FOREX TRADING

Guide to
Indicators
How Technical Indicators help
improve your trade analysis
2

Contents
Simply click the topic you’d like to read, to go directly to it.

Introduction to Indicators 4
1.1 Types of Indicators  5
1.2 Trend Indicators 5
1.3 Momentum Indicators 6
1.4 Volatility Indicators 6

Trend Indicators 7
2.1 Moving Averages (MA) 8
2.2 Ichimoku Cloud 13
2.3 Average Directional Index (ADX) 18

Momentum Indicators 20
3.1 Stochastic Indicator 21
3.2 Relative Strength Index (RSI) 26
3.3 Moving Average Convergence and Divergence (MACD) 33

Volatility Indicators 39
4.1 Bollinger Bands 40
4.2 Average True Range (ATR) 42
4.3 Parabolic Stop And Reverse (PSAR) 46

Combining Indicators 48
5.1 Dangers of overloading indicators  48
5.2 Choosing specific indicators  48
5.3 Trading with these Indicators 49
3

About the author

Desmond Leong runs the award winning research

firm Everest Fortune Group, a finalist in 2019 and
2020 for Best FX Research and Best Equity Research
in The Technical Analyst Awards.

Boasting a team of CFA, CMT and CFTe

accredited traders who specialize in technical
analysis (particularly Fibonacci, Elliott Waves
and Correlation) and fundamental analysis, they
regularly advise banks, brokers and hedge funds on
where the markets are heading and how better to
navigate them. Desmond also regularly shares his
trading insights and theories on his personal site:
The Forex Army.

Desmond is also known as the “mad coder”. He has

developed several high grade MT4 indicators that
are used to better interpret the markets. Throughout
DESMOND LEONG
this eBook series, you’ll come across indicators
Desmond has agreed to let Axi clients use as part of
a joint collaboration.

DESMOND LEONG
MARKET ANALYST, AXI

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 1
Introduction
to Indicators
5 Introduction to Indicators

1.1 Types of Indicators

“Where is the market heading next?”

That’s a question every trader will find themselves asking. And now that you should be equipped
with the Basics of Forex Trading, we’ll attempt to answer it by exploring the indicators most often
used in Technical Analysis.

These indicators can be broadly categorised as follows:

Trend Indicators
Momentum Indicators
Volatility Indicators

We’ll start with a brief overview of what each category means, then we’ll explore the indicators in
detail in later chapters.

1.2 Trend Indicators

Trend Indicators are useful in determining whether a trend is present, or if the markets are just
moving sideways with no clear direction. There’s a saying that “the trend is your friend”, so we want
to be sure to get on the right side of the trend when we’re trading.

The most common trend indicators are:

Moving Averages
Ichimoku Cloud
Average Directional Index

As the name suggests, Trend Indicators only work well in the presence of a trend. This means there
must be a clear direction that prices are moving towards, either to the upside or downside. To
determine if a trend is present, we can do so by looking at the highs and lows.

When prices consistently form higher highs and higher lows, we consider it an uptrend. Conversely,
if prices consistently form lower highs and lower lows, we can consider it to be a downtrend.

Still unsure? Check out our Guide to Forex Trading where we explore the concept of trending and
sideways market in detail.

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6 Introduction to Indicators

1.3 Momentum Indicators

Momentum Indicators measure the strength of the movement in prices and are useful in identifying
key reversal points. When the indicator reaches extreme levels, it could signal a potential change
in trend. On top of that, divergence is another widely used concept in momentum indicators (you
can explore this in more depth in Chapter 3).

Here are the most widely used momentum indicators:

Stochastic Oscillator
Relative Strength Index
Moving Average Convergence Divergence

1.4 Volatility Indicators

Volatility Indicators help us to anticipate the range of movement in prices and are useful for
placing our stop losses. When a currency pair swings wildly up and down, it has a high volatility.
Meanwhile, a currency that does not fluctuate as much has a low volatility.

The most common volatility indicators are:

Bollinger Bands
Average True Range
Parabolic Stop And Reverse

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IntroductiontoIndicators

2
Trend Indicators
8 Trend Indicators

2.1 Moving Averages (MA)

Moving Averages can act as dynamic support and resistance levels and are calculated by taking an
average of past closing prices over a specified period of time to obtain a single line on the chart.

So how do they help us? Its smoothing effect prevents short-term price fluctuations by filtering out the
“noise”.

There are two common types of Moving Averages:

Simple Moving Average (SMA)

Exponential Moving Average (EMA)

The main difference between the SMA and EMA is its sensitivity to price. This is because, in its
calculation, the EMA gives more weight to the most recent price and less weight to older prices, hence it
tracks prices closer as compared to the SMA, thereby making it more sensitive.

On the other hand, the SMA gives an equal weight to all prices that it calculates. Thus, it will produce a
smoother line as compared to the EMA. The diagram below shows a comparison between the 50 EMA
(blue) and 50 SMA (red) on EURUSD. We can see that the 50 EMA (blue) tracks recent prices more closely
as compared to the 50 SMA (red).

Source: TradingView

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9 Trend Indicators

Basics of Moving Averages

While there’s no need to manually calculate Moving Averages (thanks to the indicators being widely
available), it is important to understand the parameters used in the calculation to fine-tune your trading
strategies in the future.

As shown in the diagram below, a length of 20 means that the values are obtained from the past 20
periods of data. The most common length periods are: 5, 10, 20, 30, 50, 100 and 200.

Source: TradingView

The table below is a rough guide of the length of EMA or SMA to use, depending on the timeframe we’re
trading on. Traders who are taking shorter term trades on lower time frames would want to consider
using SMAs or EMAs with a shorter length as they are more sensitive to price changes.

Conversely, traders who are taking longer term trades on higher time frames would want to consider a
longer length for their SMA or EMA. In the chart below, we can see that the 20 EMA (purple line) tracks
prices much more closely when compared to the 50 EMA (blue line).

