Conducting chart analysis can be very beneficial to your trading career. Because, it allows you to make more insightful decisions with your trade. Statistics, chart overlays, and technical indicators provide the basis for conducting forex analysis. In this article, we are going to explore some analytical tools for forex traders that can be useful in your trading journey.
Analytical tools for forex traders are either bought via a subscription or provided for free on the trading platform. Platforms such as MetaTrader 4 or Metatrader 5 provide several technical indicators and trade automation features.
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They also provide a wide variety of indicators, patterns, and oscillators to help traders generate signals and become more profitable. These analytical tools for forex collect information such as price history, trading volume, and chart momentum to give signals. Traders are advised to be minimalist when using these analytical tools; too much of them can throw you off your decision or give a confusing reading.
Top 5 Analytical tools for forex traders
Forex analytical tools can be divided into two:
- Overlays– Overlays appear right on the price chart. They are functions of price and very crucial in decision making. Overlays are plotted over the top of the prices on a forex chart. They include indicators like moving averages, parabolic SAR, Fibonacci Retracements, and Bollinger bands.
- Oscillators– Oscillators help the trader recognize overbought and oversold stocks in non-trending market conditions. They are used to determine the range extremes to mark important entry and exit points. Examples include RSI, Stochastic indicators, etc.
Here are the top analytical tools for forex traders
1. On-balance volume
One of the top analytical tools for forex traders is the On-balance volume; sadly not most traders make use of this tool. On-balance volume is an analytical tool where the trader uses an on-balance volume (OBV) indicator to conduct technical analysis to measure the buying and selling pressure. The on-balance volume indicator acts as a cumulative indicator that adds volume on up days and subtracts volume on down days. An up day occurs when the security in question closes higher than its previous close. A down day occurs when the stock closes lower than it had previously closed.
Knowing the value of the on-balance indicator is not important, rather it is the rate of change that helps generate signals. If the OBV is moving in one direction then it indicates that a big price action is about to happen in that direction. When the price and OBV seem to be making higher peaks and troughs then the upward trend is likely to continue. When the price and OBV are making lower peaks and troughs, the downward trend is set to continue.
In a trading range, when the OBV seems to be rising, accumulation is taking place; an indication of an upward breakout. When the price is up but the OBV is down it could mean that the trend is not backed by strong buyers and could soon be reversed. When the OBV is falling, distribution may be happening- an indication of a downward breakout. When the price is rising and the OBV seems to be left behind, the upward trend is likely to be reversed or stalled.
2. Accumulation/ distribution line
The accumulation/distribution line (A/D line) is an important analytical tool for forex traders. This analysis tool works like the on-balance volume indicator; besides considering the closing price of a security for the set period, it also analyses the trading range for that period and compares it to the close of that period. If a security finishes near its accumulation point, the A/D line indicates more volume than when the security finishes near the midpoint.
If the A/D line is trending upwards, it indicates buying interest, since the stock closes above the midrange. If a stock closes above its mid-range it means there is an uptrend. On the other side, when the A/D is falling, it means that the stock price is closing in a lower position than its normal daily range, thus volume becoming negative. This is an indication of a downtrend.
Generally, when the A/D line is falling while the stock price is going up, it is an indication that the market is likely to reverse. If the price is low and the A/D line starts rising, it means that an upward trend is imminent.
3. Average directional index
Another very important analytical tools for forex traders is the average directional index (ADX). ADX is a trend indicator used to determine the strength and momentum of a market trend. When the ADX is above 40, the trend is considered strong. When it is below 20, the trend is weak or non-trending.
The ADX appears on the chart as the black line on the indicator. There are additional lines known as DI+ and DI-. they appear in red and green respectively. A combination of these three lines help project the direction and momentum of the trend
An ADX of above 20 and DI+ above DI- is an indication of an uptrend. An ADX of above 20 and DI- above D+ indicates a downtrend. An ADX below 20 indicates a weak trend and the DI- and DI+ usually rapidly crisscross each other.
4. Aroon indicator
The Aroon oscillator is used to determine the momentum of the trend and to find out whether the price is hitting new highs or lows over the set period. The Aroon oscillator helps the trader know whether a new trend is set to begin. It is made up of two lines; the Aroon-up line and the Aroon-down line.
When the Aroon-up moves above the Aroon -down, it indicates a possible trend change. When the Aroon-up is at 100 and stays at that range while the Aroon-down is near zero, it is a confirmation of an uptrend.
On the other hand, If the Aroon-down moves above the Aroon-up and Aroon-up is near100, it is an indication that a downtrend is about to occur.
The moving average convergence divergence (MACD) indicator help traders determine the direction of the trend as well as the momentum. This technical analysis tool for forex traders generates several trade signals.
When the MACD is above zero, that’s an indication of an upward trend. If the MACD lies below zero then it indicates a downwards trend.
This indicator is comprised of two lines: the MACD line and A signal line whose movements are slower. When the MACD is below the signal line, it means that the price is falling. When the MACD is above the signal line, it indicates the price is rising.
The trader should find out which side of zero the indicator lies to know which signals to follow. For instance, when the indicator is above zero, buy when the MACD to move above the signal line. If the MACD is below zero, wait for the MACD to cross below the signal line to enter a short sell position.
All forex traders should be keen on the direction and momentum of the market to enter profitable trades. There are many more indicators and oscillators designed to help traders read the market trend, however, choose a few, perfect them and incorporate them into your trading. To determine which analysis tools for forex traders to use, get a demo account and practice. Other Important analytical tools you should know include: Stochastic Oscillator, Relative Strength Index, Moving Averages, Bollinger Band, etc.,
All the best!