Generally, they use statistics, chart overlays, and technical indicators to help forex traders make better-informed trading decisions. Some of the tools described below are unique to forex trading, while others are common to all markets and can be fine-tuned for trading currencies. These global markets vary in size, in terms of their numbers of currency transactions and how many currency traders they have. That means each session in each market has different characteristics in their currency “pairs,” or the comparison of the value of the home currency against another one. For example, the EUR/USD currency pair is most active during the London and New York sessions, because these currencies are associated with Europe and the U.S. But the USD/JPY sees steady action throughout the day, as traders in Tokyo, London, and the U.S. all actively trade this pair. Many forex traders find it useful to separate the various sessions on their charts. A session highlighter shows the price action that occurred during the various sessions, by the minute or by the hour. The session highlighter automatically draws vertical lines on the price charts when a major session opens or closes. Alternatively, the trader can use colors to visually highlight the various trading sessions. These tools provide insight into what can be expected on a particular day or at a particular hour. This information helps the trader assess whether a trade has a good chance of reaching a profit target. A volatility tool can’t tell the trader which direction the price will go, but it does indicate how much the price might move in either direction. Forex volatility tools vary in complexity and format. For example, a trader may select a time period, and the tool will calculate a confidence level for the likelihood that the price will stay within that typical movement range. A single comparison like this isn’t all that useful, but watching how the ratio changes as the price moves can provide insight into how the price may move in the future. Eventually, traders must exit these positions, regardless of whether they’re at a profit or loss. Current trader positioning can predict future positions and, thus, price moves. Extremes in a currency pair, such as 90% long, can reveal that a trend reversal is coming. If 90% of traders are long, it means that most traders have already bought, which leaves very few out there to keep pushing the price up. When there is no one left to buy, the price moves in the other direction. With some position-summary tools, traders can look back in history to see which position ratios have signaled a change in price direction. If the current position ratios approach historically significant ratio levels, they could signal a price reversal. Another way to view position summaries is through the Commitment of Traders (COT) report. Myfxbook is one resource that provides COT charges going back to 2006, so traders can see how various traders were positioned at major market turning points. This data may be used to anticipate future turning points in price. Knowing the correlations between forex pairs is important. Traders often trade in multiple currencies. If their purchases all have a positive correlation to each other, the risk is multiplied, as is the potential reward. If you’re long in two pairs that are negatively correlated, you’ve hedged potential risk and reward. Note that correlations are related to the direction, but not to the magnitude, of price moves. Two currency pairs could be correlated, but one could move much more than the other. In other words, the one that moves more has greater volatility. Therefore, a study of correlations should also include a study of volatility. Many online resources provide free forex correlation tables. Correlations change over time and can be measured on different time frames. Check correlations regularly, and look for correlations on the time frame you trade on. For example, if you day trade on a one-minute chart, regularly check the correlations on one-minute and one-hour time frames if you are trading more than one pair. If swing trading on a daily chart, regularly check daily correlations.
Zigzag
The zigzag indicator draws lines over price waves only when they meet a certain minimum movement threshold. By only highlighting major movements, these lines help filter out the noise of tiny movements so traders can focus on the larger price movements, where the bigger profits lie. The zigzag can be customized to show how far the price has moved (in “pips” or percentages), which in turn can highlight tendencies in the price action. For example, a percentage-retracement zigzag could show a currency that typically retraces about 55% of a trending move on a pullback before moving in the trending direction again. A trader who notices such tendencies—and when such trends are broken—could improve their timing and location of entries and exits.
Moving Average Envelopes
Moving average envelopes are composed of three lines that are drawn directly over the price action. The middle line is a moving average, and the others are drawn above and below the moving average at an equal distance chosen by the trader. For example, a trader may use a 20-day moving average as the middle line, and draw the upper and lower lines 5% away from the middle line. When an envelope is calibrated to a specific pair, it can provide insight into potential trend changes and whether a trend is strong or weak. When the price is hovering near the upper band, it highlights an uptrend. When it breaks out of the band, it could signal an overbought or oversold level that precedes a trend change. The moving average in the middle can often be calibrated to act as a support or resistance area—it’s a rough point at which the price often stalls.
TTM Trend
Another technical indicator, TTM Trend, changes the color of the price bars on the chart based on whether short-term momentum is up or down. This tool can be used in conjunction with other trend-following strategies to capture large price moves. For example, if the trend is up, stay in a long trade while the bars are blue. When the trend is down, stay in a short trade while the bars are red. Technical tools like the ones described here can be combined to make a better and more informed trading decision. Nobody has to use all of them. Your best bet is to review the tools and practice trading with them in a demo account. You’ll find tools you need, and discard the ones that you don’t find helpful. The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.
