What Are Forex Signals and How Do They Work?
Forex signals are one of the most popular tools that forex traders depend on when making trading decisions.
Forex signals contain trade recommendations that tell you – the forex trader – which forex pair to trade, whether to buy or sell it, when to enter the market and how much profit you can aim to generate by following their specific ideas. While some forex traders choose to exclusively follow the trade ideas given by signals, others use these signals as part of their deeper analysis into the market to come up with their own, unique trading strategy.
As a forex trader, whichever way you choose to depend on forex signals, it helps to get a better understanding of what they are and how they can help you trade better. Here are some key aspects of forex signals you should know before you start using them as a tool to help you trade the forex market.
How do forex signals systems work?
There are essentially two kinds of forex signals systems – automated and manual. Read on to understand what goes on in the background and how each kind of forex signal is derived.
Automated forex signals: Automated signals are created by professional analysts and/or traders in conjunction with code developers, and use algorithms to recommend trade ideas based on historical trends on how the market moves. This type of signals exclusively uses technical indicators to observe and identify trade ideas. While the concept may sound a bit too complex, automated signals systems use several mathematical formulas to discover patterns and send out forex signals when there is a match with parameters their algorithms are programmed to detect.
Such systems are also known as forex robots or Expert Advisors (EAs) as they require no human intervention to analyse the market and come up with trade ideas. Most forex bots let you pick and choose various parameters and technical indicators that are used for the analysis to come up with signals. In addition, such systems also let you customize the spreads and currency pairs you wish to trade. Automated trading signals systems analyse technical indicators and price action to publish signals with high probability of success based on historical data on market movements.
Manual forex signals: On the other hand, manual forex trading signals are generated by professional analysts and/or traders who use technical indicators along with fundamental analysis of the markets to identify potential trade recommendations. This includes examining past information about the price and trend in a specific forex pair. Where manual forex signals differ from their automated counterparts is in the next step: analysts who put out such signals also study current news events, also known as fundamental indicators, that could influence price action in the forex pair.
While some forex traders choose to exclusively follow the trade ideas given by signals, others use these signals as part of their deeper analysis into the market to come up with their own, unique trading strategy.
Fundamental indicators such as financial and political developments and market sentiment tend to have a heavy influence on a forex pair’s movement, and this coupled with analysis of popular technical indicators on charts can offer an insight into which way a forex pair could move and by how much, so that you can jump in and profit on the movement.
While some signals systems offer forex trading signals for free, others employment a payment or subscription-based model to provide this information to you. Payment can vary from anywhere between $40 and $50 all the way up to even $500. When you subscribe to such a service, either for free or on payment, you will receive alerts via text, email or app notifications by the system whenever a new forex signal is published.
What are they based on?
As you learned in the previous section, forex signals can be generated through the analysis of technical and/or fundamental indicators. But what do we mean when we say this? To become an informed forex trader, here’s what you need to know about these indicators and their relationship with forex trading signals:
Fundamental indicators or fundamentals: Fundamental analysis involves understanding the impact the real economy has on forex markets and currency pairs. Some of the popular fundamentals used to generate forex signals include:
- Carry Trade strategy – which depends on the difference between interest rates of two currencies in a forex pair instead of price action to find trade ideas.
- News – which includes the release of key economic data and political developments from the respective countries of a forex pair and analysis on how it could impact the value of a specific currency.
- Market sentiment – which is essentially the overall momentum of the market and can drive movement in certain currencies. For instance, safe haven currencies that strengthen when the market sentiment turns risk-off, or commodity currencies that benefit when the price of commodities goes up, or risk currencies that strengthen when the markets trade with a risk-on sentiment.
- Volatility – which involves the use of some trading strategies such as the use of widened targets, minimal losses, lower leverage and diversifying of portfolio to make quick pips when the market sees sudden moves.
Technical indicators: Technical strategies are vital in identifying entry and exit levels of forex signals. Fundamentals can be used to determine the direction of movement in a forex pair, i.e., whether to enter into a buy or sell trade. On the other hand, technical indicators tell you how much of a range you can trade in and hope to earn profits, or essentially, how much risk you can take. Some of the most commonly used technical indicators in identifying forex trading signals include candlestick patterns like the bullish engulfing candle and shooting star patterns, Fibonacci indicator, head and shoulders pattern, divergence, triangles and wedges, Elliot Wave pattern, liquidity and hedging.
How can forex traders use them?
Forex signals systems send alerts to you whenever they publish a new signal, either on your email or on your smartphone. Once you receive the signal, and if it is a trade idea you are interested in, you can go ahead and place a trade based on it. Here are two ways to use this information:
For non-professional traders: As a novice who is unsure of how the forex market moves, it is safer to rely entirely on the forex signal for your trade idea. This means that you use the information provided just as it is, making no changes whatsoever to the recommended levels for entry price, stop loss and take profit. Depending on the signals system you use and its level of integration with your trading account, you can either copy the trade automatically with just a click of a button on the alert or manually copy the levels mentioned in the forex signal into a new trade that you open.
For professional traders: Once you feel more confident and have earned enough experience to conduct your own analysis and get a deeper understanding of how forex trading works, you can use these signals as an additional tool to assist with your analysis. You can use the trade recommendation provided by the forex signal and build up on it through your own technical and/or fundamental analysis, and choose to change the levels based on your risk-taking capabilities. For instance, if you feel confident that the price action could be more than what the forex signal suggests, you can move the take profit and stop loss levels further away to generate more profits.
Whatever forex signals systems you sign up for and however you choose to use the signals to help you become a better trader, do keep in mind that forex trading comes with its own share of risks and that there are no guaranteed profits to be made. Forex trading signals, while extremely useful, do not assure profits but can reduce some amount of risk from trading. It is up to you to use your discretion and trade carefully and wisely by managing your risk to generate profits.