Technical Analysis Tools for Forex Traders

Gain Forex Trading Insight With These Technical Analysis Tools

Technical analysis tools provide insight and allow the forex trader to see information in a different way than just looking at a price chart. This insight aids in making better and more informed trading decisions. Technical analysis tools include statistics, chart overlays and technical indicators. Some of the tools discussed below are unique to forex trading, while other tools are common to all markets but should be fine-tuned for trading currencies. 

1
Session Highlighter Forex Tool

forex session highlighter
EUR/USD with Important Sessions Color Coded. MetaTrader4

The forex market is open 24-hour a day during the week, as there is always a major market open somewhere in the world. For example, Europe opens, then New York, then Sydney and then Tokyo. London opens again before Tokyo closes. There are also loads of smaller markets open at the same times as these major markets. 

Since global markets vary in size (how many currency transactions they do and how many currency traders they have), each session will create different characteristics in the various currency pairs. For example, the EUR/USD currency pair is most active during the London and New York sessions, because these are currencies associated with Europe and the U.S. The USD/JPY sees steady action throughout the day as Tokyo, London, and the U.S. all actively trade this pair. Though, it's most active time is during the U.S. session.

Forex traders often find it useful to separate the various sessions on their charts. This is especially helpful if viewing the 1-minute to 1-hour times frames, as a "session highlighter" will show exactly what price action occurred during the various sessions. 

A session highlighter automatically draws vertical lines on the price charts when a major session opens or closes. Alternatively, a session can be given a specific color, visually highlighting the various trading sessions. 

There are numerous session highlighters available which can added to the forex trading platform. MT4, one of the most popular forex trading platforms, offers session highlighters for immediate download within the "Code Base" tab.

2
Forex Volatility Tools

forex volatility by hour of day
EUR/USD Volatility By Hour of Day. Mataf.net

A forex volatility tool shows how much a currency pair typically moves in a day (30-day average for example), how much it typically moves each hour of the day, how much it moves each day of the week (volatility on Monday vs. Friday, for example) and also how volatility has changed over time.  

Volatility tools like this provide insight into what can typically be expected on a particular day or during a particular hour. This information can then be utilized for helping to assess whether a trade has a good chance of reaching a profit target, for example. While volatility doesn't tell the trader which direction the price will go, volatility statistics do tell them approximately how far the price will move.

Mataf.net provides in-depth studies on how forex pairs move. Under the Forex menu select Forex Volatility to see volatility analysis for various currency pairs. 

Forex volatility tools vary in complexity and format. For example, Oanda's Value at Risk Calculator looks at how far price typically moves over a time period of the trader's choosing. It then gives a confidence level for how likely it is that the price still stays within that typical movement area (read and follow the instructions if using this tool).

Utilize volatility tools to make more informed trading decisions based on how far a price typically moves over a period of time.

3
Forex Position Summaries and COT Data

Euro COT Data Compared to EUR/USD
Euro COT Data Compared to EUR/USD. myfxbook.com

Some forex brokers provide up-to-date summaries of how their clients are positioned. For example, a position summary may reveal that 60 percent of clients are long the EUR/USD, while 40 percent of clients are short.

Typically, a single comparison like this isn't all that useful, but watching how this ratio changes as the price moves can provide insight into how the price may move in the future. This is because eventually, traders must exit these positions at a profit or loss. Therefore, current trader positioning can predict future positions and thus price moves.

Extreme readings in a currency pair, such as 90 percent long, could reveal that a trend reversal is coming. If 90 percent of traders are long, that means that most traders already have already bought, which leaves very few traders to keep pushing the price up. When there is no one left to buy the price moves the other direction, as all those who bought start to sell to get out of their positions. 

Oanda.com provides currency position ratios, as well as historical position ratios. With these tools, traders can look to history to see what position ratios have tended to reverse the price direction. As the current position ratios approach historically significant ratio levels, then it may be time to start watching for a price reversal.

Another way to view position summaries is through the Commitment of Traders (COT) report. Myfxbook.com provides COT charts going back to 2008, so traders can see how various traders (speculators, small traders, etc.) were positioned at major market turning points. This data can then be used to anticipate future turning points in price.

4
Forex Correlation Tool

forex correlation table
Forex Correlation Table, Daily Time Frame. Mataf.net

Some currency pairs tend to move together, while others move in opposite directions, and some move totally independent of each other. When two pairs tend to move in a similar fashion, this is called positive correlation. When two pairs tend to move in opposite directions, that is a negative correlation. If two pairs move independently, then they are uncorrelated. 

