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How Does the Relative Strength Index work ?

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Relative Strength Index – RSI

What is the Relative Strength Index?

Short note on relative strength index: Relative strength index is a technical indicator that compares current and historical gains and losses in order to define if the asset’s value is overpriced or underpriced. The formula for calculating RSI is:

LMFX PAMM

RSI = 100 – 100/(1 + RS*)
RS = Average of x days’ up closes / Average of x days’ down closes
The formula for RSI indicator is below:
relative strenght equation

Understanding the Relative Strength Index
The main role of this indicator is to remove noise in price movement representation. High relative strength index success rate we can see in application very often.
What is the Relative Strength Index in forex? In the forex, the Relative Strength Index or RSI is a momentum indicator that measures the magnitude of recent price changes, price strength, analyzes overbought or oversold conditions, price divergence.
Example of GBPUSD chart – RSI indicator is red:
RSI indicator example

How to read the Relative Strength Index

What does the relative strength index tell you? Interval in which RSI ranges are from 0 to 100 and it shows if the asset is overvalued or undervalued (relative strength index law). In fact, as the RSI closes to level 70, the asset can be considered overvalued and has a big chance to be overbought. On the other hand, when RSI reaches level 30 the asset is deemed to be oversold. The best way to use this index is as a piece of additional information to other stock-picking tools because using only RSI trader can create false buy and sell signals which can mislead observer.

History of relative strength index

J. Welles Wilder rsi
The relative strength index was developed by J. Welles Wilder and published in a 1978 book, New Concepts in Technical Trading Systems, and in Commodities magazine (now Futures magazine) in the June 1978 issue. It has become one of the most popular oscillator indices. The RSI compares bullish and bearish price momentum plotted against the graph of an asset’s price. Wilder developed the Average True Range, the Relative Strength Index (RSI), Average Directional Index, and the Parabolic SAR.

Relative strength index calculation example

Relative strength index algorithm – How to calculate relative strength index in excel?

I always get information from MetaTrader. So how to calculate the relative strength index using excel manually? The most simple method we can see in nice post Calculations of RSI using EXCEL.
Idea is to define close price in some time period and then start relative strength index calculation excel :

Make the trade

“Column E” has all closing prices.
“Column F” calculates the change in price by subtracting the current row from the previous row.
If the “Column F” value is greater than zero, the value will be copied to Column G. If the value is less than zero, the value will be copied to “Column H”.
“Column I” calculates the average Gain over the specified period, for example, 14.
“Column J” calculates the average Losses over the specified period, for example, 14.
“Column K” calculates the value of Relative Strength (RS).
“Column L” calculates the value of the Relative Strength Index(RSI).
Please visit the website and download relative strength index in the excel tool: Download relative strength index formula excel

You can see in this nice video relative strength index example calculation:

How we can trade using this RSI indicator – advantages of using relative strength index?

How to use the relative strength index? We can use RSI directly to define overbought and oversold price levels, trend strength. Than we can use to draw trendlines and analyze the trend. At last, we can use RSI to analyze divergence.
How does relative strength index work? We can use RSI to determine overbought and oversold moment in trading. Below 30 is oversold and above 70 is overbought. There are some rules for traders :
– The market can be oversold or overbought for a very long time. It is not smart to trade sell orders above 70 and buy orders below 30 without deep analysis.
– Do not buy in the oversold market or sell in the overbought market without some conformation in your direction (for example some big move, strong bullish or bearish candle, etc.)
– The best strategy is – buy or sell after a pullback and respect the main trend. For example, if the trend is bullish on a daily or H4 chart, the price is above 50 RSI in the strong bullish direction you can buy if the price goes in the oversold area on 5 minute or 30 minutes chart. See images below :
gbpusd overbought 30 minute chart
On the daily chart, we see bearish trend. Next 7 days price will fall 300 pips down :
GBPUSD daily profit

2) We can use the RSI indicator to find divergence and predict the change of the trend. On the image below we can see relative strength index bullish divergence (relative strength index when to buy) :
relative strength index bullish divergence

On this image below we have relative strength index bearish divergence (relative strength index weakness) example:
relative strength index bearish divergence example

Using RSI trend lines we can avoid very often false breakout in trading or Market Has Hit an Extreme. How important are levels 30 and 70 (relative strength index Bloomberg example), we can see in nice highest RSI table? In this article, we can see the opinion “Many technical traders view anything above 70 as a sign that the dollar is overbought and due for a correction.”