Time Frame Length of EMA or SMA

M5, M15, M30 5, 10

H1, H2, H4, Daily 20, 30, 50

Weekly, Monthly 100, 200

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10 Trend Indicators

Source: TradingView

Trading with a Moving Average

STRATEGY 1: PRICE & MOVING AVERAGE CROSSOVER

One of the most common trading strategies is the Moving Average Crossover. The first crossover we’ll
explore is the price and moving average crossovers.

While there are no hard and fast rules when it comes to the length or the type of moving average we
have to use, I personally prefer the 20 EMA. In a price and moving average crossover, we can interpret it
as follows:

Price crosses above Moving Average = Buy Signal

Price crosses below Moving Average = Sell Signal

In this case, using the 20 EMA as an example, with reference to the chart below, we can see that after
prices cross above the moving average, it tends to move higher. This shows a strong bullish momentum
and could generate a buy signal for traders, as represented by the green arrows. Conversely, when
prices cross below the 20 EMA, prices tend to move lower. This shows a bearish momentum, generating a
sell signal, as represented by the red arrows.

While this could play out nicely in a trending market, we do have to be careful of the whipsaws – when
prices are moving sideways.

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11 Trend Indicators

Did you notice the boxes highlighted in blue?

These are what we call “fake outs”, which means a false signal is generated before moving in the
opposite direction. For example, looking at the first blue box shown in the left of the diagram, we can
see that prices cross below the moving average (in gold), which would in turn generate a sell signal for
us. However, that turned out to be a false signal before prices continue to push higher.

Source: TradingView

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12 Trend Indicators

STRATEGY 2: MOVING AVERAGE CROSSOVERS

Another popular strategy with moving averages would be the Short Term and Long Term Moving
Average Crossovers – also commonly known as the “Golden Cross” and “Death Cross”. It uses a 50
period (length) moving average as the short term moving average and the 200 period (length) moving
average as a long term moving average.

The Golden Cross occurs when a Short Term Moving Average crosses above the Long Term Moving
Average, signalling that the short term bullish momentum is stronger and prices could push higher.
Hence, after spotting the golden cross, traders could consider entering a long position (i.e. buy the
currency pair).

Source: TradingView

Now let’s look at examples of Golden and Death Crosses in the chart above.

The red line represents the 200 day moving average while the blue line represents the 50 day moving
average. As we can see, the 50 day moving average (blue) tracks prices much closer as compared to
the 200 day moving average (red). When the blue line crosses above the red line, it’s known as a Golden
Cross, which signals a bullish momentum where we saw prices push higher thereafter. The Golden
Crosses are represented by the green arrows in the chart below.

Similarly, when the blue line crosses below the red line, that is known as a Death Cross, which signals a
bearish momentum, where we saw prices push lower thereafter. The Death Crosses are represented by
the red arrows in the chart below.

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13 Trend Indicators

2.2 Ichimoku Cloud

Basics of Ichimoku Cloud

The Ichimoku Cloud, also known as Kinko Hyo, helps traders to identify potential support and resistance
zones. The name is loosely translated from Japanese to mean “At a glance”, meaning traders would be
able to determine the trend and direction of the market at a glance.

When prices are above the cloud, it shows that prices are faced with bullish pressure and there’s
potential to move higher. Conversely, when prices are below the cloud, it shows that prices are faced
with bearish pressure and have the potential to move lower. And what happens if prices are within the
cloud? In that case, we take it to be neutral.

Components of Ichimoku Cloud

There are six key components that make up the Ichimoku Cloud:

Tenkan-sen (Conversion Line)

Kijun-sen (Base Line)
Senkou span A (Leading Span A)
Senkou span B (Leading Span B)
Kumo
Chikou span (Lagging Span)

Source: TradingView

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14 Trend Indicators

Tenkan-Sen

This is primarily used as a signal line and is calculated by taking an average of the highest high and
lowest low for the past 9 periods.

So how can we interpret the Tenkan Sen? Think of it as an indicator of market trends. If the Tenkan-
Sen moves up, it indicates that prices are in an uptrend. Conversely, if the Tenkan-Sen moves down, it
indicates that prices are in a downtrend. If the Tenkan-Sen moves sideways, it indicates that prices are
trading within a range.

Kijun-Sen

The Kijun-Sen can be used as a confirmation line as well as a support and resistance level and is
calculated by averaging the highest high and lowest low for the past 26 periods.

The Kijun Sen works just like the Tenken Sen. However, because it takes more periods into its calculation
(26 versus 9), it’s less sensitive to price changes when compared to the Tenkan Sen. It can also be seen
as a longer term moving average. Both the Tenken-Sen and Kijun-Sen are used together and the way
traders use them would be similar to the moving average crossover strategy.

Combining the Tenkan-Sen and Kijun-Sen

As mentioned above, the Tenkan-Sen and Kijun-Sen are calculated using the 9 and the 26 period high
and low respectively. This means they look back 9 and 26 periods (candles), take the highest and the
lowest price levels during that period, then use those values to plot the line in the middle of that range.

These two lines are essentially moving averages, and they can be used in the following manner:

1 They act as support and resistance during trends, just like moving averages
2 They provide momentum information, similar to the moving average
3 Moving average strategies can be applied to the Tenkan and Kijun

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15 Trend Indicators

Source: TradingView

Very simply, observe the points where the shorter term MA (Tenkan) crosses above or below the longer
term MA (Kijun).

In this method, when the shorter-term MA crosses above the longer-term MA, it’s a buy signal, as it
indicates that the trend is shifting up. This is known as a “Golden Cross.”

Meanwhile, when the shorter-term MA crosses below the longer-term MA, it’s a sell signal because it
indicates the trend is shifting down. This is known as a “Death Cross.”

