How do forex signals work and what are they?
A forex signal is one or several markers that indicate to a trader when or how to act on a specific currency price movement. Trading signals come in a wide variety of types depending on the system you are using, and could be, for example, geometric shapes, price points or other line trends on a graph. Typically, traders use signals to help them make critical decisions about their trades and are one of the most important tools at a forex trader’s disposal.
Forex trading signals are increasingly based on technical analysis of market prices, plotted using charting tools. Systems based on technical analysis would also take into account historical and current price data, using this information to create charts. Trends are then plotted on the chart that will form the basis of a trading signaling system. However, some signals providers also use fundamental analysis to discern signals. Systems based on fundamental analysis would consider current events and the market’s reaction to them, using this information to set buy or sell signals.
An experienced forex day trader knows how to use a forex signal system consisting of various symbols and signals. It’s all about knowing when they indicate when would be a good time to execute a buy or sell order.
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The benefits of trading signals
One of the major upsides of using forex trading signals is that they lessen the impact of human psychology on the trader’s trading system. As previously mentioned, one of the biggest factors in a trader’s long-term profitability is how well they manage their emotions in response to the gains and losses that come with day trading. Signaling systems lessen the influence of emotions on trading, as it is a way of automating decision making based on technical data and fundamental analysis.
Furthermore, the use of automatic trading signals also greatly increases the speed at which you can trade, as decision making is essentially automated. As such, the use of forex signals is a great option for traders who have yet to make the switch to full-time day trading.
Another way how you can use forex signals is as part of an overall risk reduction strategy. For example, you can use stop-loss signals to prevent incurring unnecessary losses when a trade starts to turn against you, while you can use profit-orders to make the most of favorable market conditions.
While you should avoid trading purely based on emotional reactions most of the time, the downside of taking emotions completely out of your trading strategy means that you have to deal with the inflexibility of an automated computer system. Similarly, you might also prefer manual trading systems, as it gives you time to fully appreciate the implications of executing a trade having used a trading signal.
Manual vs automatic trading signals
Forex trading signals can be either manual or automatic. Manual forex signaling systems refer to those signaling systems that involve you sitting in front of a computer, searching for signals and interpreting whether they indicate that you should execute a buy or sell order. Generally speaking, manual trading signals are provided by individuals with very advanced levels of experience in forex trading. As such, you should be wary of who is providing you with this information and their qualifications to do so. Generally speaking, it would not be advisable for a beginner or intermediate forex trader to use manual signals unless they have very specific experience in what data to look for.
In contrast, an automated signaling system involves the inputting of signal points into a software that will notify you when the markers are hit. This could involve, for example, a minimum or maximum price point or a certain percentage drop from a high to low point.
Individual traders can choose from a range of both automatic and manual trading signal providers, typically in exchange for a monthly or daily fee. You also might sign up for an email or newsletter service that will issue trading signals on a daily or weekly basis.
Types of trading signal indicators
- Technical pattern breakouts or break-downs. These could include various charting patterns such as triangles, rectangles and trendlines.
- Moving averages. This is a form of technical analysis that filters out random fluctuations and presents averages across specified periods of time.
- Volume surges. High trading volume is often considered a precursor to new moves in the market in either a bullish or bearish direction.
- Cycle patterns. This charts the ebb and flow of the market over time, particularly in response to seasonal buying trends.
- Interest rates. Changes in interest rates by central banks will often provoke changing in foreign exchange prices.
- Volatility measures. Measuring market volatility can allow you to spot market changes before they happen.
- Sentiment measures. Market sentiment can be measured from a range of sources that can then be used as the basis of a trading signal. Confident market behavior, for example, can suggest the beginnings of a bullish market.
There is an endless number of possibilities when it comes to formulating different types of forex trading signals, although certain signaling systems have proven more popular than others. Traders follow some of the more well-known signals to get better performance on their portfolios and these signals are known to have alerted traders on a number of significant market shifts.