3) My favorite way to use RSI – draw trend lines on the RSI chart and use it for trading!
Traders can draw trend lines below and above the RSI line. Trading RSI trend lines are the most productive way to use RSI indicator. If price breaks trendline than the trend will change. See example :
RSI trendlines
This example shows a bullish trend on 30 min chart. I can make buy orders above trendline but if the price breaks RSI trendline than the trend is changed. Of course, on the 30-minute chart, we can see 25% from ATR bearish trend in price breaks this line (around 20 pips). If price breaks daily trendline RSI that can give a few hundred pips profit.

Questions and answers from email messages:

1) How to find relative strength index indicator in Metatrader?
RSI is a major indicator. It is in indicator section in group oscillators.
how to find relative strength index

2. What is a good relative strength index number
Each number in RSI is “good”. It is just a strength index. For example, is the price is above 70 or below 30 it can be an excellent trend which can give more profit in the future. Price around 50 can be in a range market, but it can be a strong trend decline or rise if we have a strong divergence at that moment.

3. Should I set RSI settings in a different way? Is it better RSI 8 or 14; RSI 7 vs RSI 14?
My advice is to use default settings. All major world traders use (mostly) the same settings so they will make the decision based on default parameters. Summary, default settings are relative strength index best settings.

4. What are relative strength index disadvantages and what are the advantages of using relative strength index?
The biggest advantage is simplicity, easy reading as we see in chapter how relative strength index works. One of the biggest disadvantages is that RSI is a very fast indicator and sometimes we need to wait for a higher time frame price closed conformation.

MACD settings for intraday trading

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In this article we developed one test, where we created one intraday profitable strategy, and than we and then we varied the values of the MACD settings parameters in several combinations. We wanted to see what is the best MACD settings for intraday trading.
basic MACD settings in Metatrader

As we know moving average convergence/ divergence or more commonly referred to as MACD for short is an indicator for trading which was created by Gerald and is used for various types of stock price technical analysis. It was developed in the last period of the 70s.

Trading made simple

MACD has been designed to help reveal the changes in the trend duration, momentum, direction and strength of the price of stock. Oscillator or the MACD indicator is a three time series collection which is calculated with the help of data from historical prices, it is normally the price of closing. The three series are the divergence series that is a difference between the average and signal series. The other two are signal series and average series.

Signal Line Crossover

The signal line crossover of MACD shows that the acceleration direction is undergoing change. The average velocity of the MACD line when it crosses zero indicates that the direction is being changed.

How is the MACD Indicator Used for intraday trading or long term trading?

The tool is used for the identification of moving averages which indicates a new trend if it is bearish or bullish. The main goal of trading is to find a new trend as that is where one will find the most money and have a piece of the pie.

MACD Chart


The MACD charts show three different numbers being used for the settings. The first number is for the periods and it is used for the calculation of the faster-moving average.
The second number of periods is used for the slower moving average. Finally, the third number is for the number of bars which would be used for the calculation of the moving average which would be used for the difference between the slower and faster moving averages.

Trading made simple

Basic MACD settings

As an example, if one were to come across the default setting of the MACD parameters that are 12, 26, 9, these would be interpreted as:
Fast EMA period: The 12 previous bars are represented by 12 of the faster-moving average.
Slow EMA Period : The 26 previous bars are represented by 26 of the slower moving average.
Signal SMA period: The 9 previous bars are represented by 9.

Vertical lines would be plotted and are referred to as a histogram. When it comes to MACD lines, there is a misconception. The 2 lines which get drawn do not reflect the price moving averages but rather are the difference of the moving averages between both of the moving averages.

When a slower moving average is plotted, the original line would be smoothened further, this helps provide one with a much more accurate line. The difference between the slow and fast-moving average would be plotted by the histogram.
The divergence is the point where one would notice the two moving averages moving separately and the histogram will start to get bigger since the faster-moving average would be moving away or diverging from the slower moving average.
The histogram would get smaller as the moving average start getting closer to one another. This is referred to as convergence since the faster-moving average would be getting closer or converging to the slower moving average. This is the entire process of the Moving Average Convergence / Divergence.

