There are two types of indicators: leading and lagging.
- A leading indicator gives a 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 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 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?
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.
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.
Without getting into more deep, if you look at the definitions of them, you can see all oscillators like RSI, Stoch, PSAR are leading indicators.
Bollinger Bands, Moving Averages (SMA, EMA, DEMA,..), MACD are lagging indicators.
Typically, I look for my lagging indicator or coincident indicators on a higher time frame. Then I combine that indicator with my leading indicators on a lower time frame.
There is a huge battle over the definition of indicators. Famous technical analysis trader (Fibonacci trader) Joe DiNapoli. puts RSI, Stoch as lagging indicators.
That’s why we use Stochastics in our trade setup. The whole story is just because of this line.