The difference between leading and lagging indicators is implied in their
names: one leads the current market activity with a forecasted direction,
the other lags behind market activity to show what it is currently doing.|
A lagging indicator shows you what has happened in the past up to the
current market conditions, giving you the opportunity analyze previous
patterns to formulate an idea of what may happen in the future.
A leading indicator analyzes market movements to identify patterns that
repeat. It then uses this analysis to create a forecast for what may
happen in the future - doing the work and analysis for you. Naturally,
trustworthy leading indicators are very few and far between.
Which indicator should I use in my daily trading and which is better, a
lagging indicator or a leading one? That's a common question which is
being asked every second and minute amongst traders and analysts wither
they are professionals or beginners. The answer for this question varies
according to some factors which include market type, trading frequency,
market speed and trader's personality.
In order to be able to answer such a question, you should first answer
some other questions regarding to the factors mentioned before like:
1- Which market am I planning to invest in?''
It's important to define which indicator is the most suitable one for the
market you are trading in, FOREX market is open 24 hours for five days
weekly and this gives it a great advantage of a longer trading hours and
greater probability of trading than any other market (e.g., stock market).
This will for sure suggest depending on leading indicators for fast
markets as you would lose a lot of trading opportunities waiting for
lagging indicators to confirm the move.
2- What's your trading plan?
Answering this question will simply give you some necessary points you
need to decide which indicator to depend on, e.g., trading frequency,
trading time frame, trading length and risk ratio. You can't wait for 2
moving averages to cross each others to take a confirmation wither to go
long or short when you are scalping the market or trading M1 or M5 charts
"one minute or five minutes charts", it's a thing you can wait for if you
are going for medium or long term trades.
3- How do you feel while trading?
If you are an emotional person who feels fear while trading and who
regrets getting in a trade once see a red negative digits beside your
trade status, then leading indicators aren't for you, or in more clear
manner, leading indicators alone aren't for you, you need to have a
confirmation from a lagging indicator like moving averages as you can go
close a right position in a negative balance just because you felt you
didn't take some more time to confirm it. On the other hand a greedy
person needs lagging indicator as well to make him sure that he is going
in the right direction if he wants to keep on being greedy.
Now we need to know the main differences between the lagging and leading
indicators. Lagging indicators are those which indicate the market move
after it starts to happen like the moving averages which describe the move
after it starts because its main idea is to take the average of last
defined amount of time periods (i.e., a moving average with the value 9 on
a fifty minutes candlesticks chart means a sum of the close of last 9
candlesticks divided to 9). On the opposite side a leading indicator like
Relative Strength Index (RSI) is moving between two points (A) and (B)
where A is the high value which when it exceeds it you means a sell signal
"Over bought area" and B is the low value which when it goes under it
considered as a buy signal "Over sold area".
The most important point in this subject is, there's no one suitable
indicator or a plan for all traders, it depends on some factors that makes
FOREX trading unique process for each trader and analyst.