Now, that you have understood what MACD does, it is time for you to know what it can exactly do for you.

MACD for Slow and Fast Moving Averages

As the fast line crosses under the slow line, a new downtrend would be identified. One would be able to notice that the histogram would disappear temporarily as the lines cross. It is due to the difference in the lines when the cross is zero.
Furthermore, when the downtrend starts, the histogram would get bigger as the fast line would diverge or move away from the slow line. This is an indication of a solid trend. Let’s have a look at the examples.
Let’s look at an example for better understanding.

Our MACD intraday settings using Expert Advisor tests

Indicators :
1) MACD with several settings
2) Channel (we used our indicator but you can use any channel indicator, for example, Donchian channel).
3) Important level indicator. We have our indicator based on previous high and lows, but you can use Pivot points or Fib levels.

Rules :
We created several combinations and created BUY and SELL rules on 30 minutes chart :

BUY if we see bullish MACD cross or zero line cross AND price touch important level AND the price is in a bullish channel. Stop loss is the last swing important level. Target the next level.

SELL if we see bearish MACD cross or zero line cross AND price touch important level AND the price is in bearish channel. Stop loss is last swing important level. Target the next level.

In the first test we used 30 minutes chart and basic MACD settings. Then we repeated several tests with different combinations :
macd intraday settings and profits. Our tests.

Important fact:
You can combine the moving average strategy with MACD. The best moving average crossover for intraday (or longterm strategies) are a combination of SMA10, SMA50, SMA100, and SMA200 but you need to change the chart time frame for each strategy. For example, for the longterm strategy, you will use a combination of SMA10, SMA50, SMA100, and SMA200 on H4 or daily or weekly chart. For intraday trading, you will use m30 or m15 or 1-minute chart.

Trade with the help of MACD

As there are 2 moving averages that have different speeds, it would be quicker to react to the movement of price for the faster one as compared to the slower ones. Whenever a new trend is discovered, it would be the last line that would be the first to react and it would cross to the slower line eventually. When the fast line begins to diverge as the crossover starts, it would move away from the slower line and a new trend would be indicated as being formed.

Crossover Example of MACD

MACD does have a drawback and that is the fact that they tend to lag behind when it comes to price since it is just the historical prices average. One would expect a bit of lag as the MACD represents the moving averages of others and it is as such smoothed out by one another. Despite this fact, it is still one of the effective tools used by most traders.

Indication of Changes in Stock or Forex Trends

The MACD series with the help of different periods EMAs are able to indicate the changes in stock trends. Normally, the fast EMA would respond much quicker as compared to a slow one. Subtle shifts can be revealed in the stock trends with the help of the divergence series.

Mathematical Interpretation

The MACD is a measure that is filtered of the price which is the derivate of the input with regards to the time in signal processing. Velocity is the term for the derivate as used in technical stock analysis. It would estimate the derivatives just like how if it had been calculated. The difference in the time constants would be discovered with the use of filtering by the 2 low-pass filters.

Just as it would have been filtered by an EMA of a single low pass exponential filter, MACD can be seen to approximate the derivative through calculation. The time constant would equal the sum of two filters time constants which one would multiply by a similar gain. The MACD derivative would be estimated through the approximate filtering of the equivalent of an EMA filter that is of low pass.

Furthermore, the average series can also be thought of as a derivative estimate, for further smoothing would be done by the additional low-pass filter. The difference of the average series and the MACD serried would represent a measure for the second price derivate in connection to the time. The estimate would have an additional gain factor that would be equaled to the filter constant of the signal and have an additional lag.

Classification

MACD could be classified as an APO (absolute price oscillator) as it does not deal with percentage changes but instead with moving averages of the actual prices. PPO or a percentage price oscillator would compute the difference of 2 moving averages of the price on the other hand and divided by a longer moving average.
The PPO will calculate the changes that are relative to price and the APO would show smaller levels of lowered price securities and greater levels of the higher price securities. When one compares the oscillator values of various securities, a PPO would be preferred especially for ones that are of different prices.
Long term trends are ignored by DPO (Detrended Price Oscillator) which are another member of the price oscillator family. Instead, short term patterns are emphasized.

