Trading signals can be readily generated using technical indicators to enhance the objectivity of a forex trading plan.

Traders can use technical indicators in a number of different ways. For example, they might just use one indicator or they might use a combination of indicators that they have found through experience to generate especially profitable signals.

The raw data used to compute these indicators generally comes from forex market observables like the exchange rate, as well as futures trading volume and open interest data.

The following sections discuss some of the more popular technical indicators used to generate trading signals by technical analysts, as well as how forex traders might use them in their trade plans.

Moving Averages

Traders might compute an average of the exchange rate for a certain period of time. This average is then superimposed on the price action so that it moves along as time progresses. The effect is to help smooth out the price data so that trends can better be identified.

Moving averages might be computed as simple, exponential or weighted averages, and they tend to be a lagging indicator of future price action with relatively little predictive power.

Nevertheless, some traders use crossovers between a short moving average and a longer term moving average as a trading signal, with the short term average crossing above the longer term average being a bullish signal and a crossover below being a bearish signal.

The Moving Average Convergence Divergence or MACD indicator is also based on this general idea which it enhances considerably.

The Relative Strength Index or RSI

This is an especially popular banded momentum oscillator that can help a trader identify overbought and oversold conditions in the forex market.

The indicator reads above 70 in overbought markets and a reading under 30 indicates an oversold market.

Forex traders can also use the RSI to watch for regular and hidden divergence versus the price action that might indicate pending market reversals.

The Average Directional Index or ADX

This useful indicator helps show the presence and the strength of any directional trend prevailing in the market.

It is computed using high, low and close exchange rate data for the currency pair that form two lines called the DI+ and DI-.

These lines show the relative strength of positive and negative directional movement respectively, while the ADX indicator line combines them and then smoothes them using an exponential moving average.

The On Balance Volume or OBV Indicator

The OBV indicator analyzes the performance of the exchange rate to then uses that information to place a positive or negative sign on trading volume data.

A simple trading signal using the OBV indicator would be to watch for a switch in its sign to indicate a possible directional reversal in the exchange rate.

Historical Volatility

When used as an indicator, historical volatility is related to standard deviation of exchange rate movements, and it is usually expressed on an annualized basis as a percentage.

This indicator can provide a forex trader with a useful measure of risk that they can employ in making their trading decisions. For example, they could use historical volatility to help determine the appropriate level of risk to take when sizing positions.

Bollinger Bands

Another useful technical indicator related to market volatility is the Bollinger Bands that are typically depicted superimposed over the price action on a chart.

The central line of the indicator is a simple moving average, while the upper and lower lines of the indicators represent a certain number of standard deviations around the central line.

Forex traders tend to use this indicator to general a signal to initiate a short position when the market exceeds the upper line or a long position when the market falls below the lower line.

Risk Statement: Trading Foreign Exchange on margin carries a high level of risk and may not be suitable for all investors. The possibility exists that you could lose more than your initial deposit. The high degree of leverage can work against you as well as for you.