Forex traders like to use different methods and tools to help them trade profitably. There are hundreds of technical indicators available to choose from; some of them work well and some of them only seem to work some of the time.
Often traders like to combine indicators as doing so helps to provide more robust trading signals. By doing so, traders have more chance of making money. As well, filtering out trades helps to reduce commission costs overall. Here are 3 ways to combine forex indicators:
Guest post by FXTM
Volume and breakout
Volume and breakout is a classic combination that traders use but unfortunately some brokers do not provide much in the way of volume data in forex markets.
Nevertheless, the combo works because breakouts often signal changes in trend and lead to long term market moves.
Similarly, volume helps show direction as it indicates the move is ‘real’ and not just a technical move. Combining the two greatly reduces the chance of whipsaws.
Moving average and RSI
These two indicators work well as confirmation indicators in their own right and they can also be combined together for two different types of strategies.
Mean reversion strategies can benefit if the RSI is oversold or overbought. If the forex pair is a good way from its moving average, it also signals a return to the mean is likely so combining the two signals helps strengthen the trade.
In trending markets, RSI and the moving average can work in the opposite way. If a currency is overbought, and the moving average has just crossed over a slower MA, or if the price has crossed over the MA, then it’s a stronger signal to enter a trend following trade.
Either one can also be used as a filter against the other. For example, if RSI is overbought but there is no MA cross, then the trade signal can be annoyed.
Bollinger Band and open positions
Indicators can be combined with fundamental metrics too and this is sensible in forex markets.
Open position data or COT (Commitment of Traders) data, can be used to support or restrict technical signals.
As an example, let’s say that GBPUSD is riding high and has just climbed towards the top of its upper Bollinger Band. In some cases, this could be interpreted as a bullish sign but a look at the open position data suggests a one-sided situation that could limit any further move upwards.
In this example, open position data suggests that around 80% of open positions in GBPUSD are long positions. If this is the case, then there are very few bulls left in the market to buy. The situation is very one-sided and only a few short positions would be needed to make the currency drop back.
Thus when a currency hits a Bollinger Band and open position data suggests a one-sided market, there is a great potential for a reversal.
Further reading: Avoiding false dawns in the forex market