Trading Interpretation

EMAs highlight the current changes in stock prices. The MACD is able to gauge the changes in stock trends by comparison of the different lengths of the EMAs. The difference of the average that is claimed by the MACD and the MACD series helps reveal the shifts in the direction and the strength of the stock trends. It might even be necessary to correlate the indicators of the MACD to signals such as the RSI power.
There are some traders which would attribute importance to the MACD line that crosses the 0 axes and the MACD line that crosses the signal line. The importance is also due to the disagreements between the different line or the MACD line as well as the stock price.

Signal-Line Crossover in our tests

It happens when the average lines and the MACD cross meaning that when the divergence would change its sign. The interpretation of this would be that it would be recommended to buy as long as the MACD line crosses over the average line. These events indicate a trend in which the stock would accelerate towards the crossover.

False Signals in our tests

It is possible for there to be false signals just like any other forecasting algorithm. It would be prudent to apply filters to the signal line crossovers. Different approaches are used by analysts to find the right results.We chose our trading rules. You can make any test using its own strategy. Each strategy will have false signals.

Thoughts

We think that the best success we can get using standard basic MACD intraday settings because most “big dog” traders and institutions use these settings. In our test, we got similar results but basic settings made the best results.

The Best Indicators For Day Trading – Case Study

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We are looking for the best indicator for intraday trading! So we created a poll and give our top traders to vote. Our email list is more than 10 years old and all our traders are experienced traders. We asked them to pick 3 top indicators for day trading. We know that traders like to combine several indicators when they trade. This is one of the best studies for day trading that we created using our contacts (email ist).

Technical indicators for day trading survey

Trading made simple

Step 1: What indicators to use for day trading? We made the list of best trading indicators for day trading.
It is important to engage in the discovery of the top day trading indicators in regard to the particular approach that you apply to your day trading efforts. This means that it will be necessary for you to conduct testing on several of them individually. Then it is also a good idea to conduct testing on them by combining them. For example, you may decide to continue using four that tend to be evergreen or you otherwise may consider switching off based on the asset that you wish to trade and based on the conditions of the market for that day.

In the first step, we asked our traders to give suggestions. Then we made the list and created a poll in Google forms :

best day trading indicators case study list

Technical indicators for intraday trading need to have simplicity. In all situations in regard to forex trading, futures trading or day trading stocks, it is preferential to ensure that you apply simplicity in the realm of the usage of technical indicators. You may realize that your preference is to view only a paired combination of indicators for the sake of considering points of entry as well as points of exit. It is advised to apply the usage of only one such indicator within the context of each category in order to prevent distracting and needless repetition.

Trading made simple

Below are text about day trading indicators, some major tips on how to use technical indicators for day trading.

Indicators to use for day trading are:


1. Simple moving average indicator

The simple moving average indicator is implemented for the sake of providing an identification of the direction of a price trend at the present time while disregarding any spikes of short term prices. Thus, the moving average indicator tends to engage in combining the price points for a designated time period. Then it performs the division of this price point by the identified number of points of data in order to form the representation of a singular trade line. The simple moving average can be used not only for long term positions – it can be used as one of the forex day trading indicators as well.


2. Exponential moving average

The exponential moving average is recognized as being another kind of moving average. But it is different from the simple moving average in that the exponential moving average tends to grant more weight to current points of data. This results in the data seeming more responsive to the deriving of new information. When this indicator is combined with the implementation of other indicators, exponential moving averages can aid traders in the confirmation of key market moves and can provide a gauging for the legitimacy of these market moves.

3. Stochastic oscillator

A stochastic oscillator is categorized as being an indicator that performs the comparison pertaining to a particular closing price in relation to an asset in correlation to the range of the prices of the particular asset over an extended period of time. This displays the momentum of the trend as well as the strength of the trend. There is the usage of a scale with a range from zero to one hundred. When the reading is under twenty, this tends to indicate that the market is oversold. A reading that is higher than the rate of eighty indicates that the market is overbought.

