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How does the Money Flow Index (MFI) indicator work?

If you are looking to find the demand for a financial asset, you need to be able to track monetary flows in and out of the markets. The Money Flow Index (MFI) indicator is used to measure supply and demand, which is usually the simplest way to determine where a market may be going. Note that this indicator was initially designed to work with the stock markets, as forex markets are not centralised, and therefore some of the inputs will be different to the original scenarios many traders had been using in equities. The basic premise is that if demand for a particular currency is high but supply is limited, prices will rise as bidding increases. This is the same as any other bidding process: if there are more people wanting to own something, people will try to outbid each other. Of course, the opposite is true as well: when demand drops, sellers have to drop prices to attract buyers. The Money Flow Index indicator is a popular method of viewing how these forces interact with the markets. <h2>The calculation</h2> The indicator uses a couple of different mathematical equations in order to find where the market may be ready to go. The equation seeks to find the ‘Typical Price’ by determining in the mean of the high, the low, and the closing prices for the time period in question. In mathematical notation: TP = (H+L+C) / 3 I.e. the Typical Price equals the high, low, and close divided by three. The next part of the calculation takes in what is known as money flow. This takes the typical price and then multiplies it by volume. There’s no way to know in a non-centralised market exactly how much volume is being done, but by using the volume at your broker, you get a fair representation of what the larger market should be. The next equation: MF = TP x V Or, Money Flow equals Typical Price multiplied by Volume. The next part of the calculation looks at positive and negative flows over the quantity of periods that the indicator is set towards, known as money ratio. The indicator defines positive money flow as being any candle where the Typical Price is higher than the previous candle. Conversely, negative money flow is when any candle has TP lower than the previous candle. To get the positive money flow for the indicator, the calculation is to add up the total positive money flows over the time span in question. Ultimately, to get the negative money flow for the indicator, the calculation is of course to add up the total negative money flows over the same time span. The equation is: MR = positive money flow / negative money flow. Finally, everything is converted into an index using the following mathematical formula:   MFI = 100 - 100 / (1 + MR) In other words, the Monetary Flow Index is a ratio of positive money flow into an asset compared to the total money flow. The indicator of course shows this for you, and you don’t have to do the math behind it, as it is built into the <a data-di-id="di-id-8ed17442-be85d085" href="/metatrader-4/">MetaTrader 4 platform</a>.  The default measurement is 14, meaning that if you are looking at a daily chart, the Money Flow Index is giving you a reading of the last 14 days. If it is on the hourly chart, it is reading the last 14 hours, and so on. <h2>How to attach the Money Flow Index indicator</h2> To use the Money Flow Index indicator on the MetaTrader 4 or 5 platform, go to the 'Insert' menu then go to the 'Indicators' submenu, followed by the 'Volumes' submenu, and selecting 'Money Flow Index'.  The indicator will show up in its own window at the bottom of your platform. <img alt="" src="/TMXWebsite/media/TMXWebsite/money_flow_index_001.png" /> At this point, you can start to look for opportunities using the Money Flow Index. Using the indicator  The MFI indicator is used to indicate when a market is overbought or oversold. In the indicator, you will notice there are two levels marked by dashed lines of 20 and 80, with the absolute highs at the 100 level, and the absolute lows are 0. When the line is above 90, the market is possibly overbought. Conversely, the indicator moving below the 20 level suggests that the market is oversold. Let’s look at the chart below. The red arrow points out where the indicator has broken above the 80 level, suggesting an overbought condition. Shortly afterwards, the EUR/GBP pair dropped. After that, you can see there was a bounce where the blue arrow marks the Money Flow Index dropping below 20. While there is just a short term bounce, there is a bounce, nonetheless. This can often be filtered by something along the lines of a moving average, or even a trendline. <img alt="" src="/TMXWebsite/media/TMXWebsite/mfi_002.png" /> To summarise: <ul> <li>The 80 level is where a market enters an “overbought” condition</li> <li>The 20 level is where a market enters an “oversold” condition</li> <li>The indicator is built into the MetaTrader 4/5 platforms, as well as many others</li> <li>The default reading will be for the last 14 candles, but can be changed</li> <li>The Money Flow Index is often used with other indicators as well</li> </ul>   <h2>Adding an additional filter </h2> Many traders choose to compliment the MFI indicator with a moving average. This is because the moving average can keep you on the right side of a trend. If you are looking for an indication of an overbought or oversold condition within the Money Flow Index indicator, this can be validated by a move above or below a moving average. Let’s look at the below four-hour chart in the Canadian dollar/Japanese yen currency pair. <img alt="" src="/TMXWebsite/media/TMXWebsite/mfi_003.png" /> The blue arrow indicates where the Money Flow Index indicator reached the oversold condition. Shortly after that, the price crossed above the 20 exponential moving average, one that is commonly used. The way to think about this move is that the market had gotten oversold, and then by breaking above a common moving average, it shows that the momentum and trend is starting to change to the upside. At that point, most traders would enter a position. Later on, in the same chart, you can see that the Money Flow Index indicator had entered the overbought condition, and the price shortly thereafter fell below the 20 EMA. That tells you that the shift is starting to gain momentum, and the market starts to fall from there. Ultimately, this keeps you in the loop when it comes to a potential trend change, and then gives you confirmation in a one-two set up. In another example, we can apply the Bollinger Band indicator to the chart, looking for signs of oversold or overbought conditions from both indicators. <img alt="" src="/TMXWebsite/media/TMXWebsite/mfi_004.png" /> Looking at the chart, you can see where the blue arrows start that the market has broken below the oversold level, followed very quickly by the market breaking below the bottom of the Bollinger Band indicator. This shows that the market is oversold as far as the Money Flow Index indicator is concerned, but more importantly it is also oversold with both indicators. By breaking the bottom of the Bollinger Band indicator, it now is two standard deviations below its average price. With both of these indicators you have the ability to see a slowdown in volume going into the market, and at the same time you can see that the market is statistically farther away from normalcy than it should be. This almost always sets up for a ‘reversion to the mean’, demonstrated by the moving average in the middle of the Bollinger Band indicator. However, some people will also aim for the top of the indicator: it boils down to your own personal trading style.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

How to Use the Stochastic Oscillator

One of the most basic and perhaps oldest indicators used by technical analysts is the stochastic oscillator. The stochastic oscillator is an indicator that measures momentum and the strength of a trend. Essentially, its job is to analyse price movement and show how strong the price move is.    The indicator measures the momentum of price, and also shows a slowing of momentum as the momentum of a financial instrument needs to slow down before changing direction. This addresses a weakness in retail trading, the fact that far too few traders pay attention to the importance of the rate of change.    The stochastic oscillator is one of the more common indicators, and it’s one that you will see in a lot of analysis. However, like any other indicator it is simply a tool that you will be using to navigate through the forex markets, and like any other tool it is needed to be used in the proper settings and situations.  <h2>How to add the stochastic oscillator to MetaTrader charts</h2> Adding the stochastic oscillator to the MetaTrader platform is very easy. By clicking on the Insert menu, you can pull down the list and click on Indicators, followed by Oscillators, and then Stochastic Oscillator. It's a common indicator, and as such it's built into the platform and there is no need to download from anywhere else. <img alt="" src="/TMXWebsite/media/TMXWebsite/Oscillator-picture-1.jpg" /> The settings dialog box will pop up, and there are multiple parameters that you can change. The %K period and the %D period settings are available. The %K should be thought of as the slow value of the stochastic indicator and the %D should be thought of as the fast value of the stochastic indicator. It uses a couple of moving averages to measure the overall momentum. <h2>Why does momentum matter?</h2> Think back to your mathematics studies. One of the biggest influences in calculus is the absolute rate of change. The idea is that if the market is in an uptrend, but if the momentum starts to slow down, it can suggest that the market is running out of steam and, therefore, could be ripe for a reversal. In this sense, it can suggest whether or not the market is going to continue, or if it might be over-extended in one direction or the other, and other words overbought or oversold. <h2>Using the indicator to make decisions</h2> The stochastic oscillator has a multitude of uses when it comes to trading forex. We have already mentioned the most obvious use for the stochastic oscillator: the idea of identifying overbought or oversold conditions. In this scenario, the stochastic oscillator is best used in a range bound market, as it can tell you when to buy and sell in a relatively well defined situation. When you look at the stochastic oscillator window at the bottom of the chart, you see the two moving averages going back and forth in an up and down pattern. You will notice that there are two lines in the indicator window including the 80 and the 20 level.   The area above the 80 level is considered to be overbought, while the area below the 20 level is considered to be oversold. Furthermore, you need to see the moving averages inside the stochastic oscillator to cross in the overbought or oversold areas in order to get a reversal signal. Anything between the two levels is essentially ignored in this scenario. <img alt="" src="/TMXWebsite/media/TMXWebsite/Oscillator-picture-2.jpg" />   Looking at the chart, you can see that the stochastic oscillator had several moves back and forth between the 80 and the 20 levels. However, there are only a couple of areas where the indicator either broke into the overbought area or the oversold area and had a cross. You need both of these things to happen in order for it to fire off a signal.   In the graphic below, you can see that the signals fired off are color-coded by the arrows, with the red showing an overbought condition and a potential selling opportunity, and the blue showing potential buying opportunities in an oversold condition.   It should be noted that using the stochastic oscillator in this way is much more reliable when in a sideways market, preferably between significant support and resistance. This makes the stochastic oscillator truly important, because statistically speaking markets are in some type of consolidation or sideways action more than 70% of the time. In other words, it’s much more common to be in this environment than it is to be out of it.  <h2>Measuring divergence</h2> Another way that people use the stochastic oscillator in forex trading is to measure for divergence. The idea is that as with any oscillator, you could see momentum going in a different direction than the overall price. As an example, the momentum could be rising while price is falling or vice versa. If you are in a scenario where price is rising but the momentum is slowing, that means that there is less aggression to the upside and therefore less demand, even as prices press higher. This can be a sign that potential trouble is on its way.    Take a look at the chart just below. You can see that there is a clear uptrend line on the four hour chart for the GBP/AUD pair. As the price was rising, though, notice that the stochastic oscillator made a lower high, which is the opposite of an uptrend. This suggests that the rate of change is slowing down, therefore one would have to be a bit suspicious about the efficacy of the move.    After all, if there is less momentum, it suggests that there are fewer fresh orders coming in to push the market to the upside. Ultimately, you can see that shortly after the diversions with the lower high in the stochastic oscillator, the market broke down below the trend line and then eventually fell from those levels. Divergence can be found in several indicators, essentially the oscillator family. Because of this, using your divergence spotting skills can work in multiple other oscillators as well, as they all essentially work the same in this scenario. <img alt="" src="/TMXWebsite/media/TMXWebsite/Oscillator-pic-3.jpg" />

