The new forex trader often assumes that all indicators are generally alike and function in a similar fashion. This is not entirely true. All indicators take past price data and use it in an attempt to predict future price behaviour. After that they fork into two types of indicator. Some of the differences are:
- Most indicators attempt to predict future price direction or trend. Some, such as Fibonacci, plot lines at future price levels based on past price data. So here is the first distinction: some indicators will be predicting trend, while others will be identifying future price levels.
- More important is the distinction between lagging and real-time indicators. For example, MACD, RSI and Stochastics all attempt to forecast future price direction or trend. However, none of them predicts an exact time when price will change direction, or begin to trend. In this way, these indicators give a very loose idea of future price behaviour.
- The last difference is where the indicator appears on our screens: some are plotted on the actual currency chart, others are shown in a separate window below the chart. for example, MACD and stochastics are generally shown in a separate window at the bottom of the chart screen. Some traders like this because the indicator data is not cluttering up the actual chart price action. Others find it distracting having data appear separately from the chart, since it requires them to divert their attention from the price action in order to see what the indicator is saying.
It is important to acknowledge that off chart indicators like MACD can be very effective, particularly when used with other factors to determine optimal trade entries, exits etc. An example of this is Vic Noble’s strategy called the Vic Trade. This is one of the six strategies that make up the forex trading system Vic and Shirley Hudson have put together called the Recurring Forex Patterns course.
The three classes of indicator therefore are:
- Trend Predictive or Price Predictive
- Lagging or Real Time
- On Chart or Off Chart
Following on from this we can observe that some indicators are – as a general rule – of more use to us in trading than others, especially if we are price action traders. The breakdown is shown in the following grid:
Trend Predictive (MACD/RSI/Stochastic etc)
NO, HENCE LAGGING
Trend Predictive (EMA’s/Bollinger Bands etc)
YES, BUT LAGGING
Price Predictive (Support Resistance Levels, Forex Pivot Points, Fibonacci Numbers, Round Numbers)
The Three Types Of Indicator
As can be seen in the table above, the only indicators that provide real time, predictive analysis of Price are the on-chart indicators: Round Numbers, Fibonacci Numbers, Forex Pivot Points and Support and Resistance Levels. While the other indicators may be useful when trading certain systems and strategies, for the most part your trading will benefit from concentrating on these real-time, price-predictive forex indicators.
The next most important tool in the forex price action traders toolkit Forex Candlesticks.