4. Moving average convergence divergence

The moving average convergence divergence is regarded as an indicator that engages in the detection of changes concerning the movement via the application of comparisons pertaining to two moving averages. With this being the case, this type of indicator has the power to aid traders in the identification of opportunities for buying and selling around levels of support and resistance.

5, Bollinger bands

A Bollinger band is seen as being an indicator that grants the provision of a range considering the trading norm of the price of an asset. The current volatility is indicated via the increasing and decreasing of the width of the bands. When the bands are closer to one another, this is perceived to indicate that there is a lower level of volatility. But the level of volatility is recognized as being higher when the bands are further apart.

6. Relative strength index

When traders desire to engage in the identification of momentum, the relative strength index is a great option to use. This indicator is also used in regard to market conditions as well as signals of warning pertaining to price movements that are regarded as being dangerous. The relative strength index is indicated via the use of numbers between zero to one hundred. When an asset has a rating of seventy, this is usually considered to be overbought. On the other hand, when it is noted that the asset tends to sit at a rating of thirty, the asset is perceived as being oversold.
RSI indicator is one of the best momentum indicators for intraday trading as well for breakout strategies.

7. Fibonacci retracement

When you hear the term Fibonacci retracement, this refers to an indicator that has the power to be able to engage in the pinpointing of the degree that a particular market under surveillance will progress against its own recent trend. It is noted that a retracement is recognized as occurring in such instances that there is a dip in the market that is temporary. Further, this is also referred to as being a pullback. When traders believe that the market will soon move, they generally apply the usage of the Fibonacci retracement in an effort to gain confirmation if this is so. This is due to the fact that this aids in the identification of plausible rates of support as well as resistance, which could denote a trend that is upward or downward.

8. Ichimoku cloud

The Ichimoku cloud is categorized as being a rather technical indicator. This is based on the premise that this indicator engages in the identification of levels of support as well as levels of resistance in regard to the realm of trading. Yet, it is further realized that this indicator also engages in the estimation of the momentum of price points and grants traders a provision of signals in order to aid them in making decisions about their trades. It is interesting to realize that this indicator is a one look chart in regard to equilibrium determination, which is what the name of this indicator means. This is the reason that this indicator is implemented by many traders who are in need of much information from the provision of one singular chart.

9. Standard deviation

Standard deviation is an indicator that is used to aid traders in regard to the measuring of the size of the moves of price points. This allows them to engage in the identification of how plausible it is that the price of the trade will be impacted by volatility in the future.

Standard deviation is recognized for conducting comparisons of recent movements of price points in correlation to the historical movements of price points. A majority of traders tend to hold the perception that large moves of price points occur after small moves of price points and small moves of price points happen after big moves of price points.

10. Average directional index

The average directional index demonstrates the strength of a trend in pricing. It is based on a range of zero to one hundred where a rate of more twenty-five is regarded as being a trend with good strength. On the other side of the spectrum, a rate of under twenty-five is seen as a drift. This information is useful to traders to help them to realize if a trend that is either downward or upward will probably continue to proceed.

11. Murrey levels

Murrey levels are levels created from Gann’s theory. In this strategy, the trader knows that some areas are better for trend and some better for the breakout. You can download free Murrey levels indicator and learn more here.

The best indicators for day trading case study results

There are 654 traders who answer this survey in the last 12 months. Results show that there is no proof that some indicator is better than others in trading habits. The most important indicator for intraday trading based on survey results is the RSI indicator with 17% of votes.

survey results for the best indicator for day trading

Discussion about indicators

On your price chart, you can engage in the combining of sets of indicators that contain two each in an effort to seek points of initiation and to exit a trade. Take into consideration, for example, that you can combine RSI as well as the convergence and divergence of the moving average in an effort to provide the suggestion as well as the reinforcement pertaining to various signals for trading.

Conditions that have undergone the process of being overbought or being oversold can be suggested by the usage of the relative strength index, which in abbreviated form is referred to as RSI. This can be achieved by conducting the measurement of the movement of the asset’s price. J. Welles Wilder Jr. is attributed as having created this indicator. He made the suggestion that the momentum should achieve a level of 30 in relation to a scale from 0 to 100. He stated that this is indicative of the overselling of an asset. This means that this presents a buying opportunity. He mentioned that a level of 70 percent is indicative of the overbuying of an asset, which means that this is also an opportunity for selling or even short selling.