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

The Bill Williams Alligator Indicator

The Bill Williams Alligator Indicator is a trend-following indicator. As its creator stated, the entire idea of the markets is that they tend to trend between 15% and 30% of the time. Most of the market is grinding sideways in general. Most of the market is grinding sideways in general. The alligator indicator comes built into the <a data-di-id="di-id-3a56e082-fd267adf" href="/metatrader-4/">MetaTrader platform</a>, therefore attracts a lot of attention due to that alone.  This indicator only works in trends, and it should be avoided when you are in a sideways market. It’s based upon the moving averages, so gives you an idea of when a market is trending, therefore it’s relatively easy to see whether or not you should be using the indicator. The indicator is relatively simple to use, so that of course makes it popular as well.  <h2>Adding the Alligator indicator to MetaTrader</h2> It’s very easy to add the indicator to the MetaTrader platform, as it’s already built in. All one has to do is click on Insert, select Indicators, and then follow that with Bill Williams, finally select the Alligator option after that, which will set the indicator active.  Then, you get the Alligator options box, which has several different things that you can change. The basic options include the Jaws period, Teeth period, and the Lips period. You can also choose the Shift variable along with these options. <img alt="" src="/TMXWebsite/media/TMXWebsite/alligator-image-1.jpg" />   Once you click Okay, the indicator then appears on the main price chart. That being the case, you then see the lines appear. There are three moving averages, which are set at 5, 8, and 13.   The indicators are known as the jaw, the teeth, and the lips of the alligator. Although Williams describes this as an alligator, it’s essentially just three moving averages. It’s because of this that it should be relatively simple for most traders to start to use it almost immediately. <h2>What the Alligator indicator tells us</h2> The Alligator Indicator uses the previously mentioned 5, 8, and 13 smoothed moving averages. These are all <a data-di-id="di-id-2479e05d-b9dbef8f" href="/trading-academy/forex/analysis/fibonacci-ratios">Fibonacci numbers</a>, so it makes sense that there will be a certain amount of mystique around the indicator as a lot of traders like the idea of using Fibonacci.    The Jaw is the 13 smoothed moving average, which is smoothed by eight bars on previous values. The Teeth is the 8 smoothed moving average, which is smoothed by five bars on previous values. The Lips features the five bar smoothed moving average, which is smoothed even further by three bars on previous values. This will plot a green (5) moving average, a red (8) moving average, and a blue (13) moving average. <img alt="" src="/TMXWebsite/media/TMXWebsite/alligator-image-2.jpg" />   The indicator looks for convergence/divergence in order to build signals. The Jaw (blue) makes slower turns than the others, while the Lips (green) will be the fastest moving average in the indicator. Because of this, the triple indicators are used very similar to a three moving average server system. For example, if the green indicator slices through the other two to the downside, it's a sell signal. On other hand, if the green indicator slices through the other two to the upside, that’s a bullish sign and a potential buy signal.    Bill Williams suggested that when the downward cross occurred, it was when the alligator was sleeping, while an upward cross is the alligator awakening. It’s probably not that important as to whether or not he calls it one thing or the other, because this will follow a lot of the same rules that a triple moving average crossover system will. After all, that’s all this is but there are some tweaks to the calculations because they are smoothed.    If the three moving averages are stretched apart, that is generally a sign that you are in a trend and should maintain whatever the position is. In the example below, you can see that the moving averages go from being twisted to spread out relatively far at the first red arrow, they compress, and then spread out even further at the second red arrow.    At both of those arrows, the Alligator indicator is letting you know that the market is extremely bearish, and you should be hanging on to short positions. In fact, you can even make an argument for the compression between the two red arrows as not quite enough to get you out of the original position. <img alt="" src="/TMXWebsite/media/TMXWebsite/alligator-image-3.jpg" />   The indicator showing a couple of strong downtrend is the first thing he would notice, but the question then becomes whether or not you are extraordinarily cautious or if you are a little bit more aggressive. In other words, the Lips rising above the Teeth of the indicator, or the green moving average digging into the red moving average between the two arrows could be a sign to start taking profits if you are already short of the currency pair. At this point, it truly comes down to your personal preference, and traders will use both methodologies when it comes to using the Bill Williams Alligator indicator.  According to the description Bill Williams himself uses, there are a couple of ways to describe what’s going on. When the moving averages are short and choppy, then quite often he will describe it as either the market sleeping, or the alligator “being sated.” When the three moving averages start to spread and move in the same direction, then the mouth is opening and the “alligator is starting to eat.” In the chart just below, you can see that there are blue, red, and orange boxes.  In the blue boxes, the moving averages start to spread and rise, which is a very <a data-di-id="di-id-19ae81b6-bdc1b79b" href="https://www.thinkmarkets.com/en/learn-to-trade/indicators-and-patterns/general-patterns/what-is-bullish-and-bearish-divergence/">bullish sign</a>, while the orange boxes show choppy trading conditions with the moving averages, meaning that you are either flat of the market or trying to take profits from your position previously. The red rectangle is the mouth opening for the alligator to eat again, this time driving to the downside. <img alt="" src="/TMXWebsite/media/TMXWebsite/alligator-image-4.jpg" /> <h2>Adding MACD to help the Alligator indicator</h2> Looking at the Alligator indicator, one additional indicator that a lot of traders will use the MACD or Moving Average Convergence Divergence oscillator. This gives traders a “second look” at momentum in the market, right along with price. This setup will operate in the same way that the Moving Average   Convergence Divergence oscillator typically does, meaning that there are a couple of signals that you should be aware of when it comes to using this in addition to the Alligator indicator.  Looking at the chart below, there are several things that you need to be aware of. The MACD crossing above and below the zero line is important. In fact, marked on the chart are several errors to give you an idea as to how you may wish to trade the market by using the Alligator   Indicator and the MACD in concert. Taking a look at the first blue arrow, you can see that the oscillator had crossed the zero line and the histogram in the oscillator started to rise right along with the moving averages of the Alligator Indicator. The next set of arrows are orange, because they show a slowing of momentum. At this point you have the option to either close the trade or perhaps move <a data-di-id="di-id-aaebb41a-956ef5d7" href="https://www.thinkmarkets.com/en/learn-to-trade/intermediate/stop-losses-and-take-profits/">stop losses</a> up a bit closer. Shortly thereafter, there are signs of life again as the Alligator indicator starts to open its jaws again, and the MACD histogram starts to rise.    Closer to the top of the chart you see that there is an orange arrow, as the Alligator Indicator starts the clothes it’s jaw again. Furthermore, the histogram on the oscillator has started to drop, suggesting that perhaps momentum is starting to wane a bit. After that, the red arrow signifies the jaw opening yet again for the alligator to eat, while the MACD histogram is starting to drop much lower and well below the zero line. This suggests that there is quite a bit of downward pressure.  While not marked by arrows on this chart, you can see that the very end of the chart is starting to see the alligator jaws try to close, while the histogram in the MACD is starting to rise, perhaps showing that momentum to the downside is starting to drift a bit lower. <img alt="" src="/TMXWebsite/media/TMXWebsite/alligator-image-5.jpg" />   <h2>Some additional thoughts about the Alligator indicator</h2> The Bill Williams Alligator Indicator is a great trend following type of indicator, but it must be noted that you should be aware of whether or not the market is trending or not. That’s the idea of adding the MACD indicator to the chart, as it can give you a little bit more clarity as to whether or not there is momentum. Having said that, it’s also important to keep in mind that this is simply a triple moving average system.    That being said, one of the biggest concerns about anything involving a moving average is that it's a lagging indicator. In other words, it shows you where price and momentum was, not where it is. With that in mind, the indicator by itself won’t be sufficient enough to have a working system built around it. Granted, it can give you an idea when to get in and out of the market, but it also could cause a lot of choppy results if you are not cautious.    Some things to keep in mind include:    <ul> <li>Bill Williams Alligator Indicator is a lagging indicator</li> <li>It's simply three moving averages</li> <li>The indicator isn’t a system in and of itself and needs help</li> <li>Price action should probably be paid attention to as well</li> <li>The indicator is built into the MetaTrader platform</li> </ul> All things being equal, this is a nice way to find longer-term moves, but it should also be noted that it's probably going to produce better results for you on higher time frames, although that is typically the case with indicators and technical analysis in general. Ultimately, the short-term charts will continue to struggle to use anything related to a moving average, as the price fluctuations on a short time frame can be quite rapid.  Furthermore, it’s probably crucial that you experiment with the idea of whether or not the “alligator being sated” is a reason for you to take profits, or to simply stay out of the market in general. Some traders won’t take profits until the green moving average has crossed all the way through both of the other moving averages, so that is something else to think about as well. In order to figure out what works best for you, it’s important to test in a demo account so that you get familiar with the advent flow of using this indicator.    Candlestick analysis can also be useful, just as it's with any other technical indicator. For example, a hammer or a shooting star may make for a better signal than just a simple spreading of moving averages by itself. A trade setup may be something along the lines of the alligator opening up its jaws again in the Alligator indicator, the MACD showing a zero line crossing with increasing momentum, and a hammer that suggests the buyers are coming back into the market.  In other words, simply following the indicator can lead to a lot of choppy and inconsistent results if you don’t temper it with other help. That’s not necessarily that uncommon when it comes to technical analysis and indicators as most systems use at least a couple of them in order to form buy or sell signals. It’s also important to figure out a timeframe that works best for you, not to mention the fact that some markets will act slightly differently than others. That being said, this is a popular enough indicator that several other traders out there will be following it as well.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

