Ratios with Price Action .

If the market does trend in the direction that you’re looking for, price action can also help with adjusting stops and profit-taking.

Short-term traders will often look to execute a quick break-even stop to remove their initial risk from the trade. And after prices do continue to move, traders can look at moving the stop even deeper in-the-money as the trade works in the trader’s favor.

My colleague Rob Pasche put together a phenomenal article on the topic of stop adjustments, entitled ‘The More Intelligent Trailing Stop,’ and this will walk you through using price action to adjust stops as the trade moves further in-the-money.

Another indicator that’s simple to use and attempts to marginalize the lag that is ever-present with the usage of indicators, the moving average is a common chart component of short-term traders.

The scalping strategy outlined in How to Trade Short-Term is centered on moving averages, and this can show you a couple of different ways to use this utilitarian indicator with a short-term approach.

Moving averages are commonly used for trend diagnoses, so that if prices are above the moving average the trend is diagnosed as being ‘up,’ and if prices are below the trend is considered being ‘down.’ This can work phenomenally with a multiple time frame approach in which trends are being graded on a longer-term chart (like the hourly or 4-hour), and entries performed on the shorter-term chart. We discuss using moving averages in this manner in the article Trading with Moving Averages.

Traders can also use moving averages to trigger into new positions. The moving average crossover is one of the more common ways of doing so and with this method; traders are simply looking for price to cross the moving average to initiate the position. The moving average trigger is investigated in more depth in the article Three Ways to Trade with Moving Averages .

The chart below was taken from the strategy shared in How to Trade Short-Term , in which moving averages are used to filter trends and enter positions; while price action is used for risk and trade management.

This strategy uses Moving Averages for trend filter and entry trigger, and price action for risk management

Support and Resistance via Psychological Whole Numbers, and Pivot Points

Have you ever been in a trade that’s working out great, only to see that up-trend stop dead-in-its-tracks? And after price struggles to continue moving up, it begins to oscillate before reversing and moving down.

This is the story of support and resistance, and to short-term traders this can take on extreme importance because failure to see ‘the bigger picture’ can lead to confusion and losses on the shorter-term charts.

There are numerous ways to identify support and resistance, and traders can use price action to validate any particular level; but this really only comes into play after-the-fact. Of particular interest to short-term traders are ‘psychological whole numbers.’

Psychological whole numbers are simply even, rounded values on the chart. As an example 1.3900, 1.3800 and 1.3700 are ‘round’ whole numbers in EURUSD, as each of these prices end in ’00.’ But we can take this a step further with the values mid-way between these three levels, 1.3850 and 1.3750 are also ‘rounded whole numbers.’

Take a look at the most recent move in EURUSD in the chart below, and notice how even in a strong-trending market the level of 1.3850 offered temporary support as the pair could not break through. Eight hours later that momentum came back in the market as the level finally yielded to selling, only to see 1.3750 come in as support shortly thereafter.

Psychological levels can have a huge bearing on price act ion

Created with Marketscope/Trading Station II; prepared by James Stanley

At this point, the pair has still failed to break below 1.3750 as support has come into the market after the most current 200+ pip run to the down-side.

Will every price ending in ‘50’ or ‘00’ elicit support or resistance? No. But short-term traders need to remain cognizant of the potential for support and resistance to develop at these values as trends move into new territory.

If a trend appears as though it may have run into a brick wall of support or resistance, traders can use this opportunity to scale out of a position, adjust stops, and or plan re-entries after prices finish retracing and continue moving in the trend-side direction.

--- Written by James Stanley

Before employing any of the mentioned methods, traders should first test on a demo account. The demo account is free; features live prices, and can be a phenomenal testing ground for new strategies and methods.

James is available on Twitter @JStanleyFX

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Would you like to enhance your FX Education? DailyFX has recently launched DailyFX University ; which is completely free to any and all traders!

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Great Forex indicators help follow trend

As noted earlier, there are a lot of contenders for best Forex indicators – and some get quite complicated. This is why you should start with more simple Forex trading indicators.

Let's overview some of the more well-known indicators.

Simple moving average

A simple moving average (SMA) is the average price for a specific time period. Here, average means arithmetic mean. For example, the 20-day moving average is the average (mean) of the closing prices during previous 20 days.

Why use average?

The purpose it to smooth out price movements in order to better identify the trend. Note that the SMA is a lagging indicator, it incorporates prices from the past and provides a signal after the trend begins. The longer the time period of the SMA, the greater the smoothing and the slower the reaction to changes in the market.

This is why SMA is not the best Forex indicator for advance warning of a move.

But here's a good part – it is one of the best Forex indicators when it comes to confirming a trend. The indicator usually operates with averages calculated from more than one data set – one (or more) shorter time period and one longer.

Typical values for the shorter SMA might be 10, 15 or 20 days. Typical values for the longer SMA might be 50, 100 or 200 days.

You might be wondering – when does it signal a trend?

It signals a new trend when the long-term average crosses over the short-term average. The long-term average moving above the short-term average may signal the beginning of an uptrend. The long-term average moving below the short-term average may signal the beginning of a downtrend.

