Getting Confirmation on Forex Trades

01/12/2010 12:01 am EST

Focus: FOREX

One of the more important points we try to stress to new currency traders at DailyFX is to look for confirmation of a signal to enter into a trade.

This is especially true for technical indicators, which can generate many false signals on their own. The problem is that most of the time, new traders will use one technical indicator to confirm the signal generated by a different technical indicator. But most indicators are really just fancy moving averages, so they have a tendency tell us the same thing, just not always at the same time. 

Here is a daily chart of the NZD/JPY, for example:


Click to Enlarge

The daily trend is up, so we are only looking to buy on a pullback off of a high. On the pullback, we can use a technical indicator to help us time our buy entry into the trade. The first indicator on the chart is the RSI (Relative Strength Index), followed by the slow stochastics, and finally, the MACD (Moving Average Convergence/Divergence). 

We can see that the RSI signaled the buy entry after having moved to above (from below) the value of 30. Next, the slow Stochastics gave the entry on a crossover after having been below 20. 

Then, finally, the MACD gave the entry signal on the crossover. Since they are all based on moving averages, they all gave a signal to buy, but the timing is different. The RSI is usually first, but can sometimes not move to extreme levels to signal an entry, so you might miss some trades. The slow Stochastics will give you more entries than the RSI, which may mean more losing trades. 

Then, the MACD will usually give the signal last, which means not as good an entry as the other two indicators, but sometimes being late means missing losing trades. These are just three of the more popular indicators, but there are many more to choose from. But the point is that you only need one or two to help time your entry. Plotting up to ten indicators to search for that “perfect” entry will usually cause more confusion than certainty. 

So my recommendation is to pick just one or two that you find easy to use. Being able to identify the signal to enter as it is forming is what trading is all about, so keep it simple and consistent to achieve the results you are looking for. 

By Thomas Long of DailyFX.com

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