LESSON 4: TECHNICAL ANALYSIS
Objectives:
If you take this lesson to the end, you will:
1. Understand indicator-based TechnicalAnalysis.
2. Know the best types of indicators to use.
3. Know how to combine indicators.
4. Know how to back test indicators.
Forex Indicators
These are computer programs that functions to show happenings on a chart. There are many types of indicators for different functions. However, we will be dueling majorly on trend indicators.
Choosing Forex Indicators
1. Use good indicators built for Forex.
2. Use Forex indictors that are not too old, because of the dynamic nature of the forex market.
3. Use a combination and settings that works in harmony.
TRADING SYSTEM
This is a system of forex Indicators that serves primarily to detect price movements, measure Trend strength, and show optimal Entry & Exit points (Prices). Our Trading System is made of the following components:
1. The ATR
2. The Baseline
3. 1’ Trend Indicator
4. 2’ Trend Indicator
5. Volume Indicator
6. Exit Indicator.
The ATR
The Average True Range (ATR) is a technical indicator used in Forex (and other financial markets) to measure market volatility. It doesn't indicate market direction but rather how much the price of an asset is expected to move over a given period. The ATR is used to make informed decisions about stop-loss placement, position sizing, and assessing market conditions.
The ATR tells you the average number of pips, top to bottom a currency pair moves per candle. The ATR should come on the chart when the Trade has been entered.
The Baseline
A baseline refers to a central or foundational indicator used to identify the direction of Price movement or market conditions. It acts as a reference point for other indicators. Common Types of Baseline include Simple Moving Average (SMA), Exponential Moving Average (EMA), etc.
1. Go long when the price crosses and closes above the baseline, in agreement with the other components of the Trading System.
2. Go short when the price crosses and closes below the baseline, in agreement with the other components of the Trading System.
Trend Indicators
A trend indicator is a technical analysis tool that helps traders identify the direction of Price movement, whether it is an uptrend, downtrend, or sideways. These indicators are crucial for traders because they provide insight into the prevailing market conditions, enabling them to make informed decisions about entering or exiting trades. A solid understanding of trend indicators helps traders avoid trading against the market. Thus, increasing their chances of success.
Indicators in the form of Zero-line Cross, Two-line Cross and on-Chart Indicators are good Trend Indicators.
Example:
1. Zero-Line Cross Indicators – MACD, Rate of Change, ETC.
2. Two-Line Cross Indicators – ADX.
3. On-Chart Indicators – P-SAR.
Volume Indicators
A volume indicator is a tool that helps traders to understand the strength or weakness of a price movement. It is used to measure the amount of a particular currency pair being traded during a specific time period.
NB: Volume Indicators does not show the direction of Price Movement, It provides insight into the level of activity or market participations. A High volume indicates strong market activity (significant price movements or trends). While a Low volume suggests lower market participation, which may signal a period of consolidation or a lack of conviction in the current price direction.
Why Traders Need Volume Indicators:
Confirmation of Trend Strength: High volume during a price move confirms the strength of the trend, while low volume may signal a reversal.
Early Warning Signs: Volume can signal potential changes in market direction. For example, increasing volume during a downtrend may indicate a reversal or a trend change.
Divergence: A divergence between price and volume can signal a potential price reversal. For instance, if prices are rising but volume is decreasing, it may suggest weakening buying pressure.
Exit Indicators
An exit indicator is a tool or strategy that helps traders determine the optimal point at which to close a position (either a buy or a sell) to lock in profits or minimize losses. Exit indicators are an essential part of a trader's risk management plan, as they provide signals to exit the market at the right time to avoid unnecessary losses or to protect profits from a reversal.
Why Exit Indicators are Important:
Risk Management: Exit indicators help traders minimize losses and lock in profits. Without a clear exit strategy, traders may hold on to losing positions too long or exit too early, missing out on profits.
Trend Reversals: They help identify when the market is losing momentum or a reversal is about to occur, allowing traders to exit before a significant loss.
Psychological Discipline: Having an exit strategy reduces emotional decision-making. Traders are less likely to let greed or fear dictate their actions if they follow a set exit plan.
Back Testing
The process of determining the success rate of an indicator or strategy in order to know whether to, or not to use it. Back-testing can be done manually or using the Strategy tester on your platform.
Manual Back-Testing:
1. Put the indicator on your chart, on default settings.
2. Put on the ATR and record the ATR of the pair.
3. Go back 6months – 2years to see how many entries it gives.
4. If it gives as many pips as the ATR, then it is a success. Record the success rate.
5. Do this to as many indicators as possible and start using the most successful indicator on demo.
6. Record the wins and the losses.
Using the Strategy Tester:
Click on View > Strategy Tester or press Ctrl+R to open the strategy tester.
Choose the expert advisor (EA), currency pair, timeframe, and testing period to back-test your strategy.
Optimize Your Strategy:
Use the "Optimization" feature to find the best parameters for your EA by testing different settings over historical data.
Spreadsheet
1. Pull up a currency pair on MT4 daily chart.
2. Place the indicator to test on the chart.
3. Back test on default before changing the settings.
4. Place the ATR on the chart to record the success rate.
5. Create a spreadsheet by answering the following questions:
a. How many pairs are to be tested?
b. How many times to adjust the settings?
c. What is the sample size?
6. Create a separate spreadsheet for each currency pair
EXAMPLE
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EUR/USD |
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Indicator |
Settings |
Win |
Lose |
Win% |
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Win% = win/win + lose
How to Determine Win or Lose
1. Start from today backwards until the indicator gives a buy or a sell signal.
2. Find the ATR of the pair at the time the signal was given.
3. Find out if price hit the ATR first, or 1.5ATR, in the opposite direction.
a. If price hit the ATR first, it is a win.
b. If the price hits 1.5ATR in the opposite direction first, it is a lose.
4. Do this at every point you have a signal, up to the sample size – number of days to back test.
5. Input the values on your spreadsheet.
6. Repeat the process for every indicator and settings.
Feel free to ask questions in the comment, or send us a mail at morepipztraders@gmail.com
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