The majority of amateurs who try their hand at forex trading to make a few dollars as a side hustle tend to fall into one of two categories. First, there are those who download an app, start trading, lose all their money and dismiss forex trading as a waste of time. Then there are those who learn about the markets, fill their heads with 50 different indicators, find they all contradict one another, get horribly confused and then dismiss forex trading as a waste of time.
It might sound harsh, but these are the facts, and they go some way to explaining some of the frightening statistics suggesting that more than nine out of every ten forex traders end up losing money. The mistake is to draw from this the conclusion that forex is a blind alley. Traders have been making tidy profits on the currency markets for as long as money has existed, and they continue to do so today.
There is certainly room in the world of forex for the amateur or small-time investor. The trick to making a success of it is to cover the basics and adopt the right strategy. This means avoiding getting bogged down in the minutiae and focusing on some key indicators. As you gain experience, you can always refine your approach and add more complexity to your analysis with time, but the following are the essentials you need, to get off to a successful start.
The moving average is the most fundamental forex indicator, and the first one you will use. In many ways, all the other indicators are simple enhancements upon the Simple Moving Average (SMA). The reason this indicator is so important is that it cuts out the distractions of short term price fluctuations and provides an overall trend, which is, of course, the first clue in seeing whether a particular currency pair is rising or falling in value.
While the moving average is important, it is not enough by itself to inform a trading strategy, as it is only telling you about what has happened. But using it in combination with other indicators starts to provide clues as to whether the trend will continue, or if change is in the air.
RSI might sound like something the doctor needs to take a look at, but in the context of Forex trading, it is the most important indicator to spot one of those trend changes we were talking about. If you have ever watched a group of six-year-olds playing soccer, you will have noticed how they all tend to chase the ball in a pack. Forex traders can be a lot like that, but the most successful ones know that sometimes it makes sense to hang back and wait for someone to cross the ball so that they can take advantage of the open goal.
The relative strength indicator tells you whether a particular asset is being overbought or oversold and guides your thinking on whether to join the pack or hold fire and let the trend develop further.
Knowing whether a particular trade is going up or down and whether it is likely to change are two steps in the right direction. The next thing you need to think about is volatility and that’s where the Standard Deviation Indicator comes into play. If you remember your high school mathematics, you will know that standard deviation is all about how far individual values in a data set deviate from the mean, or average.
Higher standard deviation means greater volatility, and that in turn means more risk. In itself, this is a double-edged sword. Think about the effect on sterling when the UK voted to leave the European Union. The pound went into a state of extreme volatility against the dollar, which meant some people made some seriously impressive returns, while those who had called it wrong were left licking their wounds and counting their losses.
Volatility is one of the most important factors in defining an overall strategy, and goes beyond the simple question of buy or sell. It is worth spending time researching other volatility indicators such as Bollinger bands and the average true rate in addition to standard deviation.
Moving average convergence divergence
The above three indicators are enough to form a simple basis for your forex trading strategy, and get you started, at least in the test-bed environment of a demo account using one of the many trading platforms or smartphone apps. But to tie them all together, you should add a fourth, and that is the MACD indicator.
The tool is considered one of the fundamentals because it is so useful to either confirm or cast doubt upon trends that have been identified using the previous three indicators, or variations of those themes. By assessing two smoothed moving averages and then taking another smoothed moving average of the resulting data, you get a firm confirmation of the upward or downward trend you are basing your trading strategy on, and can buy or sell with greater levels of confidence.