Should You Be Using Lagging Or Leading Indicators

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“If past history was all there was to the game, the richest people would be librarians.”

-Warren Buffet

When a brand new trader decides to develop a trading strategy, most often they will not know when to start. Most often, a quick trip to the library or google would have them looking into the popular indicators like Moving Averages, Moving Average Convergence Divergence or MACD, Stochastic type indicator which shows one on how markets oscillate up and down, Relative Strength Index or RSI. The common thread of these types of indicators is that they use a recent close or past price candles to hopefully anticipate immediate action to follow.

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Dissecting the Lagging Indicators

A check on the definition of ‘Lagging Indicator’ in investopedia.com produced the following result.

Lagging Indicators are:

  1. A measurable economic factor that changes after the economy has already begun to follow a particular pattern or trend.
  2. A technical indicator that trails the price action of an underlying asset, and is used by traders to generate transaction signals or to confirm the strength of a given trend. Since these indicators lag the price of the asset, a significant move will generally occur before the indicator is able to provide a signal.

A lagging indicator is one that follows an event. The importance of a lagging indicator is its ability to confirm that a pattern is occurring or about to occur.

Let’s have a look at a type lagging indicator:

Moving Averages

Moving Averages reflects the average prices of a stipulated time. One of the most common entries employed by newbie are the golden cross and the dead cross. The golden cross is where a smaller value moving average crosses a higher moving average from bottom to top.

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In the diagram above, the blue line is the 20 simple moving average and the red line is the 100 simple moving average. The golden cross is marked A. As you can see, the price was on an uptrend after that.

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The diagram above on the other hand is the dead cross. A dead cross is where a smaller value moving average crosses a higher time frame moving average from top to bottom. The dead cross is found at point B.

The ease of using the moving average crossovers are simple thus making it the favourite among traders. However there are two major flaws associated with it.

a) It works well in a trending market but it is a nightmare trading it during a ranging market.

b) Most time price has moved considerable before a cross over happen thus traders has already missed a big chunk of the move.

If you are a big fan of oscillators, you would have faced the exact problems as mentioned above.

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Dissecting the Leading Indicator

According to investopedia.com, a leading indicator is a measurable economic factor that changes before the economy starts to follow a particular pattern or trend.

 

These types of indicators signal future events.

Let’s have a look at leading indicators:

I am only going to go through the popular ones. They are the Pivot Points, Elliot Wave and my own box theory.

Pivot Points

A pivot point and the associated support and resistance levels are often turning points for the direction of price movement in a market. In an up-trending market, the pivot point and the resistance levels may represent a ceiling level in price above which the uptrend is no longer sustainable and a reversal may occur. In a declining market, a pivot point and the support levels may represent a low price level of stability or a resistance to further decline.

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Elliot Waves

Theory named after Ralph Nelson Elliott, who concluded that the movement of the stock market could be predicted by observing and identifying a repetitive pattern of waves. Based on rhythms found in nature, the theory suggests that the market moves up in a series of five waves and down in a series of three waves.

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My Box Theory

My box theory support and resistance is based upon the suspected manipulation levels of the market makers. It is based upon market momentum and memory. I have explained in detail how I derived the said support and resistance in an earlier article titled “How to identify the correct support and resistance”.

Once you have correctly identify the correct support and resistance, you would see prices trading in the respective ranges. The market is said to be in a trend when price breakout from the said ranges and price in a range when price fail to break both support and resistance.

These levels are highly accurate and it is derived from my way of drawing the Fibonacci levels modified into a simple way. The diagram below is a sample of levels taken from one of my recent successful trades.

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