Senkou Span A (Leading Span A)

Senkou Span A – sometimes called Leading Span 1 or Leading Span A – is a line that forms one edge
of the cloud.

So how can we interpret them? If prices are above the Senkou Span the top line serves as the first
support level, while the bottom line serves as the second support level.

Conversely, if prices are below the Senkou Span, the bottom line forms the first resistance level while the
top line is the second resistance level. While there’s no need for any manual calculation as the indicators
can be loaded on TradingView, the Senkou Span A is usually obtained by taking the average of the
Tenkan-Sen and Kijun-Sen, plotted 26 periods ahead.

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16 Trend Indicators

Senkou Span B (Leading Span B)

Senkou Span B – sometimes called Leading Span 2 or Leading Span B – is a line that forms the other
edge of the “Kumo” or cloud. Together with Senkou (Leading) Span A, the cloud helps to identify support
and resistance areas.

Generally, the Senkou Span B is plotted based on the price action over the last 52 candles, though this is
dependent on the time period used in the chart. If prices are on the 1 hour chart, it means you’re taking
into account price action over the past 52 hours. Similarly, if you’re using a 1 Day chart, it takes into
account price action over the 52 days.

Generally, markets are bullish when Senkou Span A is above Senkou Span B, and vice versa when
markets are bearish. Traders often look for Kumo Twists in future clouds; where Senkou Span A and B
exchange positions, it’s a signal of potential trend reversals.

Kumo

Kumo is another word for cloud and it’s is represented by the coloured space or distance between
Senkou Span A and B. As Senkou span A and B move along with price, the cloud’s shape and height
changes accordingly. The cloud edges serve as current support and resistance areas for prices.

With reference to the chart below, we can see that larger price movements form thicker clouds, which
creates stronger support and resistance. As thinner clouds offer only weak support and resistance,
prices can and do tend to break through such thin clouds. When prices are above the clouds, we can
safely say that price is trending upwards. Conversely, when prices are below the clouds, we can also
safely say that prices are trending downwards.

Source: TradingView

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17 Trend Indicators

Source: TradingView

Now let’s look at another example.

As seen in the image above, the cloud is thick and the price seems to find it difficult to break through
to the downside. In fact, the bottom of the cloud acts as a second support level, where price bounces
higher and continues to trend upwards above the cloud. More recently, at areas where the cloud is
thinner, price seems to have no difficulty breaking above and then nearly reversing and breaking below
the cloud again!

Chikou Span

Chikou Span – also called the “Lagging Span” – is formed by plotting closing prices 26 periods behind
the last candlestick. However, despite having a default setting of 26 periods, this number can be
changed to increase or decrease the distance between the span and prices.

So how is that useful to us?

Chikou Span helps us identify trend changes when combined with other elements of the Ichimoku Cloud.
When prices are above the Chikou Span, it usually indicates a weakness in price and the potential to
move lower. Conversely, when prices are below the Chikou Span, it shows that there’s strength in prices
to move higher. Simply put, you can think of this line as a magnet that pulls prices towards it.

The Chikou is generally used in combination with candlestick of 26 previous periods:

 Chikou is above the candlestick of 26 previous periods, we can say that today’s price is in a
If
bullish phase.

 onversely, if Chikou is below the candlestick of 26 previous periods, we can say that today’s
C
price is in a bearish phase.

If the Chikou is touching the edge of the cloud, we can expect today’s price to react.

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18 Trend Indicators

Source: TradingView

The chart above shows what happens when the Chikou touches the edge of the cloud. It has been
colour coded: the blue bubble is the first scenario, the orange bubble is the second scenario.

All in all, while the Ichimoku Indicator seems to be all-encompassing, it only works well in a trending
market. Hence it’s important to ensure this indicator is applied on currency pairs that are showing a
clear upward or downward trend to provide us with more reliable trade signals.

So how can we determine the strength of a trend? This brings us to our next indicator.

2.3 Average Directional Index (ADX)

Basics of ADX

The Average Directional Index (ADX) is a tool used in Technical Analysis to measure the strength of a
trend. Along with identifying the strength of the trend, this indicator is accompanied with two other lines:
Negative Directional Indicator (-DI) and the Positive Directional Indicator (+DI).

Components of ADX

If you were to load the ADX on your chart, you would see three separate lines for the ADX indicator.

The blue lines represent the ADX, which measures the strength of a trend; an ADX reading of 25 or above
shows that a strong trend is present, whereas an ADX reading of less than 25 shows the trend is weak.
While traders generally use 25 as a benchmark for the ADX reading to determine if a trend is present,
the numbers can be changed to a higher or lower number, depending on your preference. A higher
number filters out the noise further, although they might signal the presence of a trend much later when
compared to a lower number being used as the ADX benchmark.

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19 Trend Indicators

Apart from the ADX line, we also have the +DI lines shown in green, as well as the -DI lines in red. The +DI
line represents upward momentum while the -DI line represents downward momentum.

Source: TradingView

Trading with ADX

Looking at the chart below, we can see that when ADX (blue line) crosses above 25, it means there is
a trend present. At the same time, the +DI (green line) is above the -DI (red line) which means that the
upward momentum is stronger than the downward momentum, where we saw prices trend higher after.

Source: TradingView

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Trend Indicators

3
Momentum
Indicators
21 Momentum Indicators

3.1 Stochastic Indicator

The Stochastic Indicator – which is also referred to as a Stochastic Oscillator – is a momentum
indicator that tells you the momentum of price.

Basics of the Stochastic Indicator

The oscillator works on the theory that, during an uptrend, prices should stay equal to or rise above
the previous closing price, whereas in a downtrend prices would likely remain equal to or fall below the
previous closing price.

