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What is the Best Forex Indicator for Beginner Traders?

10 December 2021 Amega

There are plenty of forex trading indicators out there, but there is no such thing as the best trading indicator for all forex traders. Each has its pros and cons because forex traders need to find an indicator that works well for their trading style.

What Makes a Forex Indicator “Good”?

As a rule of thumb, a good forex indicator must be simple, effective, and has a broad set of uses so that it allows the forex trader to generate or filter specific trading signals during all market conditions, not just trends.

Although there are numerous indicators to develop a strategy to make profits, one of the most popular forex indicators beginner and advanced traders use today must be somehow ‘universal’.

Is there a “Universal” Indicator?

The simple answer? Yes!

Developed in the late 1970s by Welles Wilder Jr., the creator of momentum and divergence, the RSI has gained a reputation as one of the best indicators available for finding buy and sell signals.

The key to effectiveness is that the RSI values oscillate in relation to each other and measure how quickly forex trades buy and sell a particular instrument, making it one of the least-lagging indicators.

Another thing that separates the RSI from many forex indicators is its simplicity. The RSI has one moving average and two extremes, indicating where there might be exhaustion in bids up or down.

One of the main reasons making the RSI the preferred indicator for technical traders is its ability to identify and then quickly move into the direction of significant price movements.

And it does this regardless of the type of market one trades.

Can the RSI be Used for Success?

When it is used in default, the RSI has good chances of success.

With the momentum oscillator ranging from 0-100%, traders can set the extreme levels at 70% and 30%. Most often, a look 14 periods back finds the best fit. However, the lookback period and the extreme levels can be modified to get the desired results.

Although the RSI calculates the percentage of price change over a set period, making it prone to false signals when used in the short term, there are several reasons why it is most probably the best indicator for beginner traders as it helps in several areas:

Market Type

The RSI tends to follow price reasonably well, which means it follows the trend pretty close.

As there are three general types of markets, sideways, breaking, and trending, the RSI can provide three signals to indicate which kind of market one trades.

When the RSI moves from 50% higher or lower, this can provide an early signal that markets may be entering a trend period – i.e., shifting from a sideways market to breaking and eventually trending.

Often, this type of signal is best used to alert the forex trader of a potential continuation of a breakout rather than a trend trade, as nearly 50% of the breakouts are false.

This somewhat validates a continuation only when the RSI starts heading towards the 60% or 40%, as highlighted below.

Forex analysis | Amega

Trend Direction

Contrary, the RSI line crossing 40% from below, or 60% from above, can be an early indication do a potential trend change. As a rule of thumb, markets are considered a bullish trend above 50% and a bearish trend below 50%.

Many forex traders use the indicator 50%-line as a filter to trade only longs or shorts, depending on whether the RSI is above or below the median value, as seen below.

Forex analysis | Amega

Support and Resistance

As with the market types showing different stages of a trend and how one can take advantage of prices halting or moving in/outside a sideways zone, the three primary RSI levels of 50%, 70%, and 30% can confirm areas of support and resistance, as seen below.

Forex analysis | Amega

Advanced traders use the RSI levels to manage risk. For example, they buy the RSI 30% up to 70% and use the 50% as a protective stop. This applies from the top-down as well. Prices seem to halt at the three primary levels regardless, meaning it provides an excellent mechanism for risk management.

In the following example, a short trader would have been closed out with a trailing stop at the RSI 50% instead of the RSI ~55%, minimizing losses.

Forex analysis | Amega

Price Extremes

With the 50% used as a mean, forex traders can use the overbought and oversold extremes to measure the trend, which in essence provides a figure for exiting in profits, and spot trend reversals as markets will eventually slow down and reverse, either to the mean or back to the other extreme.

In addition, traders that use the 50% as a trailing stop allow the trend to develop as the RSI is a good indicator for identifying and trading ranges and utilised in elongated periods of a movement, as seen below.

Forex analysis | Amega

At the same time, the RSI can trade in the overbought or oversold zones for an extended period. This is when markets trend.

Going Pro?

Pro traders use divergences to decide whether the trend is coming to an end, or few market participants are only pocketing some profits. Without a divergence, the trend is likely to continue, and the line should then oscillate around the overbought or oversold zone rather than retrace back to the mean.

Any Downsides?

As with any other indicator, the RSI has its weakness, too: it cannot be sued to predict future currency movements.
Regardless, you can still get the most from this fantastic free trading tool.

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