Leading Indicators Vs. Lagging Indicators

[RichardCox 10]

Investors that find themselves falling in the more traditional category of fundamental analysis often have many criticisms for those regularly implementing technical chart analysis as a basis for trades. Generally speaking, these criticisms suggest that charts “have little to do” with the economic drivers influencing market valuations or that previous price action has nothing to do with where valuations will travel next. In essence, these investors will argue that past performance is not an indication of future market activity. In order for an assessment like this to be accurate, there must be an idea that technical analysis involves only lagging indicators. But is this entirely true?

 

When we look at the available charting tools that are available in the commonly used trading stations, a variety of different options can be seen. Specifically, these tools will often be divided into “lagging” indicators and leading “indicators,” and the fact that there are different types of trading tools goes far to dispel some of the misconceptions that are commonly held with respect to technical chart analysis. Here, we will look at some of the differences that can be found in these two types of indicators so that traders have a better understanding of the functions in many of the commonly used trading applications.

 

Know Your Indicators

 

It’s important to understand the strengths and weaknesses of any indicator before using it in any real money trade. One of the most common mistakes new traders make is to start placing indicators on their charts without having a real understanding of the calculations behind the indicator or the way it is best used in analysis. Some might say that a full understanding of these indicators is unnecessary: Buy if prices fall into “oversold” territory, or Sell if prices reach “overbought” territory.

 

Unfortunately, trading is not this simple. If technical analysis was this easy, everyone could be a profitable trader. Even further, we could simply set software applications to find these signals and walk away as billionaires. The reality is that trading takes more work than this, and we will need to do a good deal of homework before we can make our indicators work for us in consistent and repeatable ways. Not knowing the (usually simple) formulas behind your indicators is not an acceptable practice - and it will negatively influence your trading results. Without this, it will be much more difficult to understand the true application behind each type of indicator.

 

But before you delve into the specifics of your chosen indicator, you must first understand the types of indicators that are available. The two mains types of indicators are leading and lagging indicators. Lagging indicators alert traders to situations that trends have started and that it is time to pay attention to developments that have already become apparent. Leading indicators aim to signal trend changes before they develop. This might seem to suggest that leading indicators will lead to instant riches but the fact is that the signals generated are not always accurate. Traders using leading indicators will, in many cases, encounter “head fakes” and erroneous breakouts. Trades taken on these inaccurate signals eat into the advantages created by the leading nature of these indicators. But this does not mean that they can not be used to generate consistently profitable signals over the longer term.

 

Oscillators: Leading Indicators

When using common trading platforms (such as MetaTrader), one of the main indicator options is the Oscillator. Oscillators are objects that mark two points and move back and forth between those points (always falling inside those points). When the oscillator reaches an extreme area within this 2-point range, buy and sell signals are generated. When seen near the midpoint of this range, the signal is neutral and no trade should be taken. Common examples of indicators include the Relative Strength Index (RSI), Stochastics, or Parabolic SAR. All these indicators help traders identify reversal spaces, as the prior trend reaches completion and prices are preparing to make a forceful move in the opposite direction. In the first chart, we can see examples of buy and sell signals for all three indicators.

 

As we can see from the first chart, price activity causes all three oscillators to move back and forth between buy and sell signals, creating opportunities in both directions. This chart, of course, represents an ideal example, where all indicators are in agreement with one another. For example, the RSI might show a screaming buy while the Parabolic SAR is showing a sell signal. In these cases, it is better to simply step aside and stay out of the market. Additionally, this is a good reason why traders should not use too many indicators on their charts as this will greatly reduce the number of viable signals that become present during your daily routines.

 

Another point to remember is that all leading calculators do not use the same calculations and formulas. The RSI bases its signals on the changing levels in succeeding closing prices. Stochastics uses the highs and lows of price ranges over the time frame shown on your chart, relying much less on successive time periods. Parabolic SAR is has probably the most unique calculations of the bunch, and this can complicate trading signals when combined with other indicators. From this, it should be clear that not all leading indicators are created equal, and traders should practice with a few options before committing to any one choice.