It might help you to liken the movement of price to the movement of a coin when you toss it in the air.
When you toss a coin, it reaches the top and, before coming down, it would have to slow down. Similarly,
before a price changes direction and reverses, it will normally slow down and lose its momentum. You
can then be on the lookout for these momentum shifts in order to trade reversals such as “bounces”.

Components of the Stochastic Indicator

Source: TradingView

When you turn on the Stochastic Indicator on your trading platform, it often turns up as a window on the
bottom half of the screen, under your price chart (as shown in the above picture). As you can see, this
indicator consists of two lines, blue and orange. Here is what they represent:

Blue line: %K (the main line)

Orange line: %D (a moving average of %K)

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22 Momentum Indicators

%K, which is the main blue line, is calculated with this formula:

The formula for K%

(Today’s close - Lowest Low in %K period)

x 100%
(Highest High in %K Periods - Lowest Low in %K periods)

Don’t worry – you won’t have to calculate %K yourself! This is usually done for you automatically by
whatever trading platform you’re using. However, it’s good to know how these numbers are being
generated so you’re more well-informed.

Now, let’s dive a little deeper into the Stochastic Indicator and understand how it can help you in
developing your trading strategies.

The Stochastic Indicator is mainly affected by three variables, namely the K periods, D periods and how
smooth the %K period is. Here, we’ll do a basic explanation of these variables.

K PERIOD

Firstly, we have the K period. This is the number of periods

used in the stochastic calculation. Let’s take a look at how
we input this value into the settings for the indicator.

If the 21 period is selected on an hourly chart, it means the

data from the past 21 hours are taken into consideration
when calculating the value of K.

D PERIOD

This is the number of periods when calculating D, the

moving average of K period.

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23 Momentum Indicators

SMOOTH

This number controls the internal smoothing of %K period;

the smaller the value, the faster the stochastic. For
example, if the setting of the period is 1, that’s considered
a fast stochastic. Conversely, if the setting is raised to 3, it’s
considered a slow stochastic. You can see how it changes
the stochastics by testing it out!

Trading with Stochastic Indicator

Now, how do you use the stochastic oscillator then? You should view the stochastic as contained within a
band, which is made up of 2 lines above and below the moving averages. This is commonly known as the
upper and lower band, which are set at 80 and 20 respectively. You can see the band highlighted in the
picture below.

This band allows you to deduce whether the price is currently at a level that’s deemed to be overbought
or oversold.

Simply put, if price is above the upper band, the market is deemed to be in an overbought area, thus
traders would be looking to sell and take a short position. On the other hand, if price is below the lower
band, it would mean that markets are currently in an oversold area, thus traders would be looking to buy
and take a long position.

The standard 80-20 range is commonly used by a large majority of traders as the upper and lower band.
Traders following this theory will buy once the stochastic dips below 20%, and sell once the stochastic
rises above 80%.

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24 Momentum Indicators

Beyond this, the Stochastic Indicator can be useful in helping us to determine a few important levels and
opportunities that can enhance your trading strategies. When used correctly, it can help you identify the
following:

Hidden support and resistance levels (horizontal)

Hidden support and resistance levels (diagonal)
Hidden breakout levels
Bearish divergence reversals
Bullish divergence reversals

Once you’re aware of these levels, you can then fine-tune your trading strategies and make better
trading decisions. For example, knowing the reversals can help you to trade “bounces”, while the hidden
support and resistance levels can help you to identify good stop loss and take profit levels.

More on Stochastic Indicators

Stochastic Indicators can be fine-tuned to help you to trade more profitably. This can come in the form
of better settings for the oscillator or better strategies with which you can use the indicator for.

Many traders are unsure of the best settings they should set their Stochastic Indicators to. A lot
of people prefer a fast stochastic because it moves faster and therefore presents more trading
opportunities. However, a slow stochastic may be more suitable to avoid poor trades. It can also be
good to cycle between a range of periods, instead of just sticking to the standard period of 5. For
example, I use a range of periods – mainly 13, 21, 34 and 55.

It’s common for many traders to use the industry standard of 20% and 80% as the bands on the
Stochastic Indicator. While this can be done, a much better option is to analyse the Stochastic indicator
and look for hidden support and resistance levels. Sp let’s have a look at how this can be done.

Source: TradingView

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25 Momentum Indicators

From the image, we can see that there is a stronger support level at 7% instead of the usual 20% that
the crowd is following. This is because we can see that the market has bounced off from the 7% level
much more than the 20%. From this we can tell there’s a good entry level here that we can use.

Source: TradingView

Did you notice how Stochastic bounced off our support level perfectly and price also did the same? This
shows us that hidden levels tend to be stronger if we’re able to find them, instead of just sticking to 20%
support that the crowd follows.

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26 Momentum Indicators

3.2 Relative Strength Index (RSI)

Relative Strength Index (RSI) is another example of a Momentum Indicator. Similar to the Stochastic, it
helps us to see whether the market is currently in overbought or oversold conditions.

Basics of RSI
Essentially, the RSI measures the underlying strength in terms of its average gains and losses over the last
period.

So what’s the difference between the RSI and the Stochastic Indicator?

Well, the RSI measures the speed of price movements, while the Stochastic Oscillator works best with
inconsistent trading ranges. It would be quite safe to say that the RSI works better in ranging markets,
allowing us to identify potential areas of reversals. Which indicator you pick would thus depend on what
kind of market you’re trading in.

Source: TradingView

The image above shows us the RSI alongside a price chart. As you can see, the RSI is charted quite
similarly to the Stochastic Indicator, in that it is also plotted on a separate graph, seen on a separate
window, and its values range from 0 to 100.

However, we can also see that the “band” that exists with the RSI ranges, in this case, from 30 to 70.
These are the values that traders most frequently use. The way we interpret the graph, however, is fairly
similar to the Stochastic Indicator.