Then with the application of the usage of Wilder’s levels, there can be the continued trending to an increased price of the asset for an extended period of time, whereas the RSI tends to provide the indication that the asset was overbought or oversold. Because of this reality, it is preferred to follow the RSI only in such cases that there is the conformity of its signal in relation to the trend of the price of the asset.

Indicators do not predict market future prices. Indicators only remove noise in time series data set, give the edge for traders, a better picture of chart, important levels. Anyway, there are no rules – which indicator is the best or which intraday indicator settings are the best for trading. Each trader needs to stick to his/her strategy and enjoy trading as passion and business.

The Best Forex Technical Analysis Tools

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Tools Used by Forex Traders (Best Forex Technical Analysis Tools)

Forex traders use a variety of tools in their day to day operations to help them advance. Typical price charts simply do not provide enough information for a forex trader to take calculated risks. The main source of information for forex traders comes from technical analysis tools. These tools serve the purpose of gaining additional insight into the market. Technical analysis tools include statistics and chart overlays. There are a few different types of analysis tools. The following few tools are used on a consistent basis for successful trades all over the world by forex traders.

Trading made simple

Forex analysis tools

Session Highlighters

A session highlighter is one of the most common tools used in the market today. In order to understand how a session highlighter works, it is important to understand how trading works. First and foremost, trading is open 24 hours a day during the week. At any given time within a 24 hour period, a major market is open in a city somewhere. This is why it is very important for forex traders to trade at optimal times. Europe opens first, followed by NYC and then Sydney. Following Sydney is Tokyo. Before Tokyo closes, London has already opened. This consistent pattern of trading is one of the best ways the forex market stays alive and consistent throughout the workweek. The global market can vary in size, some are large and some are small. The main point to remember is that each market has a different number of transactions and employees.

Therefore, each session is different due to its unique characteristics. Session highlighters effectively show the price action during a specific session. These can be tracked by the minute or the hour. The session highlighter is able to draw a vertical line in the event a major session closes or opens. This occurs on the price chart. Each specific trader can use colors in order to show various trading session and highlight them. It is also important to note that MT4 is one of the most prominent session highlighters.

Download Indicator of Trading Sessions

Make the trade

Forex Volatility indicators

Forex volatility tools are used in order to show how much a specific currency pair moves. Many traders will look at an average of 30 days. By viewing a 30 day average, traders can see specifics that give them insight into the best moves to make. This tool is able to show exactly how much a pair typically moves within a given hour of the day. By viewing general averages and previous statistics, traders can take calculated risks based on the information they observed. If the volatility has changed over time, traders have easy access to this information.

By using forex volatility, a trader can gauge if the investment would reach its profit target. Volatility tools do not disclose which direction a trade will go, but it will show how much the price moves. There are many tools such as the risk calculator that can be used by plugging in a time period, and the tool will provide the likelihood of the price staying within that specific range.

Forex Positions/ COT Data

Position summaries are proven to be helpful tools for revealing long and short. By watching how the ratio subsequently changes as the price changes will provide a level of insight for future trades The main goal of all these strategies is to predict how the market will behave based upon past trends. Traders will exit these positions either at loss or profit. If a large majority of traders are long, this indicates that the majority have already bought. This figure can be somewhere around 90%. There are few traders left in this scenario to continue pushing the price. Without anyone left to purchase, the prices move in the opposite direction.

COT stands for Commitment of Traders report. This report shows data all the way back to 2008. The data shows the specific position of traders during a very significant market turn. This tool helps to anticipate changes and fluctuations.

Download COT data MT4 indicators

Correlation and Indicators

Download Correlation indicators for currency

Correlation and indicator tools are used in relation to direction, but can not anticipate price moves. Correlation is subject to change over time and measured within different times. Indicators are used with graphs and charts. Indicators can draw lines over price waves which helps traders focus on larger price moves and overall profit trading.

What is the Best Momentum Indicator?

