October 16, 2017
Now that we have covered some popular technical indicators in the forex markets, let’s explain the concept of indicators a little bit closer. Generally, there are two main types of indicators: leading indicators, and lagging indicators.
As their names might suggest, leading indicators (or oscillators) give signals before a change in price happens. They are leading the price. On the other hand, lagging indicators (or momentum indicators) “lag” behind the price, and are used to confirm that a change in trend has already happened.
Now you may think that leading indicators are the only tool you need to make a lot of money in the forex market – just follow their signals and get rich. Unfortunately, it’s not that easy. Leading indicators are notorious for their fake signals. There will give false signals from time to time, which could bring you a huge loss if you follow them blindly.
Lagging indicators also have their downsides, as these indicators will give signals only when the trend already starts. That’s why relying solely on leading indicators will lead to a lot of missed opportunities over time.
Using Oscillators to Look Out for the End of a Trend
We’ve already introduced some oscillators in the previous article, like the Stochastic, Parabolic SAR and Relative Strength Index (RSI). If you’re still not sure what they represent and how to trade them, we encourage you to read through the previous articles again.
To summarize again, these indicators are used to identify a possible trend reversal. They are leading indicators as they signal a reversal before it actually happens.
The following chart shows all three indicators plotted on the EUR/USD chart. All indicators occasionally lined up and gave buy and sell signals. As you can see, trading on these signals would be very profitable.
Now, let’s see a chart with the same indicators but with opposite signals.
As you can see, in August and September all three indicators gave totally different signals, with the RSI giving no signal at all. Later in October, the Parabolic SAR gave a sell signal, while both the Stochastic and RSI were well below the 30 and 20 levels and thus giving a buy signal.
Using Momentum Indicators to Confirm a Trend
Lagging or momentum indicators are primarily used to confirm a trend. Among the indicators discussed in earlier articles, the MACD and moving averages are examples of momentum indicators.
The downside of relying on these indicators for opening a position is that you’ll probably miss the huge move that appears at the beginning of a trend. These indicators are lagging, and give signals with a delay. The positive side is that they are less likely to give false signals compared to oscillating indicators.
The chart above shows the MACD indicator combined with two moving averages – a 10-period EMA and a 50-period EMA. Both indicators gave buy signals in August and sell signals in October, confirming trends in their early phase of development.
The two main groups of indicators are lagging indicators (or momentum indicators), and leading indicators (or oscillators). Momentum indicators lag behind the price, and are generally used to confirm a trend which has already begun. This means that relying on momentum indicators to enter a trade will lead to a lot of missed pips in your daily trading.
On the other hand, oscillator are leading indicators and have the ability to predict future price movement, but are famous for their false signals which, if followed blindly, can lead to huge losses in your trading account. The best way of using any type of technical indicators is to combine them with other types of indicators and wait for the signals to overlap, or to include other types of analysis like candlestick and chart patterns.
Test Your Knowledge: Leading vs Lagging Indicators
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Leading vs. Lagging Indicators
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Leading indicators are also known as:Correct
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Lagging or momentum indicators are primarily used to:Correct