Basic tools in Forex trade

Indicators

In the following section, some of the most commonly used indicators will be presented. Even though one’s strategy may not necessarily include all of them, it is important to understand them since they could be used for future strategy development to make a system more robust.

Simple Moving Average Indicator

Definition

The simple moving average is one of the most widely used indicators. This is a very basic indicator that basically plots an average of prices according to the number of bars specified in the input length. The three most common moving average indicators are: one line moving average, two lines moving average, and three lines moving average. These three are very similar in the sense that they are all calculating the same arithmetic average using the same formula, what differs is the number of lines they plot and the different time periods they use to calculate the averages.

One line moving average: plots one moving average line. In TradeStation the default length to calculate the average is nine bars. Two line moving average: plots two moving average lines. Usually one is called the fast average, which has a shorter length, and the slow average, which has a longer length. In TradeStation the default lengths normally are nine bars for the fast line and eighteen bars for the slow line.

Three line moving average: plots three moving average lines. Usually one is called the faster average, having the shortest length, the other is called the fast average, having a short length, and the slow average, having the longest length. In TradeStation the default lengths normally are four bars for the fastest, nine bars for the fast, and eighteen bars for the slow moving average.

Three Line Moving Average

Three Line Moving Average

Formula

The formula for the one line moving average would be the sum of the number of closing prices that are being analyzed, divided by the same number of closing prices.49 This is the formula for the simple moving average:

Use

This indicator’s main use is to identify a trend in the movement of the price for a given time period. For instance, when the average values are going upward, means that the prices are going above the moving average, and this shows an uptrend. If prices are constantly lower than the average, the moving average indicator would show a down trend.

Possible Application

The moving average indicator is helpful to identify a general trend in the price duration of a certain trading instrument. This could be used to get a broad idea of what is the direction that a certain security is following. However, it is important to be aware that this is a very simple indicator and widely used by many people, so if used by itself it may not be a robust strategy.

Exponential Moving Average Indicator

Definition

The exponential moving average (EMA) is another very widely used trend indicator similar to the simple moving average (SMA) previously described. The difference from the (SMA) is it gives a greater weight to the market’s most recent prices and a reduced weight to older prices. The exponential moving average values are calculated using the number of bars back specified by the user in the length parameter of the indicator. The default length in TradeStation is nine bars. 50 Figure 7 shows a visual representation of the difference between the EMA and the SMA; as it can be seen, the EMA follow more closely the actual prices.

Formula

In order to calculate the exponential moving average first the simple moving average needs to be calculated –since the EMA needs to starts somewhere and the SMA is used as the first calculation. The second step is calculating the weighting multiplier. Finally, the last step is calculating the exponential moving averages

Use

This indicator is used to identify the trend of a financial instrument. It can be used to identify long trends or short trends and changes of momentum, according to what the trader sets the length to be. Many traders use various EMAs of different lengths in order to be able to track the different price movements and changes of momentum.

Possible Application

This indicator may be used in the same way that the simple moving average indicator, to identify the general trend of a financial asset. Furthermore, another use of this indicator can be to identify changes of momentum. For instance, if using two EMAs, one fast (shorter length) and one slow (longer length), one can see the sudden changes of momentum in a certain instrument when the two EMAs cross. This changes of momentum can help a trader determine when to enter or exit a position.

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