170# GBP/USD, GBP/JPY Scalping

4 types of indicators FX traders must know. By Troy In the end, forex traders will benefit most by deciding what combination (or combinations) fits .

When the current smoothed average is above its own moving average, then the histogram at the bottom of Figure 3 is positive and an uptrend is confirmed. Conversely, a trader holding a short position might consider taking some profit if the three-day RSI declines to a low level, such as 20 or less.

Indicator No.1: A Trend-Following Tool

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But how reliable is that indicator? As mentioned earlier, trend-following tools are prone to being whipsawed. So it would be nice to have a way to gauge whether the current trend-following indicator is correct or not. For this, we will employ a trend-confirmation tool. Much like a trend-following tool, a trend-confirmation tool may or may not be intended to generate specific buy and sell signals.

Instead, we are looking to see if the trend-following tool and the trend-confirmation tool agree. In essence, if both the trend-following tool and the trend-confirmation tool are bullish , then a trader can more confidently consider taking a long trade in the currency pair in question.

Likewise, if both are bearish , then the trader can focus on finding an opportunity to sell short the pair in question. One of the most popular — and useful — trend confirmation tools is known as the moving average convergence divergence MACD. This indicator first measures the difference between two exponentially smoothed moving averages. This difference is then smoothed and compared to a moving average of its own.

When the current smoothed average is above its own moving average, then the histogram at the bottom of Figure 3 is positive and an uptrend is confirmed. On the flip side, when the current smoothed average is below its moving average, then the histogram at the bottom of Figure 3 is negative and a downtrend is confirmed.

In essence, when the trend-following moving average combination is bearish short-term average below long-term average and the MACD histogram is negative, then we have a confirmed downtrend. When both are positive, then we have a confirmed uptrend. At the bottom of Figure 4 we see another trend-confirmation tool that might be considered in addition to or in place of MACD.

It is the rate of change indicator ROC. As displayed in Figure 4, the red line measures today's closing price divided by the closing price 28 trading days ago. The blue line represents a day moving average of the daily ROC readings. Here, if the red line is above the blue line, then the ROC is confirming an uptrend.

If the red line is below the blue line, then we have a confirmed downtrend. After opting to follow the direction of the major trend, a trader must decide whether he or she is more comfortable jumping in as soon as a clear trend is established or after a pullback occurs. In other words, if the trend is determined to be bullish, the choice becomes whether to buy into strength or buy into weakness. If you decide to get in as quickly as possible, you can consider entering a trade as soon as an uptrend or downtrend is confirmed.

On the other hand, you could wait for a pullback within the larger overall primary trend in the hope that this offers a lower risk opportunity. There are many indicators that can fit this bill. However, one that is useful from a trading standpoint is the three-day relative strength index , or three-day RSI for short. This indicator calculates the cumulative sum of up days and down days over the window period and calculates a value that can range from zero to If all of the price action is to the upside, the indicator will approach ; if all of the price action is to the downside, then the indicator will approach zero.

A reading of 50 is considered neutral. Generally speaking, a trader looking to enter on pullbacks would consider going long if the day moving average is above the day and the three-day RSI drops below a certain trigger level, such as 20, which would indicate an oversold position. Conversely, the trader might consider entering a short position if the day is below the day and the three-day RSI rises above a certain level, such as 80, which would indicate an overbought position.

Different traders may prefer using different trigger levels. In fact, the three-day RSI can also fit into this category.