We’ve covered a lot of tools that can help you analyze charts and identify trends. In fact, you may now have too much information to use effectively.
In this lesson, we’re going to look at streamlining 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 your trading plan…and which ones don’t.
Leading versus Lagging Indicators
Let’s discuss some concepts first. There are two types of indicators: leading and lagging.
A leading indicator gives a buy signal before the new trend or reversal occurs.
A lagging indicator gives a signal after the trend has started and basically informs you “hey buddy, pay attention, the trend has started, 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’s not.
When you use leading indicators, you will experience a lot of fake-outs. Leading indicators are notorious for giving bogus signals which will “mislead” you. Get it? Leading indicators that "mislead" you? Ha-ha. 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. Which sucks.
Oscillators and Trend Following Indicators
For the purpose of this lesson, let’s broadly categorize all of our technical indicators into one of two categories:
- Trend following or momentum indicators
Oscillators are leading indicators.
Momentum indicators are lagging 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.