A technical indicator is a mathematical formula that can be applied to price and volume data, and it can also be used on other technical indicators. The outcome is a value that helps forecast future price changes. Technical indicators are the wavy lines displayed above, below, and alongside price data on a chart. Forex traders who utilize technical analysis often rely on these indicators.

Technical indicators provide a different viewpoint for analyzing the strength and direction of the underlying price movements. By examining historical data, technical analysts employ indicators to predict future price trends. A technical indicator can fulfill three roles: it can alert traders when a specific condition is met, forecast the direction of price movements, and confirm analyses suggested by current price action or other technical indicators.

Technical indicators fall into two main categories: leading indicators and lagging indicators. Leading indicators provide trade signals indicating that a trend is about to begin, while lagging indicators follow the price action. Leading indicators aim to predict price movements by using shorter time frames in their calculations, which allows them to lead price changes. Popular leading indicators include MACD, RSI, and Stochastic, which typically assess how "overbought" or "oversold" an asset is, based on the assumption that an "oversold" asset will rebound.

On the other hand, lagging indicators signal after a trend or reversal has commenced. The most common lagging indicator is the Moving Average. These indicators do not alert traders to impending price changes; instead, they indicate current price movements (whether rising or falling) to inform trading decisions. While lagging indicators may result in late buy and sell signals, they significantly reduce risk by keeping traders aligned with market trends. Generally, lagging indicators are best used in trending markets, while leading indicators are more effective in sideways markets.

Technical indicators can be categorized based on their placement on a chart into two types: overlays and oscillators. Overlays are technical indicators that share the same scale as prices and are plotted directly over the price data on a chart. Examples include moving averages and Bollinger Bands. Oscillators, on the other hand, fluctuate between a local minimum and maximum and are plotted above or below the price chart. Examples of oscillators include MACD, RSI, and Stochastic.

There are four main types of technical indicators: trend-following, momentum, volatility, and volume.

Trend-Following Indicators

Trend-following indicators assist traders in identifying currency pairs that are either trending upward or downward. These indicators help determine the trend's direction and confirm its existence. They measure the trend's direction and strength through some form of price averaging. When the price exceeds the average, it indicates a bullish trend, while a price drop below the average signals a bearish trend. Examples of trend-following indicators include moving averages, which identify current trends and support/resistance levels; MACD, which reveals changes in trend strength, direction, momentum, and duration; and Parabolic SAR, which identifies potential price reversals.

Momentum Indicators

Momentum indicators help gauge the speed of price movements by comparing current prices to previous ones, and they can also analyze volume. These indicators are calculated by comparing the current closing price to earlier closing prices, often appearing as a line below the price chart that oscillates with momentum changes. A divergence between price and a momentum indicator can signal a potential change in future price direction. Examples of momentum indicators include Stochastic, which shows the closing price's position relative to the high-low range over a set period; CCI, an oscillator that identifies cyclical turns or trend reversals; and RSI, which measures a currency pair's strength or weakness by comparing its upward and downward movements over a specified timeframe.

Volatility Indicators

Volatility indicators assess the rate of price movements, regardless of direction, typically based on changes in historical high and low prices. They provide valuable insights into the range of buying and selling activity in a market and help traders identify potential reversal points. Examples of volatility indicators include Bollinger Bands, which help determine whether prices are relatively high or low; Average True Range, which measures volatility while accounting for price movement gaps; and Standard Deviation, a statistical measure of market volatility that assesses how widely prices deviate from the average price.

Volume Indicators

Volume indicators evaluate the strength of a trend or confirm a trading direction through some form of volume averaging or smoothing. Strong trends often coincide with increasing volume. Examples of volume indicators include Chaikin Money Flow (CMF), which measures the volume-weighted average of accumulation and distribution over a specified period, based on the principle that a closing price closer to the high indicates more accumulation; On Balance Volume (OBV), which tracks buying and selling pressure as a cumulative indicator that adds volume on up days and subtracts it on down days; and Volume Oscillator (VO), which shows the difference between two moving averages of a security's volume expressed as a percentage, operating on the premise that changes in volume relative to the recent past hold more technical significance than the actual volume level.

No technical indicator is infallible. To reduce false signals—instances where price movements deviate from what the indicator suggests—traders often combine a technical indicator with other "tests" or additional indicators to enhance reliability. This process is known as waiting for "confirmation" of the signal generated by the technical indicator. The supplementary tests are referred to as "filters." Common filters can be categorized into three types: time, where the signal must persist for a specified duration (e.g., a 50-day moving average must remain above a 200-day moving average for at least three trading days); magnitude, where the signal must fall within a specific range (e.g., an oscillator must exceed 80% or drop below 20%); and volume, where indicators tend to carry more weight when based on higher volume.

Some indicators perform better over particular time horizons, so it is wise to select those that align with your trading timeframe. The frequency of trading signals is another consideration; day traders typically prefer indicators that generate numerous signals daily, while swing traders may seek fewer signals. Combining indicators with price action analysis often results in fewer signals and lower trading costs. Always keep in mind that technical indicators are merely indicators; they do not guarantee a specific price movement. With technical analysis, it is often unclear whether a trend reversal is genuine or false until after the fact. Therefore, analyzing charts across multiple time frames is advisable to provide context for your assessments.