Newcomers to forex trading typically have an inexhaustible appetite for information. They want to learn everything about trading currency pairs that they can, from reading charts and technical analysis to the most effective trading strategies available.
Often, it pays to walk before you can run, and in the early going focusing on one or two strategies is wise until you have experienced first-hand how the forex market can move.
The truth is that there are dozens of factors – both macro and global to small and ‘localized’ – that will impact upon the price movements of a currency, and so newbies to trading are advised to simply focus on the forex charts as their sole guide in the early going.
The charts feature a number of indicators that highlight a myriad of patterns, but in their most simple form traders are looking for two things:
- A suggestion that there is support/resistance for a move
- That a trend will continue in its present direction
When you can ascertain this information, creating a workable trading strategy becomes a whole bunch easier.
There are a number of ways that we can measure price movements and then make predictions as to where a currency’s value may be heading next – be it a major, minor or trading an exotic pair, many of these indicators are advanced and complex, and new traders should not be concerning themselves with early in their careers.
Instead, there are two more basic indicators that we can use to assess a forex chart:
- Moving Average
- Relative Strength Index (RSI)
When you understand these, plotting a forex trading strategy becomes much more straightforward.
What is the Moving Average?
In layman’s terms, the moving average is simply recording the price of a currency pair at the close of the market across a specified period of time.
So, if we wanted the moving average of USD/EUR over a ten-day period, we would record the price that the currency closed at for each of those days, and that would give us a short-term view of where the forex pair is heading.
How to Calculate the Moving Average
The simple moving average is a pretty easy calculation to make. In the example above, we would: add the 10 closing prices together and then divide them by ten.
This really is a simple calculation, where you determine how many data points you want, record them and then simply divide them by the number of points captured.
What is the Exponential Moving Average?
The simple moving average offers a basic snapshot of how a currency pair is performing over a given period of time.
The exponential moving average takes that basic premise but drills down a bit deeper, because the simple moving average does just what it says on the tin: it offers a simple average from a broad range of data.
The exponential moving average uses a ‘smoothing’ factor in its calculation that gives a greater weighting to the most recent data points – that way, it offers traders a more accurate reading of price trends.
Trading Using the Moving Average
Now we know the moving average for a given period of time, we can:
- Determine whether the forex pair is trending up or down
- Assess whether there is support or resistance at a given price point
Clearly, a moving average which shows a pair moving higher in value can be a buy indicator, as long as there isn’t significant resistance preventing the price from breaking through to a new high.
But if the current value sits below the moving average, this would signal a downward trend – a bearish indicator that offers very little optimism for buyers.
Traders should also consider support and resistance when entering a trade based upon the moving average. Use this as a stop-loss trigger – if the price of your pair dips below the moving average, you should be prepared to close your position at this downtrend signal.
Using the moving average should be considered the most basic way to read a market, and thus any trades entered on the back of this analysis should be undertaken with caution.
What is the Relative Strength Index?
The relative strength index (RSI) is a forex chart indicator that acts as an oscillator between 0-100, highlighting changes in price momentum.
In essence, the closer the RSI is to 0 suggests an oversold asset, whereas close to 100 and you’re looking at an overbought pair – a price reversal could be possible.
How to Calculate the Relative Strength Index
Unless you’re a mathematics whizz or an algebra demon, calculating the RSI is not an easy task!
Happily, there are calculators online which will perform the maths for you after you plug your data in to them – one such option can be found at https://captaincalculator.com/financial/finance/rsi/.
Trading with the Relative Strength Index
As mentioned, the relative strength index is an oscillator that lets you know in what quantity a forex pair is being bought or sold.
Pairs with an RSI around the 50 mark offer little clues as to whether their value may be heading, but those at the extreme ends of the curve suggest that a reversal is possible – that can be a buy or sell trigger depending on your position.