Traders use indicators in technical analysis. It does not really matter whether you prefer day trading or swing trading. Indicators are always helpful. They provide information about the behaviour of the prices in the market. Generally, we can divide them into two classes, leading and lagging groups of indicators. How are they different? Which one to choose? Read today’s article and make your decision.
Two types of indicators
Indicators are tools used in technical analysis to assess market conditions and to recognise the best moment to enter transactions. Leading indicators show the future price action while the lagging ones give rather a confirmation of the past price movements.
The indicators were first designed at the beginning of the 20th century. The Dow Theory says that the market tends to repeat its behaviour and thus, it is possible to foretell future price action. Many chart patterns were discovered and many indicators were invented. Technical analysis tools not only help in trading but also in measuring economic performance.
The purpose of the leading indicators is to help traders predict the future movements of the prices. They use past data and show the results before the price actually changes. Often they indicate oversold and overbought levels and the traders can employ this information to enter and close the positions at the beginning of the particular price movement.
When the market is oversold, it is forecasted that it will soon change the direction and so traders wait to open long positions. When the market is being overbought, short trades are waiting to be opened at the beginning of the change in the direction of the trend.
Naturally, there is never a 100% guarantee and indicators tend to produce false signals. There are always chances the market will not behave as expected and many factors influence its movements. This is why your trades should be always confirmed with another tool, for example with a lagging indicator.
A few specific indicators from the leading indicators class
I am going to present a few specific indicators that belong to the group of leading indicators.
Support and resistance lines
Oftentimes the price fluctuates within some range. It seems not to go beyond it. This way you can identify support and resistance levels. Support reminds of a floor beneath with the price is not falling. Resistance is like a ceiling and the price does not go over it. So you can assume, that when the price hits these levels, it will rebound and change direction. Eventually, it will break through them, and that is why you need some extra tools to confirm trading signals.
The oscillator known as the Stochastic reveals oversold and overbought areas. It is expected that the price will change its direction when it falls into these zones. The oversold level is marked by the line of value 20 and when the price falls below it, you should be prepared to open a buy position. The overbought level is at 80 and when the price rises over it, be ready to open a sell trade.
Other examples of leading indicators are:
- Relative Strength Index
- Fibonacci retracements
- Williams %R
- Donchian channels.
This class of indicators is usually used to confirm the trend or trading signals. They use past price action data and show the situation in the market with some delay, thus the name. You will first see the movement of the price and then a lagging indicator will confirm it. This causes a small loss on pips but protects traders from trading on the basis of false signals. Naturally, there is never a 100% guarantee the signal from a lagging indicator will be accurate, so make sure you have conducted proper analysis before entering the trade.
Lagging indicators most often plot over the price chart. They work best in trending and highly volatile markets. Using more than one lagging indicator is also a good idea.
A few indicators from the lagging indicators class
Let me present you with a few examples of lagging indicators.
There are many types of moving averages. The signals are provided when the price crosses the line of indicator or when two moving averages intersect each other. Their calculations are based on historical data.
The BBands form a corridor with two boundaries and a Simple Moving Average in the middle. The corridor widens and narrows together with stronger or weaker volatility. It is also possible to trade with the crossings of the price bars with lower and upper bands.
Other lagging indicators:
- Parabolic SAR
- Moving Average Convergence Divergence.
Every trader should know both classes of indicators. They are all useful and it depends on your knowledge and skills which one you want to apply. Leading indicators help to predict future price action and lagging ones confirm market movements.
Indicators sometimes provide false signals that is why it is important you use extra confirmation. You may try to mix both, leading and lagging indicators on one chart to identify the best points to enter or exit your trades.
Remember about the Binomo demo account which is offered completely for free. This is a perfect place to check how the indicators behave and how easy it is for you to catch signals with them.
I wish you good luck!