leading indicators vs. lagging indicators

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If you’re a fan of technical indicators or you just want to know how trade using indicators then definitely want to read this article. It’s no secret that one of the reasons why traders fail when if comes to forex trading is because they don’t know how to use their strategies or indicators correctly.

In this article , i am going to talk about two types of indicators. Technical chart indicators comes in two different forms; they are either “lagging” indicators or “leading” indicators.I will explain the difference between these two indicators. I will also explain when to use them and when not to use them.

  1. Leading indicators

A leading indicator is a reversal indicator that gives a buy or a sell signal before the new trend occurs. For example, if the market price has been going up for a while, a leading indicator will give you a signal that the price is about to reverse and go down. These indicators signals you right before the price reverse, so if you are already in a buy position you should get out and look to go short or sell. The opposite is also true with a downtrend.

If the market is in a downtrend, leading indicators will give you a signal that the market is about to reverse or turn.

Examples of a leading indicators

The majority of these  leading indicators are oscillators . An oscillator is any object or data that moves back and forth between two points.  This means that these oscillator indicators are plotted within a bounded range.

The oscillator will fluctuate into overbought and oversold conditions based on set levels based on the specific oscillator.

An example of an oscillator is the  stochastic , which varies between 0 and 100. Stochastic oscillators are scaled from 0 to 100. When the stochastic lines are above 80, then it is said that the market is overbought. When the stochastic lines are below 20, then it means that the market is oversold. Hence, most novice traders that uses indicators like stochastic buy when the market is oversold, and sell when the market is overbought.

Here is an example of a stochastic oscillator

indicators

Other known oscillators  are:

  • RSI (Relative Strength Index)
  • MACD  ( Moving Average Convergence Divergence) 
  • CCI ( Commodity Channel Index)

Now, If you never traded with oscillators and this is your first time reading about oscillators  you will probably thing that oscillators are the best way to go and they will get you rich fast since they tell you when to buy, sell or exit a trade. However, oscillator are very good at giving wrong signals. This is why most traders that uses oscillators have lot of losing trades.

This doesn’t mean that leading indicators are useless and you should not use them. You just have to know when to use them. If you follow them blindly you will brow up your account in no time unless you know how to use them properly.

When to use leading indicators

Leading indicators work best during periods of sideways or non-trending trading ranges

The leading indicators will create most reliable signals on a choppy non-trending markets instead of trending markets. This simple means if you want to use oscillators or any leading indicator, you should only use them  on a non- trending markets. If you want to increase your chances of having more wining trades then do not use leading indicators on a trending market.

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2. Lagging indicators

Lagging indicators are also known as “momentum” unlike leading indicators, these lagging indicator gives a signal AFTER the trend has started.

Meaning if the price has been going up then reserve, a lagging indicator will only signals you after the price has  already reversed maybe 20 pips or 50 or even 150 pips depending of your time frame and the momentum of the trend.

These indicators are always late to the “party” therefore if you where to make 100 pips, you will probably make 20 pips or so depending on your time frame.

The other problem with lagging indicators is that they don’t work well in a choppy market where the price movement is sideways because these indicators tends to be lower during non-trending periods.

Examples of lagging indicators

The most well-known lagging indicators are:

  • Exponential Moving Avarages or EMA
  • Simple Moving Avarages or SMA
  • Ichumoku Kinko Hyo
  • Bollinger bands
When to use lagging indicators?

I have already mentioned that  lagging indicators  don’t work well in a choppy market where the price movement is sideways because these indicators tends to be lower during non-trending periods. Lagging indicators are more useful during trending periods. This is due to the fact that lagging indicators tend to focus more on the trend and produce fewer buy-and-sell signals.

Essentially, the only real use that lagging indicators have is in helping to identify a trending market. It is also important to note that while some retail traders use a single indicator solely for buy and sell signals they are best used in conjunction with other techniques.

Closing comment

Before using any trading indicator, be sure to understand what it measures and how it works. Only then can you have confidence in it’s signals.

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