What is the Bill Williams Awesome Oscillator?

The Bill Williams Awesome Oscillator is an indicator that traders use to measure momentum in a market. Like all indicators, it is typically used as part of a larger trading system. The AO is plotted in its own window at the bottom of a MetaTrader platform and has a zero line much like many other oscillators. The indicator uses the 34 simple moving average and the 5 simple moving average in its calculation. The indicator takes the difference between the two moving averages and plots them in a histogram. The moving averages that are used to calculate the indicator reading aren’t the conventional moving averages that people will use as they don’t measure the close of the candlestick, but the midpoint of the candlestick range. The oscillator is generally used to confirm a trend but can also be used to anticipate a potential reversal of the trend. As an oscillator, it will fluctuate above and below the zero line which is considered neutral. In its standard form, the histogram will print out in red or green bars, with the bar turning green when its value is higher than the one before it. If the bar of the histogram is lower than the one before, it will turn red. When the histogram is above the zero line, it indicates that the shorter moving average is trending higher than the longer one. You can think of this much like a moving average server system. When the values are below the zero line, the short term moving average is lower than the longer one, showing a downtrend. <img alt="" src="/TMXWebsite/media/TMXWebsite/williams_awesome_oscillator_1.png" /> <h2>Adding the indicator to your MetaTrader 4 platform</h2> To add the Awesome Oscillator to your <a href="/es/metatrader4/">trading platform</a>, you need to click on the ‘Insert’ menu, go down to the ‘Indicators’ submenu, and then select the ‘Bill Williams’ submenu, followed by selecting ‘Awesome Oscillator’. You will notice that the default setting is to have a green bar for ‘Value up’, and a red bar for ‘Value Down.’ You can change these colors but for the purposes of demonstration in this article we will keep them the same. <img alt="" src="/TMXWebsite/media/TMXWebsite/as_2.png" /> <h2>Using the Bill Williams Awesome Indicator</h2> While the indicator is typically part of a larger system, there are a couple of basic ways that it is typically used. The easiest way is to simply wait for the oscillator to cross the zero line. For example, if it’s below and rises above the zero line, it’s considered to be a ‘bullish cross’. On the other hand, if the AO drops below the zero line you can consider it to be a ‘bearish cross’. This adds more confidence to a potential selling position as the underlying moving averages are in congruence and both moving lower. Take a look at the chart below of the four-hour CAD/JPY pair. <img alt="" src="/TMXWebsite/media/TMXWebsite/as_3.png" /> The market breaking down right at the red arrow accompanied by the AO 'bearish cross' gives the trader an opportunity to start selling. You should also pay attention to the fact that once the indicator produced several green candlesticks, the market entered a bit of consolidation and a lot of traders would have taken profits there. Having said that, the indicator tends to work a bit better if you keep in mind the overall trend. For example, when the oscillator went back to form ingrained bars where the trade leveled out, it wasn’t a matter of buying, rather a signal to either get out of the market or tighten up your stop loss.  Take a look at the chart below, as it now has a 50 EMA plotted on it. <img alt="" src="/TMXWebsite/media/TMXWebsite/as_4.png" /> When the signal kicked off at the top of the chart, it was a clear breakdown of that EMA. Furthermore, the EMA was still above price action and turning lower when the oscillator went back to green. By using the indicator to tell you what phase the trend is an, traders could have held on to this position for much further gains. <h2>Divergence</h2> Another way that traders use the Bill Williams Awesome Oscillator is to find divergence. Divergence is when momentum and price aren’t matching. In other words, if price is rising but momentum is falling, that’s a sign that perhaps the underlying momentum and fundamentals of the market are starting to deteriorate. Conversely, if the price is falling but the momentum is becoming more bullish, then it’s possible that the sellers are starting to run out of underlying momentum, meaning they may be likely to flip their position. The Bill Williams Awesome Oscillator works the same way as any other oscillator in this sense. What you are looking for is a peak that doesn’t quite continue the overall momentum of the previous peak, while the price continues. Notice on the chart below the price was rising while the AO was running out of momentum. <img alt="" src="/TMXWebsite/media/TMXWebsite/ad_5.png" /> Notice how the first high was higher than the second one, even though prices continue to drift to the upside. Shortly thereafter, markets broke down a bit, which is the very essence of using divergence for trading. This isn’t necessarily a signal in and of itself, but it tells you that something isn’t quite right. With that in mind, there are a couple of ways to play this. Depending on when you enter the market, the divergence of an oscillator can mean several things. For example, let’s say that you had bought this pair somewhere closer to the bottom, but she started to notice that divergence was showing itself in the oscillator. That’s a warning that you may need to move your stops closer, or perhaps get out of the market altogether. Let’s say that you were in the market, but you started to see divergence. At this point you start looking for an opportunity to sell based upon whatever system you are using. Bear in mind that the price could have just as easily gone sideways after divergence and then picked back up over the longer term. It is yet another signal, not a system in and of itself. Divergence can: <ul> <li>signal a slowing market</li> <li>offer hints as to when you may need to tighten stop losses</li> <li>give the trader an opportunity to look for a reversal signal</li> <li>come and go without major ramifications, meaning that it is only part of the system.</li> </ul> <h2>Final thoughts on the Bill Williams Awesome Oscillator</h2> The Bill Williams Awesome Oscillator is an indicator that is relatively simple to use and isn’t hard to set up. In fact, it will come with any <a href="https://www.thinkmarkets.com/en/trading-platforms/mt5/">MetaTrader platform</a> you are using. It’s important to remember that it isn’t a signal in and of itself. However, what it does do is give you an idea of what a couple of moving averages might look like on your chart without plotting them on your chart itself. Remember, this is simply measuring the difference between the 5 and 34 simple moving averages. In other words, it lets you know when these widen out, and start spreading which for moving average traders suggests that momentum is picking up. The farther away from the zero line the oscillator gets, the more spread out we are and then hence should continue to see momentum. The zero line being crossed itself is simply a function of a moving average crossover. This just means that the moving average has crossed over the other one, just as you would see on a moving average of a system that would be plotted on your chart. In that sense, the oscillator itself is just another take on moving averages overall. This isn’t to dismiss this indicator, it just shows that it is another way to express the overall momentum of the marketplace, something that can be done through a multitude of indicators. It should be noted that price action comes first, and before that even comes into play you should be looking at support and resistance. That being said, if the market does break through a supporter resistance area, the Bill Williams Awesome Oscillator can give you an idea as to whether or not momentum will continue. This is a trend-following indicator, so it is not something to be used in a short-term range bound market. The indicator itself was built by Bill Williams, as we’re sure you have guessed, and has been around for some years. When using the Bill Williams Awesome Oscillator, you should think of it more or less as a tertiary signal, as support and price action should dictate what you do first.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

Ways to Use the Relative Strength Index (RSI)