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27 Momentum Indicators

When the RSI rises above 70, it’s a signal that the market is becoming overbought, and thus there’s
likely to be strong buying pressure, where an exit from this range (i.e. RSI dipping below 70 again) could
suggest a potential reversal in price. This represents an increase in the possibility of price weakening,
thus presenting us with an opportunity to sell.

Conversely, when the RSI falls below 30 it signals to us that the market is becoming oversold, thus
there’s likely to be strong selling pressure, where an exit from this range (i.e. RSI rising above 30 again)
could suggest a potential reversal in price as well. This represents an increase in the possibility of price
strengthening, thus presenting us with an opportunity to buy.

Components of RSI
The RSI is a fairly simple indicator to watch; it consists of a line graph within a band that to look out for.
In this section we’ll discuss how the RSI is calculated. Although this is not a prerequisite to understand
fully before trading, it can be useful when you adjust the settings on the RSI.

The formula to calculate the RSI is: RSI = 100- (100/(1+G/L))

In this formula, “G” represents average gain, and “L” represents a loss. This is calculated within a set
period controlled by the “Length” field. It is essentially the sum of the previous periods divided by the
number of periods.

The length of the RSI mentioned above refers to the number of periods back that the indicator will go
for its calculation. Generally, for short-term trade ideas, traders will prefer a shorter length, whereas
for long-term trade ideas, traders will tend to opt for a longer length instead. Other than the traditional
14 day period, there are also 9 day and 25 day periods that have become increasingly popular among
traders.

The source of the prices will also affect your final calculations of the RSI. You can choose to use any of
the open, high, low or close prices in your calculations, either in isolation or a combination of more than
one.

Trading with RSI

Now that you’re clearer on what the RSI is and how it works, we can move on to the trading strategies
which you can employ using the RSI.

Here are 3 popular strategies used with the RSI: chart formations, support and resistance levels, and
trading divergences.

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28 Momentum Indicators

STRATEGY 1: CHART FORMATIONS

In this strategy, we’ll try to focus on the common chart patterns that are formed in the RSI indicator and
relate them to current price action.

Source: TradingView

As you can see, the RSI indicator formed a double top before the price fell. This is because double tops
are a bearish reversal pattern that form only after an asset reaches a high price on two consecutive
occasions. Seeing this pattern in the RSI indicator should indicate to you that a downtrend is coming
soon, hence giving off a strong sell signal.

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29 Momentum Indicators

STRATEGY 2: SUPPORT AND RESISTANCE

At times, we’ll be able to find support and resistance levels on the RSI indicator much more easily than
on the price charts themselves.

Source: TradingView

Referring to the picture above, you can easily spot a strong resistance level on the RSI chart appearing
on the bottom portion of the chart, marked out with a red dotted line. When you relate it to the price
chart, you can see that it makes sense.

At the four different points in time where the same resistance level was tested, prices reversed as well.
As with other support and resistance levels, these levels become stronger the more times it has been
tested.

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30 Momentum Indicators

STRATEGY 3: DIVERGENCES

In this strategy, we want to look out for any clear divergence between the action of price and RSI. This
happens when price and RSI move in opposite directions for a period of time.

Source: TradingView

Let’s have a look at an example of how you can identify and trade divergences with the RSI.

From the above picture, we can see that price is making higher highs but the RSI is instead making lower
lows, highlighting a clear divergence. This is a strong signal that there may be a market reversal soon,
thus you should be wary of it when making your entry into the market.

More on RSI

The RSI, similar to the Stochastic, can also be adjusted to fit your trading strategies. You can choose to
use 21, 34, 55 as your periods instead of a standard that you stick to. These show us that the best RSI
period is actually a bunch of periods that we switch between.

Similarly, with the Stochastic Indicator, we can find that the RSI also allows us to find hidden support and
resistance levels which are not commonly used by the bulk of most retail traders.

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31 Momentum Indicators

Source: TradingView

Using the above example, we can see that RSI is not very responsive towards the standard 70%
resistance level. However, if we plot our own resistance level, we can see that the price is reacting
better against 52% resistance instead. The price tends to drop every time the RSI reaches the 52% level,
indicating to us that this level is a good indication of a hidden relationship between RSI and price. In this
case, you can see that it would make sense for you to enter the market here instead of waiting for the
70% level.

As you can see, RSI reacted just as we had expected it to and so did price, allowing us to benefit if we
had opened a short position here.

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32 Momentum Indicators

Source: TradingView

This shows how the RSI can be a very powerful tool for you to identify where hidden patterns and signals
are in the market.

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33 Momentum Indicators

3.3 Moving Average Convergence and

Divergence (MACD)
MACD refers to Moving Average Convergence & Divergence. This is a trend-following indicator which is
useful in helping traders to identify whether a new trend is bullish or bearish in nature.

Basics of MACD
Do recall the earlier section on Moving Averages? The MACD is essentially an improved version of Moving
Averages, since it helps us to derive a new relationship between price through the movements within the
price’s moving average.

As you can see, this indicator typically consists of a histogram and two moving lines: the MACD line and
the Signal line. The crossover of the two lines gives us signals that are quite similar to when crossovers
happen when you’re analyzing moving averages.

Components of MACD
Let’s have a quick lesson on the components of the MACD indicator.

There are three main components that we want to understand in the MACD indicator, and here’s how
you calculate each one:

The MACD Line can be calculated by finding the difference between the price’s 12-period EMA
and 26-period EMA.

The Signal Line can be calculated by running a 9-period EMA on the MACD line.

 he histogram is then calculated by deducting the signal line value from the MACD line value.
T
This shows that each component of the MACD is intricately connected to each other.

When prices are rising, the histogram will inflate and show a positive bar chart value, which is then
shown as a green bar on your trading platform. This is because the speed of price movement will
accelerate. Conversely, with falling prices, the speed of price movement decelerates, thereby causing
the histogram to deflate as a result. This results in a negative bar chart value, which is then shown as a
red bar on your trading platform.

