Forex traders use a multitude of data to determine their strategies. One practice that is quite common is the use of price-action “indicators.” Traders use these chart signals to determine where prices are headed, helping them to better time entries and exits into trades.
For the majority, there are two common types called lagging or leading indicators. Leading indicators signal when a trend or reversal is happening. Therefore, they enable traders to enter a position before the trend and capture all of the profits of that trend. Lagging indicators, on the other hand, signal that a trend has already begun. Using lagging indicators, a trader can enter a position with the trend.
So what’s the difference between the two? And is it better to use one or the other?
Leading Indicators in Forex Trading
The majority of major currencies trade within a range, as prices move from low to high or high to low. In other words, the currency pair is moving sideways. Leading indicators are most effective when a currency pair is moving within a predictable range.
Ultimately, these indicators signal when the price is nearing the top or bottom of the trend. When a currency pair nears the bottom of the range, it is considered “oversold,” and it is likely to reverse the trend. The opposite is true when it reaches the top of the range. The currency is “overbought.” Whatever type of indicator that you use, will signal a buy or sell call when the trend is at its peak.
There are many different types of leading indicators that can reveal buy and sell signals, including the Relative Strength Index, Stochastics Oscillator and the Parabolic SAR.
Lagging Indicators in Forex Trading
Lagging indicators “lag” behind the trend and do not predict new trends. Instead, these indicators are used to confirm a trend. These indicators are more useful when a currency pair is trading outside of a range and are ideal for longer-term trends.
For example, if the value of a currency pair is expected to continue in one direction for a longer period of time, a lagging indicator can be used to confirm the trend has begun. A trader can then confidently enter the trade. The two most common lagging indicators are moving averages and the MACD.
Are Lagging or Leading Indicators Better?
Both leading and lagging indicators have pros and cons. First, both can be used to help determine entry and exit points, but there is no guarantee they are right. “Whipsaws,” or false indicators, can fool these systems, and a trader might open a position in the wrong direction.
As for leading indicators, the ability to enter a trade before a trend has begun is the greatest advantage. Using a leading indicator, for example, a trader could open a position just as the trend begins, and capture the entire trend in profit. Yet, leading indicators do leave traders open to risk, as a whipsaw can give a false buy signal.
Lagging indicators, on the other hand, help traders avoid whipsaws, but in turn, the trader is more likely to miss out on profits. For example, the buy signal is given after the trend has started, and then, the sell signal is given after the trend has reversed. In other words, the trader misses out on profits at the start and end of the trend.