How To Use Leading And Lagging Indicators?

Published: 06th January 2010
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There are two types of indicators that are used by traders whether day trader or a swing trader: 1) Leading and 2) Lagging. Technical analysis without knowing and understanding these leading and lagging indicators is impossible. These leading and lagging indicators are the most important tools in the arsenal of any forex trader, stock trader or for that matter trader.

What are leading indicators? As the name suggests, a leading indicator leads the price action in the market and gives buy or sell signals ahead of the reversal in the trend or ahead of the start of a new trend in the market. Leading indicators are considered to be very important as they give you the trading signal ahead of time. One of the most popular leading indicator is the pivot points. There is a whole method of trading called pivot point trading that has been developed over time. Pivot points combined with fibonacci retracement can be highly effective. Pivot points can be calculated for any market. The other popular leading indicators are the oscillators like the Relative Strength Index (RSI) and the Stochastics. However, the problem with most of these leading indicators is that they often give false buy or sell signals. They need confirmation from other indicators.

On the other hand, the lagging indicators as the name implies lags the market price action and provide information after a trend has started or a reversal in the existing trend has taken place. So, lagging indicators provide trading signals that are often late. Sometime too late for you to join the new trend because most of the profit is already lost. One of the most simple but highly popular lagging indicators that is widely used by traders in different markets is the Moving Average. Moving Averages can be simple or exponential. Other popular lagging indicator is the Moving Average Convergence Divergence (MACD).

Stochastics is one of the popular leading indicators that is used in different markets like stocks, forex, futures, commodities, options almost all the markets. Stochastics is based on a complex statistical formula that you need not go into. You just need to know this that it gives an overbought or oversold conditions in the market. It is scaled from 0 to 100. When it touches 80, the market is considered to be overbough and when it touches 20 level at the bottom, the market is thought to be oversold.

However, MACD ( pronounced Mac Dee) on the other hand is a lagging indicator. MACD uses three exponential moving averages 12,26 and 9. 12 exponential moving average is faster. 26 exponential moving average is slower. The 9 exponential moving average gives their difference.

So what indicators to use? Professional traders combine the leading indicator with the lagging indicator to make the buy or sell decision. The best combination is combining Stochastics with MACD on 1 Hourly charts to identify the trend of the day. You must master these leading and lagging indicators if you want to make a successful trader.


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