When using the MACD indicator on your charts, you can easily change the settings to suit your trading
strategy.

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34 Momentum Indicators

Here are a few of the fields you can adjust by yourself:

Source: TradingView

 ast Length: Controls the number of time periods used to calculate the faster-moving average.
F
This is the shorter term EMA and traders will usually pick the default value of 12.
 low Length: Controls the number of time periods used to calculate the slower-moving average.
S
This is the longer term EMA and traders will usually pick the default value of 26.
 ource: Determines what data from each bar will be used in calculations. By default, traders will
S
choose to use the close price from each bar.
 ignal Smoothing: The time period for the EMA of the MACD Line otherwise known as the Signal
S
Line. By default, traders will use the default which is 9 days.

Although it’s not necessary for you to understand in great depth how to calculate all these values, it will
help to know how each value is derived so that you can adjust the settings for your MACD indicator if
needed.

Trading with MACD

It’s important to remember that the MACD indicator is a trend-following indicator. In other words, it
means the indicator works well in trending markets, but is not as useful in range-bound markets.

Typically, you can use the MACD indicator as a trading strategy by analysing 0-line crossovers, signal-line
crossovers and divergence.

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35 Momentum Indicators

STRATEGY 1: 0-LINE CROSSOVER

Source: TradingView

The main focus you should have while employing this strategy is when the MACD line crosses “0”, which
signals to you when you should buy or sell.

When the MACD line crosses the “0” line from below (i.e. from bottom to top), it is possible that a new
uptrend is emerging, therefore you should consider taking a long position. Conversely, when the MACD
line crosses the “0” line from above (i.e. from top to bottom), it’s possible that a new downtrend is
emerging, thus you should consider taking a short position.

In other words, the MACD indicator would give you a signal as to when a trend is starting in a particular
direction. Knowing this, you can then place your trades appropriately in order to make profit by riding
the trend.

You may choose to remove the histogram and signal line in order to have a clearer view of the MACD
line, which can be done in the Settings tab. You can also add in a horizontal line so you can visualise the
crossovers better.

As you can see, there are a total of four crossovers which you could have possibly used as signals to
enter the market. However, as we’ll see in the next picture, the MACD can give false signals to go short
and then long, one after the other.

As you can see in the above picture, the MACD can give false signals in a market that’s currently not
trending. Hence, you should always be aware of your own risk management strategies while using the
MACD.

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36 Momentum Indicators

STRATEGY 2: SIGNAL LINE CROSSOVER

Source: TradingView

In this strategy, traders would have to focus on the two lines in the MACD indicator to note when the two
lines cross each other. The good thing about this strategy, as compared to the 0-line crossover strategy,
is that it can preempt a price move slightly faster.

When the MACD line crosses above the Signal line, it’s a bullish sign that the market is likely to
experience an uptrend soon. When the MACD line crosses below the signal line, it’s a bearish sign that
the market is likely to experience a downtrend soon. Hence, you should generally look to place your long
and short positions accordingly.

As you can see in the above picture, the MACD indicator provided us with two opportunities to enter
the market. At the first point, we can see that the MACD crossed below the signal line, which indicates
a good time to enter with a short position and sell. At the second point, the MACD crossed above the
signal line, which indicates a good time to enter with a long position and buy.

However, do be mindful of “whipsaw” trades which can happen when the two lines cross each other
multiple times within the same period of time. To avoid this, you can consider waiting a little longer to
ensure that the trend is long-term before entering the trade.

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37 Momentum Indicators

STRATEGY 3: DIVERGENCE

Source: TradingView

This strategy allows us to focus on how the movement of price and MACD differs and, based on the
momentum of price action, decide on the likelihood of a reversal in the market.

When the price is making new highs but the MACD is not, it can be considered a bearish divergence. This
means that momentum has slowed down and it signals an impending downwards reversal. Conversely,
when the price is making new lows but the MACD is not, it can be considered a bullish divergence
instead. This also implies that momentum has slowed, thus signalling an incoming upward reversal
instead.

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38 Momentum Indicators

Here’s an example of a bullish divergence in action:

Do note that the price can continue to rise and fall for much longer than you may expect when a bullish
or bearish divergence is occurring. A more logical method of trading divergence would be to use the
histogram for trade entry and exit signals as well, since it gives a more unbiased view of the market.
Importantly, you’ll need to back up the rationale behind your trade before actually entering the market.

As with all the indicators we cover here, besure to use them in a comprehensive trading strategy instead
of in isolation, and always conduct proper risk management.

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Momentum Indicators

4
Volatility
Indicators
40 Volatility Indicators

4.1 Bollinger Bands

Basics of Bollinger Bands

Bollinger Bands are useful in helping traders to identify the range that prices are trading within, as
well as anticipate the volatility in the market. Given that it is an Oscillator Indicator, it works better in a
ranging market where prices are trading sideways, as compared to a trending market.

Bollinger Bands are made up of three bands, known as the upper, lower and middle band, as shown in
the chart below.

Components of Bollinger Bands

The length represents the period that the data is taken to plot the simple moving average, which is
also the middle band. The upper and lower bands are formed by plotting 2 standard deviations away
from the middle band. While using a standard deviation of 2 is the default setting, it can be changed
according to the user’s preference.

Trading with Bollinger Bands

Bollinger bands can serve as a good indicator when trading in a ranging market.

As shown in the chart below, when a price approaches the upper band, it serves as a dynamic
resistance level where we could see prices reverse below this level. The upper band is also identified as
an overbought region which means the excessive buying pressure is pushing prices up higher. However,
this is usually not sustainable in a ranging market, which is the reason we can expect prices to move
lower after.