You can experiment with different period lengths to find out what works best for you.

Exponential moving average

While similar to the simple moving average, this Forex trading indicator focuses on more recent prices. This means that the exponential moving average (EMA) will respond more quickly to price changes.

Typical values for long-term averages might be 50-day and 200-day EMAs. 12-day and 26-day EMAs are popular for short-term averages. A very simple system using a dual moving average is to trade each time the two moving averages cross. You buy when the the shorter moving average (MA) crosses above the slower MA, and you sell when the shorter MA crosses below the slower MA.

With this system, you will always have a position, either long the currency pair in question or short it.

You exit your trade when the shorter MA crosses the longer MA. You then place a new trade in the opposite direction to the one you have just exited. By doing this, you are effectively squaring and reversing.

If you don't want to be in the market all the time, this is not going to be the best Forex indicator combination. In that case, a combination using a third time period might suit you better.

A triple moving average strategy uses a third MA. The longest time frame acts as trend filter. When the shortest MA crosses the middle one, you do not always place a trade.

The filter says you can only place long trades when both shorter MAs are above the longest MA. You can only go short when both are below the longest MA.

The moving average convergence/divergence (MACD) is a Forex indicator designed to gauge momentum.

Want to know the best part?

As well as identifying a trend, it also attempts to measure the strength of the trend. In terms of giving you a feeling for the strength behind the move, it is perhaps the best indicator for Forex.

Calculating the divergence between a faster EMA and a slower EMA is a key concept behind the indicator.

The indicator plots two lines on the price chart. The MACD line is typically calculated by subtracting the 26-day EMA from the 12-day EMA, then a 9-day EMA of the MACD is plotted as a signal line.

When the MACD line crosses below the signal line, it is a sell signal. When it crosses above the signal line, it is a buy signal.

You can set all three parameters (26, 12 and 9) as you wish. As with moving averages, experimentation will help you find the optimal settings for you.

The Bollinger band

Any list of proven best Forex indicators needs to include some form of volatility channel.

A volatility channel is another method of identifying a trend. It uses the idea that if the price goes beyond a moving average plus an additional amount, then a trend may have begun.

A Bollinger band is a volatility channel invented by financial analyst John Bollinger more than 30 years ago. It is still among the best indicators for Forex trading out of the various volatility channel methods.

  1. the number of days for the moving average
  2. the number of standard deviations that you want the band placed away from the moving average.

The most common values are 2 or 2.5 standard deviations. In statistics, the standard deviation is a measure of how spread apart the values of a data set are. In finance, standard deviation acts as a way of gauging volatility.

What's the bottom line?

A Bollinger band will adjust to market volatility. It widens as volatility increases and narrows as volatility decreases. A long-term trend-following system using Bollinger bands might use two standard deviations and a 350-day moving average.

You would initiate a long position if the previous day's close is above the top of the channel, and take a short if the previous day's close is lower than the bottom of the band.

The exit point would be when the previous day's close crosses back through the moving average.

Fibonacci retracement indicator is based on the idea that after an extreme move, a market will have an increased chance of retracing by certain key proportions.

Those proportions come from the Fibonacci sequence.

This is a sequence of numbers known since antiquity, but popularised by the Italian mathematician known as Fibonacci. The modern sequence begins with 0 and 1. Any subsequent number is the sum of the preceding two numbers in the sequence.

Hence the sequence begins – 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233…

The Fibonacci ratios come from these numbers. The most important ratio is 0.618. This number is calculated by looking at the ratio of one number to the number immediately following it in the sequence.

This value tends toward 0.618 as you progress through the series. For example, 89/144 = 0.6181 and 144/233 = 0.6180.

Another key ratio is 0.382.

This is derived from the ratio of a number to another number two places further on in the sequence. The ratio tends toward 0.382 as you progress through the series. For example, 55/144 = 0.3819 and 89/233 = 0.3820.

The last important key ratio is 0.236. This is derived from the ratio of a number to another number three places on in the sequence.

What does this all mean?

The theory is that after a major price move, subsequent levels of support and resistance will occur close to levels suggested by the Fibonacci ratios. So it's a leading indicator – it is intended to predict price movements before they occur. This is in contrast to indicators that use moving averages, which show trends only once they have begun.

There is an element of self-fulfilling prophecy about Fibonacci ratios. There are many traders who may act on these expectations and, in turn, influence the market.

The final verdict

The best indicator for Forex trading will be the one that works best for you. You may find it is effective to combine indicators using a primary one to identify a possible opportunity and another as a filter.

The filter would determine whether the overall conditions are suitable to trade.

As with most other activities, you will learn trading with indicators by practicing. Right now you can find all the indicators we have discussed and more in MetaTrader Supreme Edition and try out strategies risk free with a demo trading account . Also, you can learn more about trading systems by watching our upcoming webinars .

If you have any particular question about a Forex and trading on the stock market I will be more than glad to help you out. Just leave me a comment or drop me a mail!

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