 

Momentum Indicators: Lagging Indicators

 

The second major category is the “lagging indicator,” which includes tools like Exponential Moving Averages and the MACD indicator. These tools are commonly used to spot trends that are starting or are already in place. The downside to using these indicators is that (since the trend is already in place) your entry signals will come later. This means less profit as a smaller portion of the overall move is captured. The upside to lagging indicators is that they send fewer false signals, which will generally mean that you are stopped out for a loss on fewer occasions.

 

In the second chart example, moving average crossovers are seen in conjunction with buy and sell signals sent by the MACD indicator. In all of these cases, the indicators were sent signals (using their accompanying formulas) and then the indicators themselves produces signals shortly afterwards. Here, traders using these signals would have missed some portion of the initial move but the validity of the signals sent would have had a better chance of eventual success.

 

Conclusion: Learn about Your Indicators and Play from Their Strengths

 

Traders have different types of indicators at their disposal, and this is helpful when looking for tools that fit your individual trading style. Leading indicators sent trading signals before new trends or reversals develop. Lagging indicators use available market information to send trading signals that have a slightly higher chance of being accurate (avoiding false breakouts but missing a portion of the early move). It is up to you too decide which approach best matches your risk tolerance and trading approach. It is possible that some tools will work better in some environments than it will in others, and this is an added reason why traders should practice their routines with a variety of indicators before committing real money to positions.

[sergso 10]

Investors that find themselves falling in the more traditional category of fundamental analysis often have many criticisms for those regularly implementing technical chart analysis as a basis for trades. Generally speaking, these criticisms suggest that charts “have little to do” with the economic drivers influencing market valuations or that previous price action has nothing to do with where valuations will travel next. In essence, these investors will argue that past performance is not an indication of future market activity. In order for an assessment like this to be accurate, there must be an idea that technical analysis involves only lagging indicators. But is this entirely true? ...

 

I read someplace once that all indicators are lagging because they use past prices.

[BRichard 10]

When using common trading platforms one of the main indicator options is the Oscillator. Oscillators are objects that mark two points and move back and forth between those points . When the oscillator reaches an extreme area within this 2-point range, buy and sell signals are generated. When seen near the midpoint of this range, the signal is neutral and no trade should be taken. Common examples of indicators include the Relative Strength Index (RSI), Stochastics, or Parabolic SAR. All these indicators help traders identify reversal spaces, as the prior trend reaches completion and prices are preparing to make a forceful move in the opposite direction....Totally agree

[DavidDaniella 10]

Actually the chart is little bit confusing, so getting difficulty to understand properly.

[Guest OILFXPRO]

Hundreds of free indicators , why are they giving them away for free , why are they writing so many books about indicators?They are free because they are worth nothing.Useless.

 

Let us say you are driving , for the past 15 minutes or 30 minute or 1 hour or 4 hours , you car indicator was giving you historical information .You are on a busy road , driving at 80 miles an hour , what good is that indicator giving you historical information that is not relevant to your future direction and journey?totally useless.

[zupcon 10]

 

Let us say you are driving , for the past 15 minutes or 30 minute or 1 hour or 4 hours , you car indicator was giving you historical information .You are on a busy road , driving at 80 miles an hour , what good is that indicator giving you historical information that is not relevant to your future direction and journey?totally useless.

 

 

Why would you need to know when you where about to run out of petrol ? You'll soon work it out when the car starts coughing and spluttering and stops !

 

Why would you need to know the water temperatures getting a bit high, you'll soon work it out when steam starts coming out of the bonnet !

 

If your driving a little to fast I'm sure a friendly police officer will pull you up and let you know

 

I assume your car doesn't have a speedometer, or a petrol gauge or a water temperature or oil gauge ?

[Guest OILFXPRO]

Why would you need to know when you where about to run out of petrol ? You'll soon work it out when the car starts coughing and spluttering and stops !

