Commonly Used Technical Indicators

Moving Averages
Moving averages are trend indicators and are used by traders as a tool to verify existing trends, identify emerging trends and signify the end of trends. Moving averages are smooth lines that enable the trader to view long term price movements without the short term fluctuations.
Of the three types of moving averages, the most common is the simple moving average; the other two are the weighted and exponential moving averages.

All the moving averages are calculated as the average of a specified number of either low, high or closing price of the period. The difference between the three types is the weighting or importance placed on each particular period. For example the weighted and exponential moving averages give greater importance to the latest prices whereas the simple gives equal importance to all the periods chosen.

Each new point of the moving average drops off the oldest period and brings in the newest period. A moving average line will change depending upon the number of periods chosen, the greater the number the slower the average. Some traders will play with a different number of moving averages all with different periods until they find a series of moving averages that they feel best indicate the behavior of the particular instrument being studied.

When choosing a moving average to work with, ideally in an upward trending market the current price should not fall beneath the moving average line chosen more then once. The moving average should form a support line during upward trends and a resistance during down trends. If the upward trend continues yet it breaks the moving average line on more then one occasion, then this is a good indication that the moving average line chosen is too fast, and has not been smoothed out enough. If for example a 30-day moving average was used then a 45-day moving average may be more appropriate for this particular instrument.

Once a trader is content with the behavior of the moving average line against the actual prices he may use the line to signify the continuation of a trend or the end of a trend. If the price closes below the moving average line on two occasions in an upward trending market – this is an indication of the end of the trend and time to exit a long position. The same logic follows in a downward trending market except in reverse; the current price needs to close above the moving average on two occasions to indicate that the downtrend is over.

Another way of using moving averages is in pairs. Many traders will first find the long-term moving average as described above and add a faster moving average (smaller period) as an even earlier indication of the end of a trend. I the shorter moving average crosses the slower moving average this may signal an earlier exit point for a trend.

Stochastics
The most commonly used stochastic is the slow stochastic. Stochastic oscillators are also used to determine either the strength of a trend or when the end of a trend is approaching. Stochastics are displayed by two lines known as %K (Faster) and %D (Slower) that oscillate between a scale ranging from 0 to 100.

The mathematics behind the oscillators is unimportant, what is important is the meaning and placement of the lines. When the lines cross above the 80 line, this is a representation of a strong upward trend, when they cross below the 20 line it is a representation of a strong downward trend. When the %K line crosses over the %D line this could be an indication of a change in the trend, and a possible exit point. When prices are fluctuating a normal appearance for the stochastics will be for them to be crossing over one another in mid range – here what is being shown is a lack of a trend.

The stochastics give their best signal when both the lines are moving to new ground at the same time as the actual price; this is a good indication of a continuation of a trend. However when the stochastics cross in a different direction of a prolonged trend this could be an indication to either exit or switch directions.

Relative Strength Index (RSI)
RSI is another momentum oscillator. RSI attempts to pick reversals in the trend. As with Stochastics they are read on a scale between 0 and 100. A Reading above 80 indicates an overbought market and readings below 20 indicate an oversold market. Trading on RSI's should occur only when there is a direction change above or below the 80 and 20 lines; as RSI lines can often remain above or below the 80, 20 levels for prolonged periods of time during strong trending markets.

The shorter the RSI period, the faster it will be and the more signals will be issued. Here a trader needs to find his balance. Day-traders will often use shorter lines for more regular signals and longer term traders will use longer RSI's.

Bollinger Bands
Bollinger Bands are volatility indicators and are used to identify extreme highs or lows in relation to the current price.

Bollinger Bands are based on a set number of standard deviations from the moving average. It essentially tries to indicate support and resistance levels or bands of expected trading.

As with the moving average, here too the trader can pick and adjust the moving average to base his Bollinger Bands on and the number of standard deviations to use. The trader can adjust these over time to suit his individual trading style. The default used is usual a 20-day moving average and two standard deviations from the moving average.

A break above or below the Bollinger Bands may show an exit point or a reversal.

Moving Average Convergence Divergence (MACD)
MACD is an enhanced study of the moving averages and behave as an oscillator. The MACD plots the difference between a 26-day exponential moving average and a 12-day exponential moving average. A 9-day moving average is generally used as a trigger line, meaning when the MACD crosses below this trigger it is a bearish signal and when it crosses above it, it's a bullish signal.

Traders use the MACD for trend reversals. For instance if the MACD indicator turns higher while prices are still falling this could be an exit point and a possible reverse trade.

Fibonacci Retracements
Fibonacci retracement levels are a sequence of numbers that indicate changes in trends from previous peaks or troughs. After a significant price move, prices will often retrace a significant portion of the original move. As prices retrace, support and resistance levels often occur at or near the Fibonacci retracement levels.

In the currency markets, the commonly used sequence of ratios is 23.6%, 38.2%, 50% and 61.8%. Fibonacci retracement levels are drawn by joining a trend line from a significant high point to a significant low point. The pullback simply represents a correction in the trend and not an end to the trend. The most significant pullbacks are the 38.2%, and 61.8% levels.