The relative strength index, or RSI for short, is one of the most popular technical indicators among the trading community. It belongs to the family of oscillators, or technical tools used to determine overbought or oversold conditions. It’s used to gauge the market sentiment.   Developed by J. Welles Wilder, the RSI measures the speed and change of price movements. A popular way of reading RSI values is to look for divergences that occur when a new high or a new low of the price isn’t confirmed by the RSI readings. <h2 dir="ltr">How it works </h2> The RSI is a momentum indicator. As such, it displays on a vertical range of 0 to 100. Readings close to 0 are viewed as “oversold”, while those closer to 100 are a sign of  “overbought” market conditions. Unlike some other momentum indicators, readings can’t go below 0 or higher than 100.   According to Wilder, the relative strength index formula is as follows:   RSI = 100 – [100 / (1 + (Average of Upward Price Change / Average of Downward Price Change)]   When the RSI displays readings higher than 70, it means the market is trading in the overbought, or overvalued, territory. On the other hand, a dip below 30 reflects an oversold market condition.    These two levels, 70 and 30, are the default values that can be modified as per the trader’s preferences. Some traders prefer to have values set at 80 and 20 to decrease the number of trips into the overbought or oversold territory and increase the effectiveness of the RSI. <h2>Strengths and weaknesses of the indicator</h2> In general, the RSI is considered to be an effective and useful technical indicator. It generates signals that are used by a trader to paint the full picture pertaining to market conditions. As such, the RSI is the strongest when the market shifts from bullish to bearish periods.   The RSI, though, has its limitations and weaknesses, same as any other indicator. Arguably, its biggest limitation is that an asset can trade for a long period of time in an overbought or oversold territory and still continue to make new highs and new lows.   For this reason, you should always cross-check signals from the RSI and compare them with other technical indicators. Overbought or oversold market conditions may overlap with signals from other indicators, creating a confluence of resistance/support with enough justification to open a trade.    To illustrate an overbought market, take a look at the EUR/USD daily chart: <img alt="" src="/TMXWebsite/media/TMXWebsite/Overbought-signal-RSI-pic-1.jpg" />   The pair had been trading into an uptrend, which makes the RSI cross into the overbought territory above 70. Despite the overbought market conditions, EUR/USD creates three additional bullish candles, pushing the price action almost 400 pips higher from the moment the RSI crossed 70.   Experienced traders tend to say that whenever the market is overbought or oversold, it can always be more overbought or more oversold. For this reason, it is not advised to open a trade that is based only on the RSI values, since they generate false signals.  In order to get more familiar with the relative strength index, its strengths and weaknesses, you may want to use the MetaTrader 5 trading platform. You can access the latest version <a data-di-id="di-id-50880195-98f211af" href="/metatrader5">here</a>. On this platform, you can use the historic price action to analyse the behaviour of the RSI and the signals it generates. <h2>RSI divergence signals</h2> The relative strength index also generates divergence signals, either bullish or bearish. The bullish RSI divergence occurs when the price action creates a new low, or a lower low, while the RSI diverges from the price action and creates a higher high. This way, the RSI leads the price action and it signals that the potential bullish reversal may take place soon.  On the other hand, the bearish divergence occurs when the price action is still trading in an uptrend, but the RSI has already started to come off the highs. As a result, the RSI signals the impending bearish reversal in the price. How to trade the RSI In order to avoid trading the false signals from the RSI, it is advised to cross-check signals against other technical indicators. In the example below, we have GBP/USD trading in an aggressive downtrend, on a daily chart. <img alt="" src="/TMXWebsite/media/TMXWebsite/Trading-the-RSI-picture-2.jpg" />   Similarly to the previous example involving EUR/USD, the RSI enters the oversold territory already in the first part of the downtrend. This happens as a result of a strong push lower as the bears completely overwhelm the bulls. As a result, readings are also decreasing in an accelerated fashion.    Our approach, in this case, is to use <a data-di-id="di-id-9164943b-24d004a1" href="https://www.thinkmarkets.com/uk/learn-to-trade/advanced/fibonacci-ratios/">Fibonacci extensions</a> to identify the 127.2% and 161.8% levels as potential support blocks. As you can see in the chart, a downtrend of around 1,800 pips stops at the first extension level.    Once we see that the bears are losing momentum, and we have a clearly identified level as a key factor for a slowdown, we check the RSI readings to get the confirmation that the market is oversold.    Given the magnitude of the move, you would expect the RSI to trade at extremely low levels. When the price action touches the 127.2% extension, the RSI trades around 15. This is not surprising given that this bearish move pushed GBP/USD towards the lowest levels since 2008.   If you go to a monthly GBP/USD chart, you will see that the last time RSI was trending around the 15 mark was in 2008. Although the RSI can always go lower until it reaches 0, a reading of 15 is quite low, especially for the higher time frames.   Hence, the RSI is best used as a confirmation indicator. You can also use other technical indicators, such as <a data-di-id="di-id-1f4e334f-6f4eda2d" href="https://www.thinkmarkets.com/uk/learn-to-trade/indicators-and-patterns/indicators/simple-moving-average-sma-indicator/">moving average</a>, Fibonacci retracements, trend lines etc., to identify important levels and then cross-check them with the RSI readings.    In this particular case, we are trading against the 127.2% extension. A stop-loss should be placed below the extension, while a profit-taking order depends on your risk sentiment and risk/reward ratio.    Practise trading of the RSI, and other technical indicators, by <a data-di-id="di-id-fd99886e-20c0aa3e" href="https://portal.thinkmarkets.com/account/individual/demo">opening a demo trading account</a>. This way, you can identify trading opportunities yourself, by applying RSI and other technical indicators to better understand their co-existence, as well as to protect your capital until you feel comfortable to trade live markets. <h2>Summary</h2> The relative strength index is a momentum indicator that identifies when the market is trading in the overbought or oversold conditions. The indicator gauges market sentiment by measuring the speed and change of price movements. As such, it is best used in trending markets, and when mixed with other technical indicators.   The RSI also displays bullish and bearish divergences, which happen when a new high or low isn’t confirmed by the RSI readings. Hence, divergences can lead the price action into a reversal, and generate a signal to the trader that the price may change its direction soon.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

