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Whilst traders may sit around waiting for the perfect buy or sell signal, the truth is there is no one way to trade forex markets. This inevitably means that whilst one trader could be convinced of a creaming buy, another looking at the same market could be dubious. Whilst there are many ways to trade forex markets, there are also many ways to read them. For this reason, it is useful to be able to use a variety of indicators in order to determine the best time to buy or sell.
Here we aim to give a brief example of how to combine the use of several indicators to get the best result.
Trend following tool
It is relatively easy to look at a market and asses the general trend. The old adage “a trend is your friend” is very true. The purpose of a trend tool is to identify whether you should be looking at a buy or sell position and the simplest way for doing this is using a moving average. A trend is favourable when the 50-day moving average is above the 200-day moving average and unfavourable when the reverse is true. So when the 50 day moving average is below the 200 day moving average. This does a good job of identifying the major trend of the market. It does not, however, give any information on entry and exit levels.
Overbought or oversold?
Once you have decided you are happy with the trend, the next decision is deciding whether to jump in immediately given that the trend is established or wait until there is a pull back. So you either enter immediately once you have confirmed the trend, or you wait for a pullback, which I established using overbought/oversold indicators. Whilst there are many indicators to choose from, perhaps one of the most useful and popular is the relative strength indicator or RSI. If the price action over the time period is to the upside, the indicator is seen moving towards 100. On the other hand, when prices are to the downside, the indicator will be closer to 0.
As an example, so far. You ma look to enter a long trade when the 50 day moving average is above the 200 day moving average. If you are looking to enter on a pullback, you would then consider entering the trade when the RSI drops below a given level, for example 20, which indicates an oversold position.
For a short position you might look to enter a trade when the 50 day moving average is below the 200 day moving average and the RSI is higher at 80, indicating an overbought position.
Whilst there are many indicators which can be used to aid exit level, the RSI indicator is incredibly useful and can be used to book profit as well. For example, if you have a long position, you may wait until the RSI hits 80 before you sell out. Alternatively, on a short waiting for the RSI to hit 20 before selling out could also be useful.