Simply defined, forex signals are suggestions that traders can use to make a decision to execute a deal in a particular currency pair. In addition to the currencies to be traded, such signals also typically specify a time, an exchange rate and a direction for the suggested trade’s execution.
Many technically minded currency traders strongly prefer the objectivity that trading using forex signals can provide. The following sections describe some of the advantages of using such trading signals and some examples that other traders have used in the past.
Trading With Signals Helps Eliminate Emotional Trading Errors
Many novice currency traders watch their portfolios fall victim to various common errors that can occur as a result of their natural emotional responses to making and losing money.
Using their own technical analysis or a professional signal service to generate fx signals that tell them exactly when to enter or exit positions can really help such traders eliminate potentially problematic emotional responses that can be the downfall of many forex market speculators.
Once a successful signal generation system has been established and tested, they simply need to develop the discipline to trade whenever that system gives them a signal.
Signal Trading Systems can Often be Back-Tested
Another advantage of trading with signals is that a particular trading strategy can usually be back tested over historical data to determine how successful it would have been if used over that time period.
Although the past is not always a good predictor of the future, this testing method allows technical traders to choose between different trading systems based on which would have been the most profitable.
Back testing can also allow traders to optimize their signal generating systems’ profitability based on an acceptable maximum drawdown level or to select a system that comes as close as possible to the ideal scenario of a system with minimal drawdowns and consistent profitability over time.
Signal Trading System Examples
Although most forex signal generating services are black boxes due to their proprietary nature, traders can use various well known technical analysis techniques to generate their own trading signals.
For example, they can use crossovers between a short term moving average and a longer term moving average to generate signals. When the short moves above the long MA, it signals a buy, and when the short MA moves under the long, it signals a sell.
Another classic trading signal is generated by the Relative Strength Index or RSI. When the RSI is in extreme territory — which is considered overbought above 70 and oversold below 30 — then watch for the exchange rate to make a new extreme level without the RSI doing the same. This sort of divergence reliably signals that a counter-trend position could be taken in that currency pair.
Traders can also use combinations of signals generated by several different technical indicators to give them even more selective trading signal results, which can have a better chance to yield a successful trade.