The indicators that you are looking at, do you know if they are leading or lagging indicators? Does it matter to you? It should.
There are MAJORdifferences between leading and lagging indicators that you need to know about. If you are going to use the data produced by indicators to act on the markets, then you need to know what those indicators are trying to tell you as far as the information that is presented.
The Difference Between a Leading and Lagging Indicator
A leading indicator is always designed to attempt to predict a movement up or down before that action happens. They are less accurate because they are intended to try to predict the future. However, they may prove more useful to you as a trader simply because they can be deployed to try to figure out where the next set of candles is likely to go in the future.
Lagging indicators are more accurate in the data that they provide, but they are also molding information based on data that has already happened. So, they may be useful for showing how the market has behaved in the past to similar conditions that it is under right now, but they are not necessarily extremely useful for predicting the future movements.
Why Each Type May Be Useful
There are pros and cons to each type of indicator, and you should not assume that one is always better than the other. It all depends on what the situation is that you are looking at, and how you prefer to trade. When you go over factors like this, you should try to carefully consider the various elements that can come into play as they relate to your risk tolerance and other factors.
Leading Indicators (or Oscillators)
Leading indicators are great in that they try to get you into the movement of a trade as it is first happening. If the indicator is correct, then you can jump into a trend as it is first starting to form. You can potentially profit a lot more on each trade when these indicators are correct. However, they are often going to be wrong, and there is some potential that you will buy or sell something based on these indicators