The best indicators in anon-trending market

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The best indicators in anon-trending marketThe best indicators in a non-trending market

Posted on8.12.2010

Every trader loves a trend, but the forex trading market doesn’t always oblige. For those times when currency pairs seem to be stuck going nowhere fast, here are the best indicators for a non-trending market.

The relative strength index (RSI) uses the closing price to compare the strength of up time periods (ascending candles) to the weakness of down time periods (descending candles). The resulting measurement of the time period’s relative strength is graphed as a single line oscillator on a scale between 0 to 100, rising and falling with buying and selling pressure and therefore with the price action.

When the currency pair has rallied, often it becomes overbought. In forex trading, this level is variously defined as 70, 75, or 80 in the RSI graph, depending upon the trader’s level of risk appetite (higher numbers equalling higher risk). After a fall in the currency pair, often it becomes oversold, which is variously defined as 30, 25, or 20 on the scale. Again, this varies with the individual trader’s risk appetite, with lower numbers here equalling higher risk.

Another useful feature of the RSI is its ability to form chart patterns, such as double tops or consolidating triangles, which can be traded just as their counterparts on the underlying charts are traded. RSI chart patterns can form with or without a corresponding pattern forming on the chart itself. Although they’re not common, they tend to be reliable.

Stochastics compare the current time period’s closing price with the highest highs and lowest lows over a defined lookback period, with the result graphed on the usual oscillator scale as a line called the %K. To this is added another line, a three time period moving average of the %K, called the %D. Stochastics also measure overbought and oversold levels, in a similar manner to the RSI, but they don’t form chart patterns.

The second line in the stochastics oscillator, however, does allow for trading using crossovers:

• When the faster %K crosses above the slower %D, it’s a bullish signal, and

• When the %K crosses beneath the %D, it’s a bearish signal.

Finally, both the RSI and stochastics can be traded using divergence. Sometimes the indicator and the price action disagree, with the price reaching a new higher high (negative divergence) or lower low (positive divergence), but the indicator failing to confirm the move. When this happens, the most common response is for the price to turn and follow the indicator in a reversal of the overextension. The higher high is likely to turn negative, and the lower low is likely to climb higher, giving the forex trader advance warning in time for a profitable market entry.