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Thursday, October 3, 2013

Leading vs. Lagging Indicators

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.
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 andlagging.
A leading indicator gives a signal beforethe new trend or reversal occurs.
A lagging indicator gives a signal afterthe trend has started and basically informs you “Hey buddy, pay attention, the trend has started and you’re missing the boat.”
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….
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, trend-following, or momentum indicators
While the two can be supportive of each other, they’re more likely to conflict with each other. We’re not saying that one or the other should be used exclusively, but you must understand the potential pitfalls of each.

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