FOREX Indicators and Oscillators

Beyond charting are various market indicators -- calculations using the primary information of open, high, low, or close. Indicators can also be charted or graphed. Buy and sell signals and complete systems can be generated from a battery of indicators. The most popular indicators are: relative strength, moving averages, oscillators or momentum analysis (actually a superset of relative strength), and Bollinger bands.

Tip: Traders are fascinated by indicators. Numbers bring a sense of certainty. Be sure you know what an indicator is actually measuring before using it.

Indicators typically are biased to sideways trading markets or up-and-down trending markets.

Relative Strength Indicator

The relative strength indicator (RSI) shows whether a currency is overbought or oversold. Overbought indicates an upward market trend, because the financial operators are buying a currency in the hope of further rate increases. Sooner or later saturation will occur because the financial operators have already created a long position. They show restraint in making additional purchases and trying to make a profit. The profits made can quickly lead to a change in the trend or at least a consolidation.

Oversold indicates that the market is showing downward trend conditions, because the operators are selling a currency in the hope of further rate falls. Over time, saturation will occur because the financial operators have created short positions. They then limit their sales and try to compensate for the short positions with profits. This can rapidly lead to a change in the trend.

You cannot determine directly whether the market is overbought or oversold. This would suppose that you knew all of the foreign exchange positions of all the financial operators. Experience shows that only speculative buying, which leads to an overbought situation, makes rapid rate rallies possible.

The RSI is a numerical indication of price fluctuations over a given period; it is expressed as a percentage.
RSI = sum of price rises/sum of all price fluctuation
To illustrate this, we have selected the daily closes (multiplied by 10,000) for the EUR/USD currency pair when it first appeared on the FOREX market in January 2002. The running time frame in this example is nine days. See Table below.

[caption id="attachment_13111" align="aligncenter" width="513"]Calculating RSI Calculating RSI[/caption]

An RSI between 30 percent and 70 percent is considered neutral. Below 25 percent indicates an oversold market; over 75 percent indicates an overbought market. The RSI should never be considered alone but in conjunction with other indicators and charts. Moreover, its interpretation depends largely on the period studied. The example in Table is nine days. An RSI over 25 days would show, given a steady evolution of rates, fewer fluctuations. The advantage of obtaining more rapid signals for selling and buying (by using a smaller number of days) is counterbalanced by a greater risk of receiving the unconfirmed signals.
By Michael Duane Archer
Michael Duane Archer has been an active futures and FOREX trader for more than 35 years. He has worked in various advisory capacities, notably as a commodity trading advisor, registered SEC investment advisor, and branch manager for Heinold of Hawaii. He currently trades FOREX and futures and is involved in several technical analysis research projects.

Copyrighted 2016. Content published with author's permission.

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