In this article, we are going to explore the broad trading indicators. We will divide them into lagging indicators and leading indicators. As we move along, you will learn how they work, why they are useful, why they are unreliable, and why you should use them anyway. Lagging and leading indicators may not be the secret to cracking the forex market, but they sure do help. To find the best forex brokers, you will need to read our forex broker reviews.
We could start by debating whether or not trading indicators work. However, we are going to assume that they are not useless. They have their uses, and they are there for a reason. Maybe you have heard of lagging indicators and leading indicators.
During this guide, we are going to focus our energies on leading and lagging indicators. It is true that some traders will say they do not work and that they are a waste of time. Other traders look at them as though they were listening to an oracle.
The market is unpredictable, and people will believe whatever makes them feel like they are making the best decision. Before we get started on indicators, there is one thing you should keep in mind: TRADING INDICATORS ARE NEITHER PROPHETIC NOR A WASTE OF TIME.
Our opinion is that trading indicators are just tools, they work, and if you use them the right way, you will be able to get some use out of them.
The Origins of Trading Indicators, Lagging and Leading Indicators
The modern financial markets use trading indicators that are more complex now, but they have their roots in the early years of the 20th century. The development of the Dow Theory is the one that essentially gave birth to them. This was sometime between 1902 and 1929.
The Dow Theory states that the price movements we see every day are not random. There is some order in the seemingly chaotic way that the forex market works.
According to the theory, a thorough analysis of the market by looking at present and prior market behavior can yield results about what could happen in the future.
For that reason, leading and lagging indicators are used for mapping economic performance. For that reason, they are not always something we relate to technical analysis and market prices only.
Sometimes, we use them on indexes and other economic variables.
A Simple Definition of Lagging and Leading Indicators
In the forex market, we use them when trying to evaluate the strengths and weaknesses of economies and financial markets. Leading indicators change before changes in economic cycles or market trends. Lagging indicators are based on events that have already happened.
With lagging indicators, we get insights into the historical data of a specific market or an economy.
To put it simply, with leading indicators, we get predictive signals about events that are yet to happen, or trends that have not started. With lagging indicators, we generate signals that are based on trends that are already happening or have just recently happened.
These signals are mostly used by traders who prefer technical analysis and make the very useful when you are trading in forex, crypto, and stock.
Let’s Explain Further
Before you can even claim to understand either lagging or leading indicators, you should know what they entail, so; we will get into some detail just to make sure that everything is clearly understood.
- Lagging Indicators Deconstructed
As we mentioned earlier, the lagging indicators give us information about the existing trends, which may not be immediately visible. This kind of indicator moves behind the economic times.
Most of the time, you will find that we use them for long-term analyses. We base these analyses on economic performance and data on previous prices. They are all about the established or already started trends and events.
There is not much use to get out of them unless you are planning to look at some long-term analyses. Usually, you will not need to do a lot of that. However, it is essential to know what they are, how they manifest, and what they indicate.
Let’s not get into the leading indicators. They are the most used and most useful kind you will find when trading.
Popular lagging indicators include; moving averages, the MACD indicators, and Bollinger bands.
- Leading Indicators
We also call them oscillators. You will learn why, in a few short paragraphs. As we mentioned, the leading indicators show you what the trend could be before it starts. Now, before you go off and pop a champagne bottle to celebrate your newfound wealth, you should know one thing:
THEY DO NOT ALWAYS WORK
Of course, they do not always work. Otherwise, everyone would use them, and you would only need very little in the way of education to get your forex career started. Hypothetically, you could catch an entire trend every time if the indicator worked every time.
When using leading trading indicators, you should expect fakeouts. They are known for giving unreliable signals that could lead you to make the wrong decision.
Which Trading indicators Should You Use?
Why, all of them! You see, the leading and lagging indicators are not all wrong for you. Lagging indicators can be beneficial, although you will always be entering the trade position. You potentially miss out on most of the profits, and that sucks.
You’d be like the guy wearing Oakleys now, thinking you are cool and hip…
You could be like the guy buying a Cathode Ray Tube TV when there are 4K displays…
There are many analogies to explain what you could be like and we won't go through them all, seeing as this is not a comedy sketch, but there are some useful steps you can take to ensure that indicators are of some use to you.
With that being said, you can use Oscillators to warn you when a trend is coming to an end.
Using Leading Indicators To Warn of an Ending Trend
Trading indicators can be tricky, but we will simplify this for you. The leading indicator is an oscillator. An oscillator is any data or object that moves to and from one point to the other. So, we have two points, A and B.