Source: TradingView

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41 Volatility Indicators

Conversely, when prices are near the lower band, it serves as a dynamic support level where we could
see prices bounce above this level. The lower band is also seen as an oversold region, where excessive
selling pressure is pushing prices lower. However, this is usually not sustainable in a ranging market,
which is the reason why we can expect prices to move higher after.

Now that we’ve covered the use of the upper and lower bands, where approximately 90% of the price
movement occurs, what about the other 10%?

A strong break above or below the Bollinger Bands is usually triggered by high impact news events.

Source: TradingView

Examples include an announcement of new tariffs imposed by the US on other countries, a sudden
change in interest rates by central banks, or the discovery of a Covid-19 vaccine that could be released
into the mass market at a reasonable price. In these scenarios, prices could push higher or lower,
testing the extreme limits of the band. In the chart below, we can see prices testing the upper band and
showing no signs of pulling back.

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42 Volatility Indicators

Another popular concept with Bollinger Bands is using the “squeeze” to anticipate the volatile movement
in prices. As shown in the diagram below, the squeeze – as depicted by the blue arrows – is seen when
the upper and lower band comes closer together, narrowing the gap between them. This is considered
a period of low volatility as prices are trading within a smaller range and it’s useful in helping us to
anticipate the volatility that follows. After seeing the squeeze, we can expect an increase in volatility
where prices cover a wider range within a short period of time.

Conversely, the further the upper and lower bands are from one another, we can expect a decrease in
volatility following that. However, these are not trading signals as they do not give an indication as to
when the change might take place, or the direction that prices could move. Hence, we would need to
combine them with other indicators to generate more accurate trading signals.

Source: TradingView

4.2 Average True Range (ATR)

Basics of ATR
The Average True Range, or ATR, is a Technical Indicator that shows us the volatility of price over a given
time frame. It is calculated by averaging the price movement over a period, which essentially levels out
the spikes and dips in price to provide a more holistic view of what the true price is – or, in other words,
the price’s “true range”. This “true range” is calculated by finding the difference between the previous
close and the current price (high or low).

While ATR is a good measure of volatility, it’s important for you to understand that it is not a trend
indicator. In other words, it doesn’t exactly tell you where the market is heading. However, it still remains
a great indicator of volatility and many profitable traders still use it to manage their trades effectively.

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43 Volatility Indicators

Components of ATR
Let’s dive deeper into the details of ATR and how it is derived.

Source: TradingView

It may be helpful for you to understand that the ATR essentially functions like a moving average. A
common time period used to calculate ATR is 14 periods (or 14 candles), which gives us a good view of a
particular chart’s volatility. This can be applied to charts of any time period, be it hourly, daily, weekly or
monthly charts.

In the above picture, you can see a tab that labelled “Smoothing”. This refers to how the average
is calculated, or what type of Moving Average is used. If you recall, you can choose between the
Exponential and Simple Moving Averages, which we discussed in our chapter on Moving Averages. These
are the most common averages used by traders.

As for the “Length”, this refers to the number of time periods. You can choose your time period based
on the time frame that you want to measure. When measuring recent volatility, you can use shorter
averages such as 2 to 10 periods, while longer term volatility can be measured using 20 to 50 periods.

You may also see that there’s a small number near the indicator. This tells you the average number of
pips moved in the past period, according to the time frame the ATR is set to.

Trading with ATR

Now that you have a better understanding of ATR, let’s explore how we can use ATR in our trading
strategies!

As we discovered earlier, ATR is not a trend indicator. In other words, it doesn’t tell us which direction to
go, instead simply showing us an average of how much price moves over a certain period of time. Thus,
ATR can be a good way for you to determine your stop loss and take profit targets.

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44 Volatility Indicators

STRATEGY 1: PLACING YOUR STOP LOSS LEVELS

Because ATR is a volatility indicator, it would preempt traders on how wide the price movements will be
in the market based on how volatile it is. This will be a good indicator for us to know where to place our
stop losses.

When the ATR reading is high, it signals to us that the market is experiencing high volatility at the
moment, thus we can expect much wider price movements. You can use this signal and decide to set
your stop loss further away in order to avoid getting stopped out prematurely. Likewise, when ATR is
showing us a low reading, it means volatility is low, thus you can afford to use a smaller stop loss. This is
similar to using a Volatility Stop, which is another indicator used in Technical Analysis.

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45 Volatility Indicators

Now let’s compare the ATR readings on two different markets and see how we can adjust our stop losses
accordingly.

In this image, we can see that EURUSD in the daily time frame has an ATR reading that shows us an
average of 73.1 pips movement in a day.

And in this image we see that the ATR for GBPUSD is 123.8 pips in the daily time frame.

This means that GBPUSD moves 1.6x more than EURUSD on a daily time frame. Hence, it would be wiser
to use a larger stop loss when trading GBPUSD.

STRATEGY 2: PLACING YOUR TAKE PROFIT LEVELS

Setting your take profit levels is similar to how you set your stop loss levels using ATR. Essentially, you
should find out how volatile the market is to determine how far you should set your take profit level from
your entry price.

In a volatile market with high ATR readings, you would be able to aim for a larger profit and maximise
the market move, hence you can afford to set your take profit level much further from your entry level.
Likewise, in a less volatile market with low ATR readings, you should adjust your take profit to be closer to
your entry level so that you don’t miss any move in the market.

STRATEGY 3: CONFIRMING YOUR ENTRY

The ATR can also be helpful as the last step in determining whether you want to enter a particular
trade, regardless of what direction you hope the market will move in. That being said, using the ATR as
a trading strategy in isolation is not recommended; instead, you should look to combine it with other
technical indicators to validate your idea.

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46 Volatility Indicators

4.3 Parabolic Stop And Reverse (PSAR)

Basics of PSAR
The Parabolic Stop and Reverse – also known as the Parabolic SAR or PSAR – is a trailing stop-based
trading system and indicator. It’s commonly used by traders to determine trend direction and potential
reversals in price. This can be an indicator as to where traders can see suitable entry and exit points in
the market.