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Best momentum indicator for forex traders

Forex traders use a variety of tools to understand market conditions and take decisions accordingly. Traders use momentum indicators to understand the rate at which the price of the forex rate changes. These indicators should be used with other tools since they only consider the timeframe for the price change, not the direction of movement. Some of the other technical indicators which are used with the momentum indicators are the moving averages and trend lines for the direction of price movement and price trends.

Trading made simple

The best momentum indicator is an indicator that most traders use and help traders to make better decisions, analyze the impact, to get a better look at the chart. Most indicators are oscillators and they do not predict market price, they just explain better price charts and technical indicators can help traders to pick the right entry and exit position for trades.

Advantages

The momentum indicators will indicate the movement of the forex rates over time, and the strength of these movements through the rates may increase or decrease. These indicators are useful since they help the analysts and traders determine the point where the market is reversing. At the reversing point, there is a divergence between the momentum and movement in forex rates.

Divergence

Divergence occurs when the forex rate is moving in a particular direction, and the momentum which was originally in the same direction is now no longer following the forex rate downwards. This indicates that the momentum indicator has diverged from the forex rate movement and the current price movement is losing momentum. Divergence is noticed when the momentum is stalling and indicates the current trend in exchange rates is likely to end soon and reverse quickly. The divergence is considered bullish if both the momentum and forex rates are diverging in an upward manner. If the momentum indicator and exchange rates were moving upward, and the indicator started moving downward, this is considered a bearish divergence.

Trading made simple

Popular Momentum Indicators

Though there a large number of momentum indicators available, some of the popular indicators are listed below so that a trader can choose the Best momentum indicator.

Moving Average Convergence Divergence MACD

The Moving Average Convergence Divergence (abbreviated as MACD – see analysis) is a popular momentum indicator. Two moving averages are used by the MACD to produce an oscillator, deducting the longer average from the shorter average. These averages will overlap, converge and move away, indicating the momentum. While the trader or analyst may choose any period, they are typically using the exponential moving average (EMA) for a period of 26 days and 12 days. The resulting MACD line is graphed against a 9 day EMA which is used to detect when the price movement will turn. The histogram is used to determine the weakening uptrend or downtrend when the histogram is positive but moving downward, and the histogram is negative but moving upward respectively.

Relative Strength

The Relative Strength Index (RSI) (full review on our website) is another momentum indicator that is popular. Like the MACD, it is an oscillator that measures the speed of the forex rate changes. The value of the RSI fluctuates from zero to 100. A rising RSI value above 50, indicates a positive momentum, though if it increases above 70, it could indicate that traders have overinvested in the currency. Similarly, if the RSI value decreases below 50, there is a negative momentum or downtrend. However, if the RSI reading will decrease below 30, it could indicate that traders and investors have oversold the currency. Traders are using the RSI to monitor the divergence when the indicator crosses the centerline.RSI indicator can be used to calculate the strength of the currency pair.
Example of RSI bearish divergence :
relative strength index bearish divergence example
Example of RSI bullish divergence:
relative strength index bullish divergence

Average Directional-index

The Average Directional Index (ADX) was created by Welles Wilder as part of his Directional Movement system. It consists of Minus (-DI) and Plus (+DI) directional indicator, ADX, which together measure both the direction, momentum of price movement. -DI and +DI are derived by comparing the consecutive lows, and the corresponding highs. The ADX is calculated from the smoothed average of the +DI and -DI. If the ADX value is more than twenty, it indicates that there is a market trend, and if ADX is less than 20, the market is considered to be directionless. The ADX only measures the strength of the trend, not its direction

Conclusion

Forex traders and analysts are using momentum indicators extensively and these are important to help them decide on the forex rates when they should buy or sell forex. However, most traders use these indicators along with other tools, which also reveal the trend direction. After the direction of the change in the forex rate is determined, these indicators are helpful since they provide information on the trends in price movement, and when these trends are changing or reversing.

While we limit our evaluation to foreign exchange only, it is reasonable to assume that the other primary asset classes included in a typical managed futures portfolio, namely, fixed income, commodities, and stock indices, would also benefit from a combination of momentum and macro/fundamental strategies.

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