What Forex Traders Need to Know About Parabolic SAR

Parabolic SAR, also known as Parabolic Stop and Reverse, is a common indicator mainly for short-term traders, although it can be used by longer-term traders, too.    This indicator is a bit different from many others as the idea is to stay in the marketplace all the time. That being said, though, it can be used however it suits the trader. As the Parabolic Stop and Reverse indicator is built into the <a data-di-id="di-id-b7a43191-be85d085" href="/metatrader-4/">MetaTrader platform</a>, a lot of traders have at least experimented with it. The indicator focuses on the direction of the price of a financial asset, and it gives a quick heads up as to when the market may be changing directions. The Parabolic SAR was developed by J Welles Wilder Jr., who also created the RSI, or the relative strength index. That being the case, the market took to this indicator relatively quickly, as the author is well known and respected. <h2>How to add Parabolic SAR to MetaTrader charts</h2> Adding Parabolic SAR to your MetaTrader charts is very simple. All you need to do is click on Insert, pull down the menu and click on Indicators, followed by Trend. After that you simply select Parabolic SAR to attach it to the chart. As it is built into the platform, there is no need to download from an external place. <img alt="" src="/TMXWebsite/media/TMXWebsite/Image-1-how-to-add.jpg" />   At this point, you have a couple of potential inputs, including the Step and Maximum indications, along with the style of the indicator itself. Most people will use the standard settings, so this is how we will present it in this article. If you don’t yet have MetaTrader, you may want to consider opening a <a data-di-id="di-id-6f6dc126-895442f8" href="https://portal.thinkmarkets.com/account/individual/demo">demo account</a> and learn how to trade using virtual funds before risking your own capital. <h2>How to read the indicator</h2> The Parabolic SAR plots dots on the chart, showing the direction of the short-term trend. When the dots are below the candlesticks, it suggests that there is buying pressure underneath, pushing the market higher. You will notice how these dots run in consecutive strings, keeping the trader in the trend longer than they may be willing to get involved in without them.  The idea is that the indicator tells you which direction the market is moving, but it also tells you where to put your stop loss. The stop loss goes at the dot, and if it gets hit you will notice that the dots switch sides, changing the overall trend. For example, if the dots are underneath candlesticks, then you are a buyer with your stop loss moving every time the new dot is presented. Eventually, the market hits that stop loss, and then flips the direction of the indicator, telling the trader to switch the direction in which they are trading. <img alt="" src="/TMXWebsite/media/TMXWebsite/PSAR-on-chart-image-2.jpg" /> There are a couple of things that should be noted here, for example that this is a trending type of indicator. It also gives a bit of a wide berth for stop losses, so it is easier to deal with this indicator and use it effectively on shorter-term charts. In fact, that’s how most traders use it.    Take a look at the following chart. It’s a 15 minute GBP/AUD pair chart and notice that although there were some whipped cells along the way, the trades that work out are quite explosive. On the chart, you can see that the market rallied quite significantly, then whipsawed a bit, only to rally again. In other words, you probably had two very small losses in comparison to a couple of decent gains. The rollover from the highs of the chart were a nice selling opportunity, followed by a relatively flat market that produced a couple of choppy moves that probably went against you before your stop loss was hit. In other words, it should become apparent that the indicator is not to be used in a range-bound type scenario. <img alt="" src="/TMXWebsite/media/TMXWebsite/image-3-PSAR-example.jpg" />   The one major advantage of this indicator, though, is that it’s completely mechanical, therefore, you know where your stop losses are and you know when it’s time to get out. In a sense, it can be thought of as an algorithm, but was calculated by the trader themselves, as it has been around since before algorithmic trading became really popular.    Quite often, a lot of the issues that you run into with the Parabolic SAR indicator can be smoothed out by following a couple of key points.. After all, the market tends to be very noisy, and does tend to be unidirectional most of the time. Granted, you will get the occasional pullback, but overall trends tend to last much longer than pullbacks do, and therefore most of the money is made hanging onto the trend. It’s in this scenario that the Parabolic SAR indicator shines. <img alt="" src="/TMXWebsite/media/TMXWebsite/PSAR-with-50-SMA-image-4.jpg" /> After that, the market broke above the 50 day SMA and once the Parabolic SAR dot was printed above the 50 day exponential moving average, or EMA, the trader using both of these indicators would have gone long. You can see that the trade lasted for quite some time, before pulling back towards the 50 day SMA again. This allows an opportunity to go long and once the indicator flashed all of the dots underneath, traders would have been buyers. Just as we saw with the big move higher, the indicator started to flash a sell signal before it crossed over the 50 day SMA, which was a confirmation that you should start selling again. As you can see, this combination can be quite useful. However, in general, moving averages tied into the Parabolic SAR tend to work better with longer-term charts, making it a bit of a hybrid system as the Parabolic SAR itself does well on a shorter time frame. Adding a moving average seems to be even more filtered and reliable, at least on longer time frames. Add a moving average to use Parabolic SAR longer term If you add a moving average to the chart, that can give you an idea about the overall trend. When used with the Parabolic SAR indicator, it helps you avoid potential losses. For example, look at the several red arrows at the beginning of the chart below on the AUD/NZD daily chart. The red arrow shows you when the market has broken below the 50 day simple moving average, or SMA, something that is quite often used to determine the overall trend. With the Parabolic SAR flashing a sell signal, and the dots sitting right around the moving average, this presents itself as a nice shorting opportunity. Designed as a system, yet not to be used on its own This indicator was originally designed to be a system, but quite frankly it’s not all encompassing. It’s very rare that a particular indicator can give you a reliable trading system by itself, and the Parabolic SAR isn’t going to be any different. It’s obvious that the indicator is very useful, but it does tend to need a little bit of hell. You can use the Parabolic SAR with the moving average as shown previously, but some traders will also use the indicator only when a particular candlestick pattern appears, perhaps something along the lines of a <a data-di-id="di-id-d9587a39-c31ca62b" href="/trading-academy/forex/analysis/shooting-star-candlestick-pattern">shooting star</a> or an <a data-di-id="di-id-44ad5a9-b8b72175" href="/trading-academy/forex/analysis/bullish-bearish-engulfing-patterns">engulfing candlestick</a>. That said, the indicator doesn’t perform as well in extraordinarily volatile markets, because it does not have time to react. What you are hoping to see is a steady trend in one direction or the other to take advantage of. Ultimately, the market conditions will dictate the tool you should use.   In short, the Parabolic SAR is useful, as it shows:    <ul dir="ltr"> <li role="presentation">         The overall trend</li> <li role="presentation">         Where to place your stop loss</li> <li role="presentation">         When to change direction </li> </ul> However, Parabolic SAR has some limitations as:    <ul dir="ltr"> <li role="presentation">         It needs a trend</li> <li role="presentation">         Sideways markets lead to losses </li> </ul> In summary, this is an indicator that traders should perhaps demo trade initially, using indicators with it to determine whether or not it’s a nice longer-term type trading environment, or whether it’s something you will be using for short-term trades. Remember, indicators don’t have to be used as initially designed, they are simply tools in your toolbox. It is not uncommon to see a professional trader take indicators and use them in a completely new way, and you would do well to experiment with different settings and environments for this indicator.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

What is the Average True Range (ATR) indicator?

The Average True Range indicator, or ATR, is an indicator that measures the market volatility of a financial asset by analysing the range of price for a defined period of candles. It is used as a measure of volatility and is quite often used by traders to determine how far a particular move may go. While it can be used with any timeframe, the original form of ATR was used on a daily chart to analyse the range of the last 14 days. The ATR suggests if a market is overbought or oversold, specifically whether or not it has moved much further than it typically would. It is quite common for short-term prop traders to base their position on whether or not the market is likely to continue going forward before closing out to go home. Longer-term traders tend to use it on higher time frames to see when a potential pullback or bounce could occur. Adding the ATR to your charts on MT4 and MT5 In order to add the Average True Range indicator to your <a href="/trading-platforms/">charts</a>, you need to click the 'Insert' menu, the ‘Indicators’ submenu, the ‘Oscillators’ submenu, and then choose ‘Average True Range’. Once you do this, you will see the indicator open up on a window underneath the price, just as you would any other oscillator. In this example below, you can see that the ATR shows a signal line that goes up and down, in this case with the lowest band being the 0.0108 level, with the 0.0318 level above being the top range. <img alt="" src="/TMXWebsite/media/TMXWebsite/average_true-_range_1.png" /> Notice how the line goes up and down, and this is the crux of the indicator. At the top left corner of the ATR section, you can see that it has the reading of 0.0309, telling us that the GBP/AUD pair has an average range of 309 pips per candle over the last 14 candles. In this example, that means 309 pips per day: <img alt="" src="/TMXWebsite/media/TMXWebsite/atr_2.png" /> Now that the indicator is attached to your charting platform, we can start to discuss how this can become crucial information for those looking to trade the currency markets. <h2 dir="ltr">How to use the ATR</h2> The most common way is to pay attention to how big a move the market could potentially make during a given trading session. For example, think about the GBP/AUD pair mentioned previously. If the average range of trading during the previous 14 days was 309 pips, this is crucial information if you are trading short-term charts. For example, wouldn’t it be valuable information to know whether or not a market was likely to continue moving further after making an initial charge? If you find yourself in an uptrend that has already moved 290 pips, then you know it’s very unlikely that we will continue further, all things being equal. Obviously, this doesn’t have to be the case, but it is one way that short-term traders will gauge whether or not they should stay in a move. On the other hand, in that same scenario you may have seen that the market has rallied 45 pips, but has the ATR reading of 309. In that scenario, a short-term trader will typically look at this as an opportunity to hang onto the trade for a bigger move. Granted, some traders will use the five-minute chart to trade, and the one-hour chart for the ATR. Others will use the daily chart to figure this out, just as the example above shows. In the end, it comes down to your trading style.   <ul> <li>ATR can give you an idea of how far a move can go</li> <li>ATR does and can change in extreme conditions</li> <li>ATR measures the size of the range, not necessarily the direction</li> </ul> When you place a trade and the ATR is added at an extraordinarily low level, this tells you the trading opportunities are probably going to be short-term at best, and for small profits. Quite often, traders will scan multiple charts to see what the ATR reading is, and therefore look for those with larger readings. This means there are more possibilities and therefore more profits if you get it right. Some traders will also recognise that a reading that is expanding to the upside could also lead to longer term trades if so inclined. <h2 dir="ltr">The EMA and the ATR</h2> As with most indicators, the ATR should be used just on its own. Without a doubt, the most important thing on a chart is price. Furthermore, trends should be paid attention to as well. This is where the EMA comes and as it defines a trend quite plainly. Take a look at the chart below: <img alt="" src="/TMXWebsite/media/TMXWebsite/atr_3.png" /> Notice that the 20-day EMA has been sloping lower for several months. You can see clearly that the market had initially used it as support, but then found it to be rather resistive. Beyond that, the ATR reading was relatively low until the last couple of weeks. Notice how the ATR is expanding. This is crucial information for short-term traders, and they will certainly use this daily chart as a bit of a guideline for day trading the NZD/CHF pair. By paying attention to the overall trend in the fact that volatility is certainly growing, short-term traders will be able to sell this market on signs of exhaustion and take advantage of the downtrend overall. You can see clearly that sellers had been in control, even though there were times where the market rallied a bit, but they also sold after that short-term rally. For the shorter-term trader, this market has offered plenty of opportunities due to not only trading with the overall downtrend but recognising that the market is starting to expand its reach per session. In this particular example, the market had initially been moving at roughly 37 pips a day, but by the time the trader started to see extreme volatility, it had increased to an average of 107 pips a day. For those trading short-term charts, a range that is over 100 pips per session offered plenty of room for trades to move. In this sense, the ATR has nothing to do with your system, it just gives you an idea as to whether or not there is plenty of opportunity in the particular currency pair. For example, the trader that uses the ATR indicator to tell how far a market could move might be trading the five minute charts, shorting every shooting star candlestick formation that they see. They may also use something like a large, round, psychologically significant figure on that same short-term chart. By only selling and hanging onto trades for longer as the ATR has risen, they are on the right side of the trade, and are collecting more profits than they may have if they had not used the Average True Range indicator. The Average True Range indicator is also used for <a href="https://www.thinkmarkets.com/en/learn-to-trade/intermediate/stop-losses-and-take-profits/">stop loss placement</a>. For example, if the Average True Range is 100 pips, then those placing a trade off of the daily chart could for example place a stop loss 100 pips from the entry, knowing that if the market were to go 100 pips against you, something has certainly changed as far as volatility is concerned, and it most certainly is working against you. If that’s going to be the case, then it’s time to bail out of the marketplace. Depending on what your risk appetite is, you can adjust your position size to fit that 100 pip ATR. In other words, if you have a 2% risk appetite per trade, then you just make sure that the 100 pips that you are basing your trade off of as far as the stop loss is concerned, doesn’t measure more than 2% of your account. <h2 dir="ltr">Some things to pay attention to</h2> As mentioned in the bullet points above, the Average True Range indicator doesn’t tell you which direction the price of a security is going, only that it is moving more or less as opposed to the range. This is the range between the low and the high of the day and doesn’t take into account <a href="/trading-academy/forex/analysis/japanese-candlesticks">the shape of the candlestick</a>, as an example. The Average True Range indicator is used by a lot of professional traders. They don’t tend to hold trades over the longer term, unless they are part of some type of investment firm. Your typical prop trader or day trader is going to be flat overnight, so they don’t have to worry about positions while sleeping. Beyond that, the ATR gives them an idea of how much the market is going to move per session, so they can use that in the morning when they show up. A lot of the same traders will scan the charts first thing in the morning to get an idea as to which markets offer the most opportunity. Remember, as a trader you need to see volatility in order to make money. A currency pair that has a very low ATR typically is an offering much in the way of profits, unless of course you are looking for some type of grinding and range bound market, which there are strategies built for. Nonetheless, most traders don’t trade like that so the higher the ATR reading, the typically more attractive the pair will be. That being said, it also can suggest that there is more danger. Remember, where there is risk, there is reward but you need to do so in an intelligent manner, which is where using the ATR as an idea for the stop loss comes into play. Unlike other oscillators, ATR doesn’t necessarily offer much in the way of divergence trading, which is a standard of other ones such as:   <ul> <li>The MACD</li> <li>Stochastic Oscillator</li> <li>Commodity Channel Index</li> </ul> In the past few years, some traders have found that using a longer-term ATR as being effective. One of the more common readings is 20 candles, but the default reading is 14. Some longer-term trend traders will even use higher timeframe reading such as 50 on a daily chart. As the 50 day EMA is very common, quite often you will see a 50 ATR on a daily chart married with the 50-day EMA. In the chart below, you can see how the 50-day EMA keeps you on the right side of the trend, and the ATR tells you when it’s time to expect bigger moves and hanging onto that short-term trade a little longer. Notice how the ATR was relatively sideways for a while, right along with the 50 day EMA. As the 50 day EMA is starting to rollover, the ATR is climbing rapidly, which of course leads to trading opportunities. <img alt="" src="/TMXWebsite/media/TMXWebsite/atr_4.png" /> While the ATR isn’t necessarily the most sophisticated approach to technical analysis, it can keep you out of serious trouble. If you have missed a market move, you know it is very unlikely that entering a new trade would make sense. Another thing to think about is that algorithms tend to use ATR a lot as well, as they focus on short-term setups typically. Because of this, it can also keep you on the correct side of prop shops and larger short-term funds.