The PSAR indicator is overlaid onto a chart and appears as a series of dots either above or below an
asset’s price, depending on the direction that the price is moving in. A dot is placed below the price
when it’s trending upward, and above when the price is trending downward instead.

Components of PSAR
Calculating PSAR values will require the use of some complicated formulas which may be off-putting for
some. There’s no need to worry as most charting software will calculate these values for you, though it is
useful to have a basic understanding of how the PSAR is calculated. But before we move onto the actual
formulas, there are a few components worth discussing.

Recall that the PSAR is a trailing stop-based system. In other words, it uses a trailing stop level which
follows prices as it continues moving upwards or downwards. This stop level increases the speed based
on an “Acceleration Factor”. This Acceleration Factor (AF) is a constant of 0.02, and increases by 0.02
each time a new Extreme Point is reached, with a maximum of 0.20. The Extreme Point (EP) refers to the
highest high for an uptrend and the lowest low in a downtrend, and is consistently updated whenever a
new EP appears.

Still with us? Great! Now that you’ve digested that information, we can move on to the actual formulas.

The PSAR calculation is dependent on whether it is being used in an uptrend or a downtrend:

In an uptrend,
PSAR = Prior PSAR - Prior AF*(Prior EP- Prior PSAR)

In a downtrend,
PSAR = Prior PSAR - Prior AF*(Prior PSAR - Prior EP)

Again, you don’t have to worry too much about these calculations as they are calculated automatically
for you on your trading platform.

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47 Volatility Indicators

Trading with PSAR

The PSAR is especially useful for traders that want to know where the possible reversals in price are, as
well as those who want to know when a reversal will occur that will signal the end of a trend.

If the dot switches its placement, it signals to us that the current trend is likely to come to an end soon.
This means you should be looking to close any open positions before the price reverses against you. You
can also think of it as a potential to open a new trade to benefit from the reversal if you don’t have any
current trades open, thus you’ll be able to find suitable entry and exit points in the market. Many traders
also choose to use the PSAR dots to set trailing stop loss orders.

However, one thing to note is that the PSAR moves regardless of whether or not the price moves. This
means that if the price was initially in an uptrend but starts ranging, the PSAR will continue to keep rising.
A reversal signal will be generated as long as the PSAR catches up with price. This instance may look
as though price is going to reverse, but instead the price may just continue to range instead. Hence, a
reversal signal from the PSAR does not necessarily mean the price will be reversing.

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Volatility Indicators

5
Combining
Indicators
48 Combining Indicators

5.1 Dangers of overloading indicators

Now that we’ve explored the use of these indicators, how can we use them in our trades? In this section,
we’ll go through three examples of how we can combine these indicators to generate trading signals,
and the thought process behind them.

As a general rule of thumb, I try not to use more than three indicators in each chart analysis because
overloading the chart with indicators can do more harm than good – especially if the indicators present
conflicting views. This is why it’s important that the indicators you add onto a chart make sense for you.

Source: TradingView

5.2 Choosing specific indicators

Let’s look at the chart on EURUSD on the H2 timeframe. Starting on a clean chart, with no technical
indicators, we saw prices bounce off the support level at 1.16155 before pushing higher. It’s important
that there is presence of a key graphical level, in this case a horizontal swing low support that price
bounced off as this means that there are many buyers looking out for that level. Hence, when price
bounced off the support level at 1.16155, it shows there’s strong buying pressure where prices could
potentially push higher.

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49 Combining Indicators

Source: TradingView

After we’ve determined that, the next step is to load our indicators. In this example, I’ve chosen the
EMA to determine if there’s a change in trend and the Stochastic Indicator to determine if the bullish
momentum is sustainable. Finally, ADX, which is an indicator to measure the strength of the trend along
with the directional bias to show where prices are heading towards (+DI & -DI), is added into the picture
as well.

5.3 Trading with these Indicators

Source: TradingView

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50 Combining Indicators

NOW THAT WE’VE CHOSEN THE INDICATORS, HOW CAN WE INTERPRET THEM?

From the chart above, we can see an opportunity to enter a buy order, starting from the right of the
vertical dotted line on November 4th. Prices are holding above the EMAs which means that the short
term bullish momentum is stronger, signalling a potential for prices to push higher. On top of that, the 20
EMA is also holding above our 50 EMA which supports our bullish bias.

NOW, LET’S LOOK AT STOCHASTICS AS OUR NEXT INDICATOR.

Stochastic is bouncing off our support level which supports our bullish bias. More importantly, Stochastic
is an indication of the momentum and, in this example, we saw that along with a bounce in Stochastic
off our support level (green horizontal line), the stochastic indicator is showing a bullish divergence as
well. If you recall, a bullish divergence is a powerful tool in identifying key reversal points and is formed
when prices form a lower low while the stochastic indicator forms a higher low, as represented by the
golden lines.

HOW CAN WE INTERPRET THIS BULLISH DIVERGENCE?

It shows that the downtrend momentum is waning and signals a potential trend reversal.

FINALLY, LET’S LOOK AT ADX

Now that we’ve found a strong support level that prices bounced off from – along with a trend indicator
(EMA) and momentum indicator (stochastic) supporting this view – it’s time for us to determine the
strength of the trend.

Simply put, we want to ensure this uptrend is sustainable before getting into the trade with a long
position. The last thing we want is to buy into EURUSD before realising that we’re at the end of an uptrend
and prices are now moving against us. Hence, ADX is introduced into this analysis and, looking at the
indicator, which holds above 25, it shows that the uptrend is still intact.

At the same time, the +DI is also holding above the -DI which confirms the direction of the trend going
upwards. Hence, from the example on EURUSD, we can see that combining these indicators gives us a
higher probability setups.

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51 Combining Indicators

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