 

Why would you need to know the water temperatures getting a bit high, you'll soon work it out when steam starts coming out of the bonnet !

 

If your driving a little to fast I'm sure a friendly police officer will pull you up and let you know

 

I assume your car doesn't have a speedometer, or a petrol gauge or a water temperature or oil gauge ?

 

These indicators are part of the car mechanics , the indicators I was referring to are directional indicators turn left turn right etc.Money is made by knowing where price is heading and knowing direction .Technical anylysis is being used for finding direction , that is where it is useless.

 

If indicators were worth anything , you would get hundreds more of indicator sellers and mt4 indicator forums , full of internet indicator fooktards.George Sorros was looking at an indicator , when he broke the bank of England.

[zupcon 10]

These indicators are part of the car mechanics , the indicators I was referring to are directional indicators turn left turn right etc.Money is made by knowing where price is heading and knowing direction .Technical anylysis is being used for finding direction , that is where it is useless.

 

If indicators were worth anything , you would get hundreds more of indicator sellers and mt4 indicator forums , full of internet indicator fooktards.George Sorros was looking at an indicator , when he broke the bank of England.

 

What a quaint view of technical analysis you have

 

Surely no one dumb enough to actually believe that indicators can be used to predict direction, or to predict anything at all ! I supposed you might find the odd creationist who trades who holds that view, but amongst the rational and sane, that idea is just a non starter.

 

I don't know a single trader who believes that prediction is possible, sure there's a few people trolling forums who claim TA is predictive, but those guys aren't being serious, they are doing it for lulz, or they're doing it to promote various scams etc. it's not meant to be taken seriously FFS

 

Fair enough, anyone stumbling across the typical trading forum for the first time might initially get that impression, but 10 minutes of looking at a chart, and another 10 minutes reading a bit deeper should be enough to put most people straight.

 

I have systems that use a directional bias, and I have systems that use a randomly selected direction. Over a sample size of tens of thousands of trades over the last decade, there's not much difference really. You might argue that's because my ability to predict direction isn't particularly effective, and you'd probably be right, but the again, I don't make money by getting the direction right so I can't really be arsed doing much more research in this area.

 

The people who buy indicators are a special breed. They'll continue to buy indicators regardless, it doesn't matter what the indicator does, or if it "works" the important thing is what it looks like, what colors it uses, how "technical" or "high tech" it appears to be, and the type of advertising used.

 

Just because an indicator allows someone to make money doesn't mean people will buy it. Even MT4 provides indicators for free that anyone who knows the score can use to make money, but despite that, people don't use those indicators.

 

The number of people selling indicators has nothing whatsoever to do with indicators working not working, or there "worth"

 

By the way how many of your "probability based indicator" did you manage to sell at the zoo before they banned you ? Hope you made a killing :rofl:

Edited September 10, 2013 by zupcon

[SIUYA 11]

 

The people who buy indicators are a special breed. They'll continue to buy indicators regardless, it doesn't matter what the indicator does, or if it "works" the important thing is what it looks like, what colors it uses, how "technical" or "high tech" it appears to be, and the type of advertising used.

 

Like the diet/fitness industry....

Check out this interesting article.

 

The transformation that only takes a few minutes

[zupcon 10]

Like the diet/fitness industry....

Check out this interesting article.

 

The transformation that only takes a few minutes

 

I was actually thinking of using exactly that as an example !

[sergso 10]

Price patterns with no parameters seem to work much better than lagging indicators like DMI, MACD, RSI, etc. This blog has an interesting article about different types of systems.

[jacobwhite08 10]

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[prax 10]

perhaps when i read this post 4 years ago i will gladly discuss it. on that day trading are bit rough, market maker broker everywhere, 4 digit type, high spread. oftenly use MA as lagging and fibo for leading. but now i moved on armada markets ecn broker type with low spread, fast execution, and for past 2 years been trade by price action only, because this kind of strategies are fully applied on ecn broker.