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Bollinger bands consist of three lines. It is a statistical approach to Forex trading. Upper and lower lines are two standard deviations above and below a 20-day exponential moving average. Standard deviation is a statistical measure of volatility. These bands area always adjusting: widening during volatile markets (market are volatile when a there is a lot of price action) and contracting during non so volatile market periods.

Using two standard deviations ensures that 95% of the price data will fall between the two Bollinger bands. This is the statistical meaning of the two standard deviations. Prices are considered to be overbought, or better, statistically overextended to the upside when they touch the upper band and oversold or overextended to the downside when they touch the lower band.

One could use the upper and lower bands as price targets. If price bounces off the lower band and crosses above the 20 day average then the upper band becomes the upper price target and vice versa.

In a strong uptrend prices tend to fluctuate between the upper band and the 20 day moving average. A crossing of the 20 day average warns of a possible reversal to the downside.
A move that originates at one band tends to go all the way to the other band. This observation is useful when projecting price targets. The figure below (Figure 5.11) shows the use of Bollinger Bands in real market. Study carefully Bollinger Bands. They are one of the most useful tools in live trading.

Illustration of a chart with Bollinger Bands

Stochastic Oscillator consists of two lines that oscillate between a vertical scale of 0 to 100. %K is the main line. It is moving faster that %D line. %D line is the second line and is a moving average of %K.

Stochastic works better in broad trading ranges or in a mild trend with a slight upward or downward bias. The worst market for normal use of stochastic is a persistent trending market that has only minor corrections. Although, one could trade stochastic by ignoring the usual overbought and oversold levels and entering the market when the end of a reaction against the trend is signaled by a crossover from any level.

There are three ways to interpret the Stochastic Oscillator:

1)Buy when the oscillator (%K or %D) falls below 20 and then rises back above that level. Sell when oscillator rises above 80 and then falls below that level. Extra caution: If the oscillator reaches the extremes of the scale it should not be interpreted that the currency will necessarily reverse in the immediate future. It will indeed reverse but it may be between the next day and several days after. Unfortunately with stochastic it is impossible to know the time interval between the signal appearance and the price reversal.

2)Buy when the %K line rises above the %D line and sell when the %K line falls below the %D line. (crossovers)

2)Look for the classic divergences, that is prices making new highs as the stochastic oscillator fails to surpass the previous highs.

Slow stochastic oscillator is using a technique to smooth the lines reaction in an attempt to reduce volatility and improve signal accuracy. This oscillator is most popular among traders because it provides less but more accurate trading signals.

Illustration of stochastic oversold level and crossover

Illustration of stochastic divergence

MACD displays the correlation between a 26-day and 12-day exponential moving average. In addition there is a 9-day exponential moving average (which is the signal or the trigger) line plotted on top.There are three most used ways to trade the MACD
 Crossovers: sell when the MACD falls below its signal line and buy when the MACD rises above it. One could also buy or sell when the MACD goes above or below zero.
 Overbought or oversold areas: if the shorter moving average pulls away dramatically from the longer moving average and the MACD rises it is likely that the price is overextended and will soon return to more realistic levels
 Divergences: the end of the trend may be near when MACD diverges from the price of a currency pair. A bullish divergence occurs when the MACD is making new highs while the price fails to follow. A bearish divergence occurs when the MACD is making new lows while prices fail to follow. These divergences are most significant when they occur at relatively overbought or oversold levels, that is after extended market moves

Illustration of a MACD crossover

Illustration of MACD divergence

Illustration of MACD overbought area and crossover

Moving averages provide the average of the price action over time. There are three types of moving averages:
 Simple moving average(SMA)
 Linearly weighted moving average(WMA)
 Exponential moving average (EMA)

The time period of these averages that most people take into account is 4, 9 and 18 days for day traders and 20, 40, 100 and 200 days for longer term trading.

Select exponential moving average from your charting service. Give the charting package the above values and see the result. You have three moving averages in your chart. Look the figure below. We have a 10 day moving average (blue line), 20 line moving average (pink line) and 40 moving average (green line)

Longer term moving averages especially 100 and 200 days often act as strong resistance or support for the price. Look the figure below and notice how market respected 100 (blue line) and 200 day (pink line) moving averages as support lines.

Looking closer we may notice a head and shoulder pattern evolving and having as neckline the 100 day moving average. Isn’t it beautiful? When you will practice what you will learn in this book a new beautiful world will evolve in front of your eyes in the previously “desert” charts that seemed confusing.

When a shorter period moving average intersects a longer period moving average you may take this into account for a possible trend reversal hint. Look the first figure. The shorter period moving average (blue) intersected pink line (20 day moving average) and then green line (40 day moving average). This signaled that the previous trend changed and this trend reversal continued until the shorter moving average intersected upwards this time the longer moving average at the right end of the figure.

Moving averages are lagging indicators. Price takes action and moving average follows.
Some people are using moving averages extensively and design trading systems based solely on them.

RSI is a popular oscillator. It measures relative changes between the higher and lower closing prices. Its author used 14 days but a 9 day period is most popular today.
RSI can be used as an overbought/oversold indicator. Levels of 70 or more (bearish signal) are overbought and 30 or less (bullish signal) are oversold.
RSI’s advantage unfolds using it as a divergence indicator. If the price is making new highs but RSI fails to surpass previous high this may be an indication of a forthcoming reversal. When the RSI then turns down and falls below it most recent trough it is said to have completed a “failure swing” which serves as a confirmation of the forthcoming reversal.

Illustration of RSI divergence

Illustration of RSI overbought levels

Illustrations of RSI oversold levels

Watch the video to visualize the use of RSI divergence.