6 Lectura mínimaPrincipiantes

Forex Indicators and patterns

A Guide to Trading the Head and Shoulders Pattern

The head and shoulders pattern, as well as the inverse head and shoulders formation, are two of the most popular trading formations. Although they are not so easy to identify, they are very reliable and effective patterns that offer extremely lucrative risk-reward opportunities.  In this blog post, we are looking at the structure of the head and shoulders and inverse head and shoulders patterns, how to correctly draw them on the chart  as well as their most effective use case. Moreover, we will be sharing tips on how to trade and make profit by trading the head and shoulders and inverse head and shoulders formations.  <h2>Spotting the head and shoulders pattern</h2> The head and shoulders pattern is arguably the most popular reversal pattern among traders. It's called head and shoulders formation because it resembles a baseline with three peaks, with the centre peak being the highest out of the three. As such, the three tops look like a ‘left shoulder’, ‘head’, and a ‘right shoulder’. Both the traditional formation - head and shoulders - and the inverse head and shoulders formations are reversal patterns. Both consist of three mandatory elements:   <ol> <li> Head - This is the highest (traditional formation) or the lowest (inverse version) peak of the formation. In both versions, the head should be at a higher/lower level compared to the two peaks on each of the sides.  </li> <li> Shoulders - Two tops sitting on both sides of the centre peak are called left and right shoulders. Ideally, they should be symmetrical i.e. at the same or near the same price level. As these are extremely difficult to identify, asymmetrical shoulders are also widely accepted, as long as the distance in two peaks is not huge.  </li> <li> Neckline - A trend line that connects bottoms of the two shoulders is called a neckline. It's arguably the most important feature of the pattern as its break activates the pattern.  </li> </ol>   The key difference between the traditional version and the inverse formation is that they occur at the opposite sides of the chart. A head and shoulders pattern is a bearish reversal pattern, which signals that the uptrend has peaked, and the reversal has started as the series of the higher highs (the first and second peak) is broken with the third peak, which is lower than the second. <img alt="" src="/TMXWebsite/media/TMXWebsite/traditional-head-and-shoulders-pattern.jpg" />   As you can see in the picture above, the traditional formation starts in an uptrend and ends in a downtrend. As such, head and shoulders signals a top (the second peak) of the current uptrend. A break of the neckline activates the pattern and makes the entire setup tradeable.  On the other hand, the inverse head and shoulders is a bullish reversal pattern that occurs at the end of a downtrend. The sellers have run out of gas as they were unable to continue the series of the lower lows. The third low (the right shoulder) is at a higher level than the previous peak.  <img alt="" src="/TMXWebsite/media/TMXWebsite/Inverse-head-and-shoulders-pattern.jpg" /> After the creation of a first peak (the left shoulder), the price action rebounds modestly before continuing lower to create a lower low (the head). The price then again rebounds to a level similar to where the first rebound was finished, creating a base for the neckline to be drawn.  What follows is another pullback to create a third low (the right shoulder), before the price action finally bursts higher, breaking the neckline resistance, and activating the inverse head and shoulders pattern.    <h2>Strengths and weaknesses</h2> Both versions of the pattern share the same strengths and weaknesses, as they only differ in the context of structure. Arguably, the greatest advantage of the head and shoulders pattern is that it defines clear areas to set risk levels and profit targets.  Due to its design, the pattern offers a clearly defined<a href="https://www.thinkmarkets.com/en/learn-to-trade/intermediate/stop-losses-and-take-profits/"> stop loss, take profit,</a> and entry levels. A trader should only follow the set of rules (described below) and make sure that they don’t “jump the gun” and enter a trade before the neckline is broken.  It's extremely important to stress that both the inverse and the traditional head and shoulders patterns only occur at the bottom of an uptrend or downtrend. This is a common mistake traders and analysts make. It doesn’t matter that you drew a perfect head and shoulders pattern, if there is no prior uptrend or downtrend as both versions are reversal patterns.    The key limitation of the head and shoulders pattern is that a strong trend sometimes causes the price action to continue in the same direction despite the third peak/low being a lower high or higher bottom. In this case, the head and shoulders, or inverse head and shoulders, are seen as continuation patterns as the prevailing trend has resumed after taking a short break. <h2 dir="ltr">Drawing the pattern</h2> Unlike some other chart patterns, trading the success of the head and shoulder formation rests very much on how well you draw the initial pattern. As outlined earlier, this pattern offers a set of predefined levels, as you are actually trading against the neckline. Thus, drawing the pattern and identifying three key elements is the crucial part of the entire trading process.  The daily chart of USD/CAD shows a head and shoulders pattern that helps reverse the direction of a trend. The price action pushes higher, creating three consecutive peaks with the right shoulder slightly lower than the left shoulder. Still, there are two clear peaks on each side of the centre peak, with a slightly ascending trend line connecting two shoulders.  <img alt="" src="/TMXWebsite/media/TMXWebsite/head-and-shoulders-pic-3.jpg" /> You can see that we started in an aggressive uptrend and finished the pattern in a downtrend, with the bears ultimately erasing more than half of the earlier gains. A similar situation occurs with the inverse head and shoulders pattern lower. This is a NZD/USD daily chart where the sellers are pressing the price lower, creating a series of lows. The head is represented by a series of similar lows, while the two shoulders are sitting on each side of the head. Although the head usually consists of a single peak/low, we can also have rounded lows or peaks, as long as there are shoulders visible on each side of the head. <img alt="" src="/TMXWebsite/media/TMXWebsite/head-and-shoulders-pic-4.jpg" /> You can see that the NZD/USD pair creates a new short term low (the lowest low of the head) before pushing higher to create a series of the higher lows before eventually surging higher above the neckline.    <h2>Trading the head and shoulders pattern</h2> We stated earlier that possibly the greatest advantage of this formation is that it offers precisely defined levels. The key is a neckline due to the three reasons:   <ol> <li>A break of the neckline activates the pattern. Before the neckline is broken, we consider the pattern to still be in the making. </li> <li>A neckline defines the stop loss i.e. after the breakout, any reverse move to the other side of the neckline activates the stop loss and automatically invalidates the pattern. </li> <li>A distance between the neckline and the head is measured to calculate the take profit. </li> </ol>   We will now use the same two examples to give you a step-by-step guide on how to trade the head and shoulders and inverse head and shoulders patterns. Once we have drawn the pattern and identified three key elements of the formation, we monitor the “draft” pattern closely and wait for the bears to potentially break the neckline and activate the formation. There are two options for the head and shoulders pattern as far as the entry is concerned.  <img alt="" src="/TMXWebsite/media/TMXWebsite/head-and-shoulders-pic-5.jpg" />   The first option offers you a chance to enter a short trade as soon as the neckline is broken and the daily candle closes below the broken neckline. This option means that you can’t miss a trade.  However, this one is also riskier as this move lower can easily prove to be a failed breakdown. In this case, your stop-loss would be activated almost instantly.  The second option is prefered by the majority of the trading community. It's based on an idea that you should make an entry after the price action closes below the neckline and the breakdown is confirmed. Accordingly, the buyers will then push the price action to retest the neckline, the so-called “throwback”, before resuming lower. Thus, you should place the entry when the throwback occurs. Of course, the price action can still return above the neckline, however, the chances are smaller than with the first option. The limitation of the second option is that the price action can simply resume lower without performing a throwback i.e. a retest of the neckline is not guaranteed (see example 2 lower). USD/CAD closed below the neckline on a daily basis, then the buyers pushed the price higher the next day, before ultimately sliding lower. From the risk-reward perspective, this is a perfect scenario as you are given the opportunity to enter a trade on the retest.  Wherever you decided to place the entry, the stop-loss should be located above the neckline. You are advised to always allow for a cushion between the stop-loss and a neckline. As you can see in our example, the buyers were able to trade briefly above the neckline before getting rejected.  The take profit is calculated by measuring the distance between the head and a neckline (the green line), and then copy-pasting the same trend line starting from the neckline and extending lower. This way, you define the exact point at which the head and shoulders pattern should be completed.    Finally, our entry is at $1.2820, stop loss around $1.2860, while a take profit order is set at $1.2550. Hence, we risked 40 pips to make 270 pips, which is a phenomenal risk-reward ratio and the best evidence as to why the head and shoulders is such an effective reversal pattern.    We now move to our second example by explaining how to trade the inverse head and shoulders. In essence, we follow the same set of rules. Once we have drawn all the key elements, we are waiting for the NZD bulls to push the price higher. <img alt="" src="/TMXWebsite/media/TMXWebsite/head-and-shoulders-pic-6.jpg" /> Earlier we discussed two options available to set your entry. This example belongs to the second option and it perfectly shows why this is a riskier option. As you can see, the bulls never returned to retest the broken neckline once the breakout occured. Hence, if you had opted to wait for a retest, you’d have missed the trade.  By choosing the first option, you’d enter a trade once the daily close above the neckline has been secured. The stop loss is again placed below the neckline, while the blue line measures the distance for a take profit order. A few weeks later, the inverse head and shoulders pattern is completed. In this case, we risked 70 pips to gain around 200 pips, which makes a nearly 1:3 risk-reward ratio, meaning this was a very good setup from the risk tolerance perspective.

