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You’re likely already familiar with how traders and investors use technical indicators to predict potential market trends and movements.
There are many types of indicators, but these different tools all fall into either one of two types: leading or lagging.
In this lesson, you’ll learn the difference between the two types of indicators and how best to use each one.
Leading indicators are predictive tools. You can use these technical indicators to anticipate how the market will likely behave in the near future.
Traders typically use leading indicators to determine whether an asset is “overbought” or “oversold” and by how much.
In forex – or any other assets for that matter – this practice operates on the principle that oversold assets are likely to “bounce back.” This means that a corrective movement is expected to follow, and the asset’s prices will go into reversal.
You can use different types of leading indicators depending on what you want to identify. For instance, you might use stochastic oscillators to verify overbought or oversold conditions. You may also use Bollinger Bands to determine volatility and potential reversal points.
Below are some of the leading indicators you can use for technical analysis.
You can use the RSI indicator to measure the speed and change of price movements. As the RSI lets you know price movement strength and momentum, you can use this indicator to identify possible points of reversal.
The stochastic oscillator compares the closing prices of recent trading periods with the previous one.
This leading indicator works on the assumption that changes in market momentum direction happen much faster than volume or price changes and can be used to predict market movements.
While leading indicators tell you about potential trends, lagging indicators warn you about trends that are already happening.
These indicators follow price movements and notify you about these trends after the fact. As lagging indicators provide signals for already existing trends, they work best for price movements within longer trends.
Due to its nature, lagging indicators are often used to confirm the trend signals generated by leading indicators.
Like leading indicators, you can use different types of lagging indicators for various purposes.
These include:
The MACD is an indicator you can use to gauge a trend’s strength and direction. It measures the distance between two exponential moving averages (EMA) from two different periods and plots this on a chart.
The MACD histogram, an MACD component, represents the difference between the MACD and Signal Lines. The difference between these two lines can give you insights into the strength of a trend’s momentum.
Bollinger Bands are a type of lagging indicator that uses historical price data to determine the standard deviation of prices.
Three bands comprise this indicator: an upper band that signals possible overbought levels, a lower band that indicates oversold conditions, and a middle band that signifies the moving average of a given period.
The Parabolic SAR indicator is a trend-following tool that uses price candles to identify potential price reversals. It marks places above or below price candles with dots to signify market trends.
Dots above price candles indicate a shift from bearish to bullish market conditions and signals traders to buy. Conversely, dots below the candles suggest a reversal from bullish to bearish trends and signals traders to go short.
It’s not a good idea to use only one indicator and forego the other. As you’ve read earlier, traders often use leading and lagging indicators together.
Doing this will give you a more reliable prediction of possible market movements, as the two indicators can confirm the results of each. It effectively reduces the number of false signals you’ll come across and prevents you from making poor trading decisions.
In the next lesson, you’ll read about another popular technical analysis tool: pivot points.