Trading the FX markets can be extremely rewarding and challenging so traders are continually looking for an edge to give them a competitive advantage. Currency markets are fast moving and occasionally brutal.
Get the trade right and there can be large rewards when the trade goes your way and profits roll in. Get it wrong, however, and your trading capital can be depleted, and your confidence shattered. Therefore many traders use forex signals to help them decide when to enter, and more importantly, when to exit an FX trade, thereby increasing their chances of success and minimizing their losses.
What is a trading signal?
A trading signal occurs when an event indicates that there is potentially a good chance of success in effecting a trade. The signal may be a trade entry signal which indicates that a trade should be entered or, if you are currently in a trade, the signal may provide an indication that you should now exit the trade by closing your position.
In forex trading, trading signals may result from either changes in economic conditions or be based on technical trading indicators that meet certain conditions to generate the forex signal that traders react to.
Economic indicators such as gross domestic product (GDP) or changes to a country’s inflation rate are generally used by those with large currency holdings or financial institutions looking to take long term positions in the market.
The use of technical indicators to generate forex signals are generally used by traders who are looking for short term positions as they are hoping to profit from short term volatilities in the FX markets where rapid market fluctuations results in buy and sell signals over short time periods.
We are concentrating on the technical indicator-based forex signals in this article.
Types of technical indicators used to generate forex signals
Technical indicators, or technical analysis as it is known, try and extract signals from the FX market noise. With the spot prices of currency pairs moving up and down as it responds to the buying and selling pressure from the market participants, a technical indicator will often try and smooth the fluctuations to elicit a trend.
Determining the trend will help a trader decide if the price for a currency pair is going up over time, is in a down trend or is range bound with no real directional drive. Many trading signals incorporate a trend determination component as it is clearly important to know in which direction the market is currently heading. These signals generally use moving averages to help smooth market fluctuations.
Support and resistance
The more you study financial instruments such as equity and forex markets, the more aware you become of the influence of the herd which exerts a canny effect on price when many traders making individual decisions at the same time exerts an effect on the market price of a currency pair.
Traders become twitchy when a currency pair hits a notable price point such as when the USD/GBP hits a notable price of, for example, 1.3 you will often find rising price progression stalling as those holding that currency pair fear that a resistance point has been reached and close out of their holding in case selling pressure causes a fall in value.
On the other hand if a currency pair, such as USD/GBP is falling to the 1.3 exchange rate in our example, these traders may feel that a resistance point has been reached where a price rebound is possible, which would weaken their trading position.
Support and resistance levels exert a large influence on FX prices so forex signals will often incorporate these levels into their trading signal determinations.
Markets never keep on rising, or falling, indefinitely. They move within a trend by advancing and then retracing (falling in an up trend, rising in a down trend) as traders wish to exit their trades and realise their profits. Or exit their trade to prevent further losses.
In a similar way to the support and resistance levels in which traders make independent decisions that create a herd effect on the markets, market retracements often react to mathematical phenomena based on the Fibonacci series.
Fibonacci based indicators determine likely retracement prices and therefore can help a FX trader decide whether to enter or exit a forex trade. These retracement prices play an important role in the prices of FX trading pairs and are often incorporated into forex signal generation.
Forex traders soon realise that they are competing in a fast-moving marketplace where well financed institutions such as banks, large corporations and professional traders attempt to maximise their profits. When somebody makes a profit in a financial market, it is at the expense of those who have lost money.
Therefore many traders seek to maximise their chances of success by using trading signals to help them decide whether to enter or exit a trade, or, importantly, do nothing. It is important that these signals use tried and tested methodologies that incorporate technical analysis such as trend analysis, support and resistance points and possible retracement levels.
Using and adhering to good forex signals should boost the chances of making successful trades in the forex markets and are generally a good idea for new traders or those seeking to build their experience and confidence in the currency markets.