What is a signal in forex trading?
As such, it is very rare that you will find a forex trader who is able to understand exactly when to buy and sell based purely on their own research and insights. That is why forex brokers help traders by offering signals.
A signal might also inform traders whether to go long or go short on a currency trade, as well as countless other decisions that can help bolster your currency portfolio and help you build a sustainable and profitable trading strategy. Forex signals are invaluable tools that all traders can take advantage of to make better, more informed trades. Read on to find out everything you need to know about signals in forex trading.
Put simply, a signal is an automatic, on-screen alert that informs traders about a particular shift in a particular currency market, one that is often accompanied by a suggestion on how to use this information.
A signal might inform you that USD/EUR has just reached a breakout price level, meaning that now would be the best time to buy dollars. Conversely, a signal notification might inform you that NZD/JPY markets have just gone from bull to bear, suggesting you might want to dump your Kiwi dollars before the price dips below a certain point.
These are just two very basic examples. Today, many forex trading signals contain immensely detailed insights and highly specific instructions on what course of action traders can take. Such electronically-compiled, largely automated pieces of trading information have been used in both forex and stock trading since at least the early 2000s.
Any trading strategy that relies on the information provided by these signals is aptly referred to as “signals trading”. Virtually all signals are composed of an algorithm that is able to process and condense countless terabits of market data into one concise message.
Although you are not obligated to act on the advice of a forex signal, the insights provided by them are a great way to get a snapshot of the market without having to conduct countless hours of your own research. For many traders, signals remove the decision-making element from forex trading entirely, allowing you to base your strategy on the instructions of a complex, black-box algorithm.
Forex signals remain immensely popular among both institutional and retail investors to this day, for a number of reasons. For one, signals are incredibly time-efficient. Forex signals can be generated either by an automated trading bot or by an expert analyst. Either way, each signal is the result of levels of technical and fundamental analysis that the vast majority of traders could never conduct in a timely fashion.
Instead of spending countless hours poring over forex charts and financial news bulletins, you can use signals from experienced and trustworthy brokers to get the insights you need. Forex signals also help to minimise risks and reduce potential losses.
For example, a forex signal might tell you when to open a position on GBP/EUR, but it will also recommend where you should put your stop-loss. This is a way of informing traders of the risks inherent in a position and helping to minimise this by suggesting the price point at which you should cut your losses and automatically exit a trade.
In addition, forex signals can help remove the “emotional” element of trading. As an expert trader will tell you, listening to your feelings is not an advisable strategy. Emotional traders make mistakes and tend to keep positions open for too long, deepening losses as a result. By listening to signals, you are paying attention to cold, hard market data. It is a rational approach to trading that can greatly minimize human error.
How can signals in forex trading help you?
There are many ways that forex trading can assist traders to make the right decisions. For one, a signal can give a “buy” or “sell” instruction based on early market data, indicating that a pair is about to trend upwards.
Likewise, a signal might inform you that fundamental market data is suggesting that a particular pair is about to nosedive, giving you the option to exit the trade before losses start to materialise. Perhaps you are watching the value of a currency you have invested heavily into rising, but you don’t know when the best time to take your profits and leave the trade would be.
This is where a signal could come in handy, giving a notification telling you that now is the best time to sell up, take your money, and get out. A forex signal might condense a vast amount of information in just a few seconds and spit out a suggestion based on this information.
For example, the US Department of Labor might have just released its highly-anticipated non-farm payroll data, showing the state of employment and wages across the US. This data has a huge impact on many currency pairs and the report itself can easily run into hundreds of pages. Rather than reading this yourself, you can just wait a few seconds for a forex signal to process the data and put out a buy or sell order based on this information.
There are many different types of traders that rely on data and tools that provide signals for forex trading. A day trader might rely on so-called technical analysis signals to get real-time updates on live currency markets.
A more long-term investor might use forex signals that rely on fundamental analysis (an analysis that looks at global macroeconomic developments and megatrends) to help diversify their portfolio and make strategic investments in specific currencies.
An institutional investor might rely on signals to make a large volume of trades within a very short period of time. An investor that is wary of losing more than they are comfortable with could use signals to automatically close a position once losses reach a certain, pre-defined point. The list goes on.
Types of forex trading signals you should know about
There are several different types of forex trading signals that you should know about, each of which performs a different function and can help inform a different aspect of your trading strategy.
These are short, simple bulletins that will simply tell you whether you buy or sell a particular currency pair. Many action signals will just read “BUY USD/JPY”, for example, without any accompanying information.
These are signals that are composed by a real, expert forex broker, rather than by an algorithm. Usually, only premium account holders can access manual signals.
These are signals that are entirely composed by a computer algorithm. All of the information on the relevant forex market is fed into the algorithm, with the output being the signal.
These are signals that recommend the exact stop-loss that a trader should place on a particular currency pair, in order to minimise potential losses.
Take profit signals
These are signals that inform traders that a currency pair they have an open position with might have peaked and that now is the time to sell and take your profits.
Currency Market Price (CMP) signals are pure informational signals that simply list the real-time market price for a particular pair. There is usually no recommendation or call-to-action with a CMP signal.
Risks of signal trading forex
While there are many potential benefits to using forex signals, there are also a number of risks inherent in signal trading. For one, it is often difficult to actually determine why a signal is recommending a particular course of action. Many algorithms that produce signals are black-box algorithms that even the code writers do not properly understand.
This is naturally a risky way to trade and there is no guarantee of success. Furthermore, many signals are also being followed and obeyed by thousands of other traders at the same time. Following a crowd like this means that you are more likely to miss out on a rare opportunity.
Use a forex broker that you can trust
If you are ready to start trading forex, you need a broker that can provide you with data and signals that you can trust. For this, we have got you covered. Make sure to consult our in-depth forex broker reviews to find out the best licensed US brokers for you.