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How to Read the Psychological State of the Market

By   /   January 8, 2013  /   No Comments

The psychological state of Forex markets is not as easy to read or measure as price action. However, by looking at the volume levels in the market and other technical indicators, one can accurately read market psychology and predict collective market behaviour. Forex traders use various indicators to ascertain the market strength. The use of these market indicators, oscillators, currency price charts, and other types of Forex technical indicators offer strong, valuable insights into market trends.

Some of the most popular oscillators for Forex traders include the Moving Average Convergence/Divergence (MACD) technical analysis indicator, the Relative Strength Index (RSI) technical momentum indicator, and the Stochastic Oscillator which is also a technical momentum indicator.

The MACD indicator spots changes in a currency price’s strength, momentum, duration, and direction. It is usually calculated from historical data of currency prices, mostly the day’s closing price. A Forex trader should learn to detect even the subtlest of shifts in a currency price’s trend by comparing the differences to the averages.

The Relative Strength Index (RSI) is a technical momentum indicator used for comparing recent currency gains against recent currency losses with the intention to determine which currencies have either been overbought or oversold. RSI is calculated using the following mathematical formula:

RSI = 100 – 100/ (1+RS*)

Where:

RS = the average of x days’ up closes / Average of x days’ down closes

The RSI ranges from 0 to 100 and a currency is said to be overbought immediately the RSI reaches the 70 level. This means that the currency may be getting overvalued and the shrewd trader should exit the trade at that point. In the same way, when the RSI reaches 30, this should be translated to indicate that the currency may be oversold and therefore may be soon undervalued. Experienced traders should know that large shifts in the price action charts of a currency will affect RSI by creating false trade entry and exit points.

Stochastic Oscillator

A stochastic oscillator is a technical momentum indicator that compares a currency pair’s closing price to the pair’s price action over a stipulated time period. To reduce the oscillator’s sensitivity to market movements, one may reduce the time period under consideration or employ a moving average of the result. The stochastic oscillator indicator is calculated using this formula:

%K = 100 [(C – L14) / (H14 – L14)]

                        Where:

C = the most recent closing price

L14 = the lowest of the 14 previous trading sessions

H14 = the highest traded price of the same 14-day period

The stochastic oscillator indicator works on the premise that in upward-trending markets, prices often close the day at points near their high and the reverse is true in downward-trending markets.

 

 

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