We have previously dealt with support and resistance levels, but trading based mainly on these two indicators may lead us to some loss caused from false signals. Trading decisions should never be based on one method, but you must always confirm everything with other indicators. We will see what are the most common false signals and learn how to filter them.
Technical analysis in forex trading is very important, but we must pay attention to the signals derived from various indicators.
False signals mislead the trader as the market seems to move towards one direction, but maybe it is actually preparing to do the opposite. It’s all a matter of volatility, which in these cases, however, turns out to be false.
In times like these, characterized by a very volatile market, it is not uncommon to witness to false breaks in the levels of support and resistance. The consequence would be to open positions that will go against the real trend or close positions that could have brought us a much greater profit.
The two false signals most often present are those related to the breaking of the support level and the resistance level.
The support trend line is obtained by combining the minimum touched by the price, this is usually traced in bearish trends and its breakthrough indicates a trend reversal, hence the shift from a rising trend to a bearish one.
The resistance trend line is traced by combining the maximum touched by the price. Even in this case the breakdown indicates a trend reversal, that is, the shift from a bearish trend to a bullish trend.
There are cases where, despite the break of a trend line, there is no trend reversal and therefore there is a false signal.
Totally eliminating false signals is virtually impossible. At the same time it is true that with a series of arrangements it is possible to reduce them dramatically, giving greater security to any trader and the success of every trading strategies.
In order to identify false signals, you must use the indicators that are specifically designed. The first of all is the RSI, or the Stochastic oscillator. This indicator, in fact, allows to identify those areas where the market exaggerates to one direction with the price level. If the imposed levels are ‘violated’ by oscillators who consider exaggerated this price movement in one direction, it is the case that to not enter the market and wait for more secure and probably even more profitable, future positions.
RSI and Stochastic oscillatore therefore can play a key role in detecting false signals in Forex. They can also be used to determine the size of the position: for example it is possible to enter in a market in half position, not after the break of a level, to complete the purchase or sale on any pullback at best prices.
It is possible to use another very particular indicator to identify false signals: the volume indicator. It indicates the amount of capital that is marketed at a given time. Using this indicator we can understand if there is an increased interest of investors or a decrease.
Recognizing false signals helps to avoid losses and improve your trading. By practicing the little “tricks” described above, we will be able to improve our on-line trading and reduce the chances of falling into the trap of a false signal.