The oscillator (leading indicator), will usually signal when to buy or sell with the exception being when the oscillator is nowhere near point A or B. That is when it is in between and not on either end.
If it sounds familiar, it is because you remember the Stochastic, Relative Strength Index, and Parabolic SAR. All of them are oscillators.
The Oscillator Premise: To understand this trading indicator, you need to realize that the premise of oscillators indicates that as the momentum starts to slow, fewer buyers (in an uptrend) or fewer sellers (in a downtrend) are willing to trade at the new price.
When the signal changes momentum, it is usually a sign that the ongoing trend is weakening. The trading indicators are all about signaling the possibility of a trend reversal, where the previous trend has finished its run, and the price is about to change direction.
Where Things Get Complicated
The trading indicators you use will not always agree. They work differently. Leading indicators could be in conflict and mess up your trade if you follow them religiously. Only by watching them over a long time, can you make a guess that is informed or correct.
Here’s the thing: they all work differently. The leading indicators have a different way of operating. Let’s look at the three main ones individually to understand what that means.
- Stochastic- with this leading indicator, they are based on a high-to-low range of the timeframes, but they do not account for the changes that take place from one hour to the next one.
- Relative Strength Index (RSI)- With this trading indicator, signals are based on the change from one closing price to the next.
- Parabolic SAR has a bunch of calculations unique to itself that cause even more conflict.
The point here is that these leading indicators always assume that the movement in price leads to the same reversal. Of course, that is wrong. In reality, it does not work that way at all. But then again, what are you going to do? Quit? Don’t think so.
While you should be aware that the leading indicators may be wrong, you cannot simply avoid them. If it seems like you are getting mixed signals, that’s definitely because you are. You are better off doing nothing than taking a guess.
Remember this: IF IT FEELS LIKE THE CHART IS NOT MEETING YOUR CRITERIA, ABORT THE TRADE. Move to where it feels like the criteria work.
The Four Popular Leading Indicators
It is good to know what they are and what they do so that you can use them if you encounter them. So, here we go:
- Relative Strength Index (RSI)
The relative strength index is a trading indicator showing momentum. Traders use it when they want to identify whether a market is oversold or overbought. When the RSI gives out a signal, it is the popular opinion that the market will reverse.
With that information, a trader is provided a leading indicator that they should enter or exit a position. The RSI has a scale of 1 to 100, and when it is above 70, the market is often thought to be overbought and will appear red on the chart.
Below thirty, the market is oversold and appears green on the chart.
- Stochastic Oscillator
This trading indicator is used in comparing the recent closing prices to previous trading ranges. The stochastic bases its premise on the idea that the market momentum changes direction faster than price or volume.
With that in mind, traders can use this trading indicator to predict the course of the market's movement. If it reaches a reading of 80 and above, the market is thought to be overbought, and if it is under 20, the market is considered oversold.
- Williams Percentage Range (%R)
The Williams percentage range is known as the William %R and is similar to the stochastic oscillator. The difference here is that this trading indicator works on a negative scale. So, the range is from -0 to -100, and as with the others, it uses the -2o and -80 mark to indicate whether the market is overbought or oversold, respectively.
The green line would now be below -80, indicating that the price is most likely going to go up. The red line above the -20 mark indicates that the price will most likely fall.
Being a very sensitive trading indicator means that it could start to highs or lows, even if the real market price doesn't follow that pattern. That means you get premature and unreliable entry signals. Use -10 and -90 as more extreme signals on price to avoid this.
- On-Balance-Volume (OBV)
This trading indicator is also momentum-based. With it, you can look at the market and make predictions about market prices. However, it is mostly used in trading shares because the volume is appropriately and well-documented by the stock exchanges.
As a trader, you will focus on volume decreases and increases when there is no equivalent change in price. It indicates that the price will increase or decrease very soon.
It is unreliable as well as it gives false signals around the time when substantial volume spikes happen around announcements that catch the market by surprise.
The most important thing that you should learn from all this is that the trading indicators, whether they are lagging indicators or leading indicators, is that there is no single method of looking at them, that will ensure you always stay profitable.
Lagging and leading indicators are just what they are, and it all comes down to the individual benefits that they offer. Collectively, these benefits may work sometimes, and sometimes they may not.
The best way for you to use the technical trading indicators is in tandem with each other. The lagging and leading indicators are very important when you want to build a strategy. In the forex market, trading indicators are an inextricable part of the strategy that you end up using.
When utilized well, you can do so much more. Give yourself that edge and use the trading indicators to your advantage. As we have stressed time and again, the forex market is about navigating a game of mathematical probabilities and has nothing to do with following your gut or luck.