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Forex Indicators and patterns

The Descending Triangle Candlestick Chart Pattern

The descending trendline is a bearish candlestick formation that occurs in a mid-trend. It usually takes place in a downtrend, and it signals that the impending breakdown will continue the overall downtrend. Similarly to the ascending triangle, the bearish triangle pattern consists of two simple trend lines that connect the lower highs and the horizontal support.   In this blog post we will discuss how the descending triangle is created, what the message that the market sends is, as well as share tips on a simple, but effective trading strategy based on descending triangles. <h2>What the Descending Triangle Shows Us</h2> As illustrated below, the descending triangle is a bearish continuation chart pattern. The price action trades in a clear downtrend, as there is a series of the lower lows and lower highs. The sellers, who are in control of the price action, take a temporary pause to consolidate their most recent gains before extending the downtrend lower.    Descending triangles usually take place in a mid-trend, as there is a first part of the trend - the start of a downtrend, while after the consolidation phase there is a continuation of the overall trend. Therefore, the descending triangle is usually in the middle of a bigger trend that helps the sellers to extend the downtrend. <img alt="" src="/TMXWebsite/media/TMXWebsite/the-descending-triangle-pattern-pic-1.jpg" />   Consolidation of the price action takes form in the context of a descending triangle. Two trend lines, that connect the lower highs and the horizontal support, converge until they intersect. The narrower the space between the two lines is, the stronger the breakout usually is. There are three key features of a descending triangle: <ul dir="ltr"> <li>Strong trend - In order for the descending triangle to exist in the first place, the price action must stem from a clear downtrend;</li> <li>Temporary pause - This element refers to the consolidation phase, which will help the sellers to consolidate their strength;</li> <li>Breakout - The break of the lower flat line marks the breakout, which activates the pattern. It also helps us determine the entry, take profit, and stop loss at a later stage.</li> </ul> Given that the descending triangle is a bearish formation, the likelihood of the trend continuing lower is higher than the chance of a reversal taking place. In this regard, the descending triangle acts as a conductor, or a tool for the sellers to help extend the downtrend.  Even the most aggressive moves in trading don’t occur in the vertical fashion. The dominant side, in this case sellers, need some breathing space to regroup for another push lower. These temporary pauses can take different forms, with the descending triangle being one of them. <h2>Strengths and Weaknesses</h2> The descending triangle shares the same set of strengths and weaknesses as the ascending triangle. As outlined earlier, it helps us define the trading environment as two trend lines provide us with levels to play against.  Although a failed break of the triangle to the downside can always happen, the likelihood of the trend continuing in the same direction is always higher than the reversal. For this reason, descending triangles are an effective tool that helps us better position our entry, take profit, and stop loss.  Contrarily, the failed breakouts are the biggest weakness of a descending triangle. The price action may breakout, and even close below the lower trend line, but still return to the inside of the triangle. In order to minimize the chance of a failed breakout, it is always advised to consult other <a href="/trading-academy/forex/analysis/rsi-indicator">technical indicators</a><a href="/trading-academy/forex/analysis/technical-indicators-beginners-guide"> </a>and confirm the breakout e.g. volume, <a href="https://www.thinkmarkets.com/en/learn-to-trade/indicators-and-patterns/indicators/relative-strength-index-rsi-indicator/">RSI</a> etc. <h2>Spotting the Descending Triangle Pattern</h2> We said earlier that the descending triangles usually occur in the mid-trend, as this helps extend the downtrend. In the chart below, EUR/USD trades lower in a continuous manner. You see that after a series of the lower lows, the price action makes two equal lows, allowing for the supporting trend line to be drawn.  Still, the sellers do not allow the buyers to break the series of the lower highs, which continues until the two trend lines come close to intersecting. Just before this happens, the sellers are successful in breaking the triangle to the downside, therefore securing a continuation of the downtrend. <img alt="" src="/TMXWebsite/media/TMXWebsite/the-descending-triangle-pattern-pic-2.jpg" />   Spotting the descending triangle is very straightforward and easy. The first step should be associated with identifying the downtrend. After that, you should be looking for at least two equal, or close to equal, lows that help draw the flat supporting line, while the opposite trend line should be extending lower to reflect the lower highs.  It is important to note that the lower trend isn’t always completely flat, as it is difficult to expect precise levels from volatile markets. As long as the lower trend line is nearly flat, we consider it legitimate. The break of this line marks the activation of the descending triangle pattern and the moment when we consider entering the market to capitalize on the next leg lower. <h2>Trading the Descending Triangle Pattern</h2> One of the biggest advantages of the descending triangle pattern is that it helps to format our trade as the breakout nears. A break of the supporting line activates the pattern and offers us two options for entry, as it is the case with all candlestick chart patterns.   We can either dip into the market immediately after the breakout candle closes, or wait for a potential throwback. We see that in this case the throwback - a retest of the broken trend line - never occurred. Hence, the end result proved that we only had a single chance to capitalize on the move lower. <img alt="" src="/TMXWebsite/media/TMXWebsite/the-descending-triangle-pattern-pic-3.jpg" /> Hence, the black horizontal line reflects the entry taken immediately after the breakout candle on the hourly chart closed. We said earlier that a move back to the inside of the triangle signals a failed breakout and invalidates our pattern. For this reason, we place the stop loss above the broken trend line to protect our capital and limit potential losses.  The take profit is measured by calculating the distance between the two trend lines when the triangle was first formed. The same line is then copied from the level where the breakout occurred, while the other end of the trend line signals a level where the pattern is completed. In our case, the take-profit order (the green line) was hit quite quickly as the sellers moved the price action lower without much resistance from the buyers. Finally, we booked 125 pips while we risked 45 pips on the other hand, which makes a very profitable R:R ratio of almost 1:3.

