Leading vs. Lagging Indicators

In the previous grade, popular chart indicators were discussed.

We’ve already covered a lot of tools that can help you analyze potential trending and range-bound trade opportunities.

Still doing great so far? Awesome! Let’s move on. Welcome to Grade 6!

In this lesson, we’re going to streamline your use of these chart indicators.

We want you to fully understand the strengths and weaknesses of each tool, so you’ll be able to determine which ones work for you and which ones don’t.Let’s discuss some concepts first. There are two types of indicators: leading and lagging.

A leading indicator gives a signal before the new trend or reversal occurs.

These indicators help you profit by predicting what prices will do next.

Leading indicators typically work by measuring how “overbought” or “oversold” something is.

This is done with the assumption that if a currency pair is “oversold”, it will bounce back.

A lagging indicator gives a signal after the trend has started and basically informs you “Hey buddy, pay attention, the trend has started and you’re missing the boat.”

Lagging indicators work well when prices move in relatively long trends.

They don’t warn you of any upcoming changes in prices though, they simply tell you what prices are doing (rising or falling) so that you can trade accordingly.

You’re probably thinking, “Ooooh, I’m going to get rich with leading indicators!” since you would be able to profit from a new trend right at the start. You’re right.

You would “catch” the entire trend every single time IF the leading indicator was correct every single time. But it won’t be.

When you use leading indicators, you will experience a lot of fakeouts. Leading indicators are notorious for giving bogus signals which could “mislead” you.

Get it? Leading indicators that “mislead” you?

Haha. Man, we’re so funny we even crack ourselves up.

The other option is to use lagging indicators, which aren’t as prone to bogus signals.

Lagging indicators only give signals after the price change is clearly forming a trend. The downside is that you’d be a little late in entering a position.

Often the biggest gains of a trend occur in the first few bars, so by using a lagging indicator you could potentially miss out on much of the profit. And that sucks.It’s kinda like wearing bell-bottoms in the 1980s and thinking you’re so cool and hip with fashion…

It’s kinda like discovering Facebook for the first time when all your friends are already on TikTok…

It’s kinda like getting excited buying a new flip phone that now takes photos when the iPhone 11 Pro came out…

Lagging indicators have you buy and sell late. But in exchange for missing any early opportunities, they greatly reduce your risk by keeping you on the right side of the market.

For the purpose of this lesson, let’s broadly categorize all of our technical indicators into one of two categories:

1. Leading indicators or oscillators
2. Lagging or trend-following indicators

While the two can be supportive of each other, they’re more likely to conflict with each other.

Lagging indicators don’t work well in sideways markets.

Do you know what does though? Leading indicators!

Yup, leading indicators perform best in sideways, “ranging” markets.

The general approach is that you should use lagging indicators during trending markets and leading indicators during sideways markets.

We’re not saying that one or the other should be used exclusively, but you must understand the potential pitfalls of each.

Reprinted from Babypips，the copyright all reserved by the original author.