Mean reversion, which is one of the most common ways to analyze a market, can be done through several different indicators. Simply put, you are trying to find a market that is a bit overbought or oversold, and treating it with the expectation that we will see markets return feel that would be considered normal. After all, markets try to find some type of normalcy, a lot of times represented in the form of a moving average. And as such, a lot of the mean reversion techniques involve moving averages such as with the Bollinger Bands. We also have mean reversion using overbought and oversold indicators with such things as Stochastic Oscillators, MACD, and other indicators that are quite often presented on the bottom of your chart. Essentially, they all work the same, they simply signal when markets may have been a little over exuberant, and as a result could very well turn things back around and try to find will be a little bit more in the way of normalcy. This doesn’t mean that markets always return to the mean, just that they typically will. After all, quite often the market will do so – but there are some ‘black swan events’ that can happen. This is rare, but it does happen. In other words, it is like any other type of trading, it’s not 100%, but it plays the averages like most traders tend to. Having said that, it makes sense that more often than not, you will ‘win’, and over the longer-term, those ‘wins’ should outnumber all of your loses.

The Average Directional Index or ADX, is a momentum indicator that you can use trade financial instruments. It comes with 3 lines, two which shows the directional strength of both positive and negative movement, and then the ADX indicator itself. Most traders ignore the other 2 lines, and for the purposes of this video I will focus on the actual indicator line itself. It is the solid green line, and what it measures it is the actual strength of the trend. It is not dependent on whether or not the trend is up or down, just that it has strength. In other words, it rises when the trend strength is strong, and declines when it may be weakening. The weaker the trend, the more likely you are to see consolidation. When traders use the ADX, they are trying to find a real momentum. So in other words, if we get a break out or some other type of buying signal, traders will often use the indicator to see if there’s any real indication of underlying strength. After all, there are such things as “false breakouts”, which are sudden moves that completely reverse themselves. By using this indicator, you can perhaps avoid some of those. Also, it can tell you sometimes when we are starting to run out of steam, and therefore might be time to step away from the trend and close your position.

When looking at the MACD, or the Moving Average Convergence Divergence indicator, you are looking at one of the most popular indicators used by technical analysts in all fields. The first thing you need to understand is exactly what this indicator is. It has a signal line, which ironically most traders completely ignore. However, you also have a histogram, and that’s where people tend to focus on. The indicator is simply the measure of the space between 2 moving averages. In this video, I have the 4-hour chart of the New Zealand dollar versus the Swiss franc. I have the 12 and the 26 moving average plotted on the indicator, even though the moving averages don’t show up on the chart. When I do put them on the chart though, you can see that they are spaced out in relation to the MACD. In other words, as the momentum is going to the upside with the shorter-term moving average rising above the longer-term moving average, the histogram rises. The wider the space between the 2 moving averages, the larger the histogram goes in whichever direction the momentum is flowing. At the same time, you have to keep in mind that the zero line will be crossed every time that the moving averages across. And again, you have the 9 moving average used as the dashed red line on the indicator, but typically most people don’t use that as it tends to clutter up the signals.

One of the most basic forms a technical analysis is trend line analysis. You are essentially looking for support or resistance that follows an angle on the chart. Over time, other traders tend to notice these angles and the support or resistance at that angle into up being a bit of a self-fulfilling prophecy every time we hit that line. However, there are a couple of basic rules when looking at trend line to determine whether or not they are actually valid. As a general rule, the higher the timeframe the more important the trend line. This is because the markets take quite a bit more time to form a trend line on a weekly chart, as opposed to a 5-minute chart. It takes a lot more volume in market trading, and that of course means that there is much more confidence in the barrier. Also, most people require the trend line to withstand at least 3 attempts to break through it. In other words, the trend line needs to be touched 3 times during the previous trading. As far as trend line breakouts are concerned, there are a few ways to trade them. The easiest and simplest way although the riskiest, is to simply buy or sell once we break above or below the trend line in question. However, there is the possibility that you get a little bit of a false break out, so some people will actually use the second method. In this method, people will wait until there is a candle close above or below the trend line in question. Obviously, the higher the timeframe of the candle, the more likely it is to give a true signal. Lastly, some people will be even more risk adverse and wait for not only the breakout, but the return and the retesting of the former trend line as the opposite force. In other words, if we break above the top of a downtrend line, quite often the markets will come back to that trend line and trying to find out if what was once resistance will become support. Once it does, that confirms that the breakout still has plenty of momentum behind it. However, the markets don’t always come back retest, so you do run the risk of missing the move. Ultimately, trend lines are used in almost every trading system out there, and some people will trade just using trend lines themselves. Either way, you have to be very comfortable using them if you plan on doing any type of technical analysis at all.

Candlestick reversal patterns are essentially just candles that show signs of exhaustion, or a sudden shift in momentum. In other words, we may have been going higher, but suddenly looks as if we are either running out of momentum to the upside, or than the sellers have come in and absolutely taken over. Either one is reason enough to think that we are going to turn things back around. Of course, the opposite is true as well. For example, we may have been falling rather rapidly but eventually the market bounces in the way during the course of the candle that tells us perhaps the buyers are about to take over again. One of the great things about reversal candles is that they can give you a bit of a “heads up” as to trouble ahead. For example, perhaps you were short of a particular currency pair and it forms what is known as a hammer. The hammer is simply a candle that shows that the sellers ran out of momentum, and ended up reversing quite a bit of the momentum. This often can be the sign of the market turning back around to the upside. So if you are already short, this may give you the idea to either exit the market, or at least move your stop loss is to lower levels. You also have the same thing in an uptrend, we form what is known as a shooting star, which is essentially a market going fairly high, and then dropping back down to form a candle with a very long wick. You can move your stop losses higher. On the other hand, when you see the signals you can start trading in the other direction. It’s a great way to pick up trend changes. There are also what is known as in golfing candles, and they are simply candles that swallow the previous candle in the opposite direction. What I mean by this is that if the market has been falling, and you simply get a very huge green candle, that typically means of the buyers have taken control again. With that being the case, it looks as if it’s time to either exit any short positions that you have, or start buying. Obviously, the exact opposite is true as well.