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Forex Indicators and patterns

Fibonacci ratios

The Fibonacci ratios commonly used are 100%, 61.8%, 50%, 38.2%, 23.6% - these are shown as horizontal lines on a chart and may identify areas of support and resistance. These levels are created by drawing a trend line between two extreme points and diving the vertical distance by the key Fibonacci ratios. These extreme levels are known as the recent swing high and swing low,  To identify the Fibonacci levels for an uptrend, click on the swing low and draw the trend line to the swing high. In a down trend you simply reverse the trend line. The following chart shows the Fibonacci levels on price which is in an uptrend. <img alt="Fibonacci Retracement" src="/TMXWebsite/media/TMXWebsite/Fibonacci-Retracement.png" style="vertical-align: middle;" /> As you can see on the chart, we have plotted the Fibonacci levels by clicking on the swing lows at 1.000 and swing highs at 1.14. The Fibonacci levels plotted show where price travels to and reverses, and are evident at the 61.8%, 38.2% and 23.6% levels. The 61.8% level is a common support level, as in the above example you can see the price has tested this level on many occasions. More recently, you can see where the price broke through the 38.2% level and retested this level. In this example there’s an expectation for the currency pair to test the 23.6% level at 1.11. The next chart shows the Fibonacci ratios plotted for the pricing action in a down trend.  As you can see, we’ve drawn a trend line from the swing high at 1.1037 to the swing low at 1.0994. Again, you can clearly see where the price reversed at key Fibonacci levels such as the 50% and 23.6% levels. <img alt="Fibonacci Retracement" src="/TMXWebsite/media/TMXWebsite/Fibonacci-Retracement-2.png" style="vertical-align: middle;" /> Fibonacci levels are by no means fool proof – they’re not areas where you would buy and sell from. You should look at them as areas of interest – an indication of where the price may go to in the future.   <h3>Combining Fibonacci ratios with support and resistance</h3> Fibonacci ratios can be subjective, but can also be used to identify key support and resistance levels. A potential way to use the Fibonacci levels is to spot potential support and resistance levels, and see if these levels line up with the Fibonacci levels. If you do spot these levels, the chances of the price bouncing off them are higher. <img alt="Fibonacci Retracement" src="/TMXWebsite/media/TMXWebsite/Fibonacci-Retracement-and-Support.png" style="vertical-align: middle;" /> As you can see from the chart, the key Fibonacci levels 61.8% and 38.2% have been areas of support and resistance previously, and by identifying this on the chart, these levels can potentially be areas where you could enter the market. With traders looking at the same support and resistance levels, there’s a good chance that there will be a number of orders around those levels.

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Forex Indicators and patterns

Timezones and liquidity

<h2>Forex market hours and liquidity</h2> With indices, shares and most other financial products that are traded on various global exchanges, you can only make trades during the exchange’s business hours. Fortunately for forex traders, currencies are free of this restriction and can be traded day or night, with the forex market hours being open 24 hours a day, 5 days a week. <h2>Capturing trading opportunities around the clock</h2> Because the Forex market does not have a physical location or a central exchange, it is considered an Over-the-Counter (OTC), or "Interbank", market due to the fact that the entire market is run electronically, within a network of banks. This means that you can place trades through your broker 24 hours a day and trade at a time that’s convenient for you. Below you can see a 24 hour period which shows the active trading sessions of the Interbank and Retail FX markets, using London as the time zone as this is the central hub to Forex trading. <h2>Nylon session</h2> The highest volume of trading activity happens during the London session (as it also has Europe as well) but liquidity is at its highest when New York opens and overlaps with the London session. This is referred to as the ‘Nylon’ session (New York and London) when liquidity and trading volume is at its highest. Therefore we can expect larger moves and is an ideal time to trade breakout strategies. This is a popular time for intraday traders to participate as due to the higher volume and liquidity, spreads are at their tightest so transaction costs for the traders is lower. <img alt="timezones" src="/TMXWebsite/media/TMXWebsite/timezones_1.png" />   <h2>Asia Session</h2> Whilst New York and London are considered important trading centres the same can also be said for Tokyo, Hong Kong and Singapore. As London and New York banks close their official trading sessions, the Asian banks open and trade which is why Forex is seen as a 24 hour market. However the volume is not as high as the Nylon session which means we tend to see smaller price movements and wider spreads.   <h2>24-liquidity cycle</h2> The visually show you the changes in liquidity around a 24 hour period the chart below has a 14 period ATR indicator (Average True Range). This is a proxy for volume and each horizontal line represents 24hrs. We can see that during the Asian session volume and liquidity is at its lowest and increases when Europe and London opens, with the peak during the Nylon session. Whilst it is not precise to the hour or minute I hope this demonstrates the daily cycle of increasing and decreasing volume. <img alt="timezones" src="/TMXWebsite/media/TMXWebsite/timezones_2.png" />

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Forex Indicators and patterns

What are bullish and bearish Pennant patterns?

Pennants are another type of multi-candle chart pattern. Like <a href="/trading-academy/forex/analysis/bear-bull-flag-pattern">Flag formations</a>, bullish and bearish Pennants are continuation patterns indicating that the prevailing trend will likely continue after a brief pause.  <h2>Bullish Pennant chart Pattern structure</h2> A bullish Pennant pattern has a very similar structure to a bullish Flag – a pole, a body (pennant) and a breakout. The main difference is that while the Flag’s body is made of candles trading strictly within two parallel trendlines, the Pennant’s body looks more like a triangle.  <img alt="A bullish Pennant chart pattern" src="/TMXWebsite/media/TMXWebsite/A-bullish-Pennant-chart-pattern.png" /> In general, to be considered valid, bullish Pennant patterns need to have the following characteristics: <ul> <li>A bullish flagpole with higher highs and higher lows; </li> <li>A consolidation phase that takes place between the two converging trendlines;</li> <li>A breakout through the upper line.</li> </ul> <h2> Bearish Pennant chart Pattern structure</h2> A bearish Pennant is a continuation pattern that resembles a bearish Flag as well, following the same logic – its body has the shape of a pennant instead of a flag.  <img alt="A bearish Pennant chart pattern" src="/TMXWebsite/media/TMXWebsite/A-bearish-Pennant-chart-pattern.png" /> The main characteristics of this pattern are: <ul> <li>A strongly bearish flagpole with lower highs and lower lows; </li> <li>A relatively short body between the two converging lines; </li> <li>A breakout through the bottom line. </li> </ul> <h2>How do Pennant chart patterns work? </h2> Both bullish and bearish Pennants can show us that the dominant power on the market had enough strength to push the price in their favour and create a trend. At some point, it weakens, allowing the opposing power to test its resistance, which sends the price sideways, bouncing back and forth between the two trendlines.    Eventually, the previously dominant power consolidates its efforts to resist the attempts of price reversal and pushes for the trend’s continuation.  If the breakout in any of the two Pennants happens in the opposite direction invalidating the pattern, it means that the dominant power lost its ground, and the trend may reverse.  <h2>How to trade with Pennant chart patterns</h2> The first step in a trading strategy with Pennants is to wait for the pattern to be completed. This means that you need to be able to identify a clear breakout – the last element of the pattern. Once you have all the elements in place – you can open a position. <h3>Trading with a bullish Pennant pattern</h3> As a bullish Pennant suggests a continuation of an upward price movement, traders usually go long once they spot this formation.  On the image below, you can see a clear example of a bullish Pennant chart pattern.   <img alt="Trading example with a bullish Pennant pattern" src="/TMXWebsite/media/TMXWebsite/Trading-example-with-a-bullish-Pennant-pattern.png" /> In this case, a rule of thumb for opening a position is to set the closing price of the breakout candle as an entry level and its opening price as a stop loss. However, if the opening price is just at the boundary of the breakout point, a stop should be placed slightly below this point. The general idea is that the price should not trade deeply into the pattern - if this happens, the pattern will fail, and the trader will generate a loss.   For a target take-profit level, you can visually copy-paste the Pennant’s flagpole and place it at the breakout point. The end of it is where the uptrend will likely pause, stop or reverse.  Risk-averse traders usually wait for one more bullish candle to close after the breakout to confirm the trend. This can mean a missed trading opportunity on the one hand, but on the other hand, it can prevent risk should the price move downward instead. The drawback with this approach is that the risk-to-reward ratio will be inferior. <h2>Trading with a bearish Pennant pattern</h2> A bearish Pennant works exactly the same way but in reverse. As a continuation chart pattern, it suggests a resumption of a downward price movement. Once the pattern is confirmed, traders tend to go short.  The image below illustrates a bearish Pennant formed in a chart with a clear breakout through the bottom trendline.   <img alt="Trading example with a bearish Pennant pattern" src="/TMXWebsite/media/TMXWebsite/Trading-example-with-a-bearish-Pennant-pattern.png" /> Following a trading example with a bullish Pennant, risk-prone traders can use the closing price of the breakout candle as an entry and its opening price as a stop loss. The target price, or take profit level, can be set by copy-pasting the Pennant’s flagpole to the breakout point.  If you study price charts, you will notice that quite often, the price breaks in the opposite direction – through the bottom trendline in a bullish Pennant or breakout through the upper trend line in a bullish version of it. When it happens, the patterns are considered invalid, as there is no clear indication of the price direction.   That’s why it’s important to keep in mind that Pennant patterns, like any other chart pattern, don’t provide a guaranteed trading signal but only a suggestion. Experienced traders use additional tools, such as one- and two-candle patterns or technical indicators, to gain additional insights into the market conditions. It is also important to note that patterns in smaller timeframes, like the 5 or even 30 minute timeframes tend to have a lower success rate compared to a pattern formed on the 4-hour or daily chart.  It can also be helpful to try trading with Pennants in a risk-free demo environment first and move to trading with real money when you gain confidence in your skills. Create a demo account now and start practising. If you want to know more about chart patterns, check out our next article, where we’ll talk about a unique pattern called a Cup and handle.

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