Common trading signal types
The following signal types are some of the most commonly used by traders:
- This is a call-to-action signal that usually takes the form of a buy or sell instruction to a trader.
- Stop loss. Stop-loss signals provide an exit point for traders and are designed to protect the trader’s capital investment from incurring any further losses. Given their risk management function, stop-loss signals are one of the most frequently used by traders.
- Take profit. In contrast to the stop-loss signal, a take profit order is triggered once a certain profit level is met.
- Current market price. While not a buy or sell order, a current market price signal can be used to automate the gathering of current market information.
Generally, forex signals can be divided into short- and long-term signals. Short-term signals will provide traders with daily and intra-day trading signals that provide guidance for a specific trading day. In contrast, long-term signals are intended for use as part of a longer-term trading strategy, perhaps over the course of several days or weeks. This important distinction emphasizes the fact that forex signals are always time sensitive and that traders should be aware of the time frame within which their chosen signals are intended for use.
Choosing a forex signal provider
One of the most popular ways traders use signals is through the use of a third party. Signal providers can be a great way to reliably get information of how to use forex signals and indicators that you can then implement in your own trading strategies. Consider the following when choosing one:
- The age of the provider. How long they have been trading successfully is a strong indicator and users should be wary of newer signal providers who may lack experience
- Sales jargon and marketing hype. Unrealistic claims and extravagant language may indicate they are more concerned with selling the image of success rather providing a quality service.
- Free trial. It is always recommended to use a demo account before committing. You should be wary of providers who don’t offer a free trial.
- Forex brokers. Use a forex broker comparison to ensure your chosen signals provider uses the same forex broker as you do.
- Performance figures. Although you should always be concerned with what performance impact you can hope to have with a particular signaling system, it is always advisable to be critical of any claims. If it looks too good to be true, it more than likely is!
It’s worth noting that not all signal providers are created equal, and with the number of players in the market these days, it can be increasingly difficult to tell a good one from a bad one, but considering all of the above can make life easier.
How to implement and use forex trading signals
Trading signals can also be combined with fundamental analysis, which, in contrast to technical analysis, considers micro and macroeconomic factors when implementing a trading strategy. These are critical to the the finetuning of any trading strategy. Fundamental analysis typically looks to a financial instrument’s intrinsic value using quantitative and, most importantly, qualitative factors. It is generally recommended that a balance of fundamental and technical analysis is needed for a successful trading strategy, as oftentimes certain aspects of market behavior will not be captured successfully by both approaches. Although the use of trading signals can be a great way to lessen the emotional and cognitive burden of responding to market events, you should remember that any automated system comes with positives and negatives. It should also be noted that for newer users trading signal systems are best implemented under the guidance of a more experienced trader. For this reason, novice traders might prefer a manual, expert-guided system rather than a fully automated forex signal platform. When it comes time to choose a signaling provider, please consider the above tips on how best to choose one! The forex trading space is increasingly saturated today, and in such circumstances, it can be very tricky to separate the good from the bad.
You should consider the following parting rules before you implement trading signals in your own trading system:
- Know your forex signal providers. When using trading signals, it is of the utmost importance to understand the differences between forex signal providers. The type and quality of service will vary greatly between providers, and traders should be aware of their needs and preferences before committing to a provider. You should make use of free trial periods if available to help make this decision.
- Know your risk tolerance. High amounts volatility, liquidity, and leverage mean forex trading can be a risky business for day traders. With that in mind, you should always be aware of your own personal risk tolerance before putting in place any trading signaling system. Doing so ensures you are always investing what you are comfortable with losing.
- Know the market conditions. When relying on any system that automates or takes human perception out of a trading decision-making process, it is advisable to remember that this doesn’t mean you can simply overlook market conditions completely. If you are hoping to stay in the game long term, you should always keep an eye on the market conditions regardless of how complex the automated system in place is.