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Should You Be Using Lagging Or Leading Chart Indicators?

By , Forex Trading Instructor
15 August 2013 03:00 GMT

Article Summary: Many traders learn to use the indicators that are based on past price action to develop a trading plan. While many of these indictors have their place, there are other indicators that help you see where price is likely to stop before the time arrives. Naturally, this can be a very useful tool in your trading.

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

-Warren Buffet

When a new trader decides to incorporate charting into their trading, they often don’t know where to start. Most often, a quick search of how to find opportunities on the charts will lead you to the more popular indicators like a moving average, relative strength index or RSI, the moving average convergence divergence or MACD, or a Stochastic type indicator that shows you how markets oscillate up and down. The common thread of these types indicators is that they use a recent close of past price candles to hopefully anticipate immediate action to follow.

Looking Backwards

There is nothing wrong with looking at the last several periods in the market to determine aspects like whether the markets are trending or ranging. That is the often the best method to get the context for what is most likely the current state of the market. However, entering trades may be better done through price reacting to a leading indicator.

Learn Forex: Moving Averages Can Give Context But Aren’t Predictive By Their Nature

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Leading Indicators

There are a handful of leading indicators that could not be given their due justice here. However, it’s important to know of the popular ones so that you can find one that works well with your current form of analysis. The basic function of a leading indicator is to help you see how price could unfold.

Pivot Points

Pivot points are a personal favorite because they are the most objective of leading indicators. Pivot points are taken from critical past price points and then a calculation is plotted on the chart to give you three key levels. The pivot point sits in the middle of the calculations with resistance points or profit targets for buy trades above the pivot point and support or profit targets on sell trades. Therefore, if you believe EURUSD is likely to move higher you could target the green resistance levels and put a stop below the lower support level that matches your risk management rules.

Learn Forex: Pivots give you objective points to target with your trade.

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Elliott Wave

Elliott Wave is a theory about the market in how trends and corrections unfold. The main arguments are that a trend subdivides into 5 waves with each wave displaying distinct characteristics. The leading nature of Elliott Wave comes in its use of Fibonacci ratios. If you’re unfamiliar with how to trade Fibonacci relationships, you can register for this FREE online course HERE. One common ratio that is used to define a profit target is that wave 5 often travels 61.8% of the distance covered in waves 1-3.

Learn Forex: Elliott Wave is very helpful for gathering context of the market

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Sentiment

Trading with sentiment may seem counter intuitive at first. That is because a trading signal comes from reading sentiment by taking a trade in the direction of the trend but is opposite against the majority of traders or investors. Therefore, if there is a strong uptrend but the majority of traders are short or selling, then you would look to enter against the majority and trade in the direction of the trend.

Learn Forex: Don’t Fight the Trend & Don’t Follow the Herd

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The reason that sentiment is considered a leading indicator is that it is used on the premise that all things being equal, a trend will continue and traders who are fighting the trend will only prolong its existence as they exit their trades against the trends to prevent themselves from losing more capital.

LearnForex: The DailyFX Speculative Sentiment Index Is our Sentiment Tool of Choice

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Presented by dailyfx.com/technical_analysis/sentiment

The Speculative Sentiment Index or SSI is updated twice a day for FXCM or DailyFX Plus account holders. Otherwise, it is updated once a week. This information can be very helpful in giving you an edge during a strong trend.

Closing Thoughts

There are no perfect indicators. By their nature, an indicator will help you see likely outcomes; however, you shouldn’t seek certainty because it does not exist within indicators. Leading indicators can be a helpful addition once you know how to use them to capture an edge in your trading and hopefully this article has made you more comfortable in accessing these great options.

Happy Trading!

-Written by Tyler Yell, Trading Instructor

To contact Tyler, email tyell@fxcm.com.

To be added to Tyler’s e-mail distribution list, please click here.

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15 August 2013 03:00 GMT