Knowing the correlation between forex pairs is important. If a trader notices a trade setup in two or three different pairs, she should check the correlation before taking all three trades. If they all move together, then the trade is effectively tripling her risk (and profit potential) because if they all move together, she will likely win or lose on all three. 

Correlations can be tricky, as the trader needs to consider both the correlation and the direction of the trade. For example, the EUR/USD and USD/CHF had a -96.8 correlation in 2016 (subject to change). If a trader went long both these pairs, one pair would likely move up while the other pair moved down. But going long one, and short the other, could double risk because the trader is effectively taking the same trade twice. If one pair goes up, the other will go down. If the trader picks the right positions (the long position goes up and the short position goes down), they win on both trades. But they also could easily lose on both trades (short position goes up and long positions goes down). 

Correlations are just related to direction, but not the magnitude of price moves. Two currency pairs could be correlated, and yet one moves way more (more volatile) than the other. Therefore, a study of correlations should also include a study of volatility (discussed above).

Mataf.net, Myfxbook.net, and Oanda.com all provide free forex correlation tables. Correlations change over time, and can be measured on different time frames. Check correlations regularly, and look for correlations on the time frame you trade on (the time frame on your charts). For example, if you day trade on a 1-minute chart, regularly check the correlations on 1-minute and 1-hour time frames (if trading more than one pair). If swing trading on a daily chart, regularly check daily correlations.

5
Technical Indicators for Forex Trading

Evelopes with TTM trend on forex chart
Envelopes and TTM Trend Added To EUR/USD Daily Chart. ThinkorSwim

There are loads of technical indicators that forex traders can add to their charts. There are commonly used indicators, such as the MACD, RSI and moving averages, and then there are less commonly used tools such as the zigzag, envelopes and TTM Trend. Let's explore some of these less common, but useful, technical indicators.

The zigzag indicator draws lines over price waves of a certain size. These lines help filter out the noise of tiny movements, so instead traders can focus on the larger price moves where bigger profits lie. The zigzag can also be customized to show how far the price has moved (in pips or percentages) which in turn can highlight tendencies in the price action. For example, a percentage retracement zigzag could show that a currency typically retraces about 55 percent of a trending move on a pullback, before moving in the trending direction again. In terms of pips, this would equate to moving up 10 pips, pulling back 5.5 pips, moving up 20 pips, pulling back 11 pips, and so forth. If such tendencies are noticed, this could improve the timing and location of entries and exits.

Envelopes are composed of three lines and drawn directly over the price action. The middle line is a moving average, and the other two lines are drawn above and below the moving average at an equal distance (chosen by the trader). When an envelope is calibrated to a specific pair, it can provide insight into potential trend changes, as well as when a trend is strong or weak. Set the indicator so that when the price is hitting the lower band, it shows a downtrend. When the price is hitting the upper band it highlights an uptrend. The moving average in the middle can often to be calibrated to act as a support/resistance area (not an exact level, but rather an area where the price often stalls). The attached chart shows how a properly calibrated envelope captures the major movements of a forex pair.

TTM Trend—another technical indicator—changes the color of the price bars on the chart based on whether short-term momentum is up or down (averaged over a number of days). This tool can be used in conjunction with trend following strategies to capture large price moves. For example, if the trend is up, stay in a long trade while the bars are blue. When the trend is down, stay in a short trade while the bars are red. If a trend has been found, the indicator can also provide entry points. For example, if the trend is down but the price is in a short-term move to the upside, wait till the TTM bars turn red again. This indicates that short-term momentum has shifted back to the downside, in alignment with the longer-term downtrend.

No indicator should be relied on exclusively. Rather, combine any forex indicators you do use with risk management and price action analysis to determine the best trades (and also determine when not to trade).

6
Final Word on Forex Trading Tools

technical tools for forex traders
Photographer is my life/Getty Images

When most people hear "technical analysis" they think of technical indicators such as the MACD or RSI. But technical analysis is much more than that. Technical analysis is also about extracting information from price formations, statistics and how traders are positioned. All these technical tools can be combined to make better and more informed trading decision. Traders don't need to utilize all these tools, rather these are just some of the technical tools available to forex traders. 

Review the tools and practice trading with them in a demo account. Utilize the tools you find effective, and discard the ones that you don't find helpful. Each trader may find different ways to use these tools, other than the ways described. Trading is personal, so pick the tools (and how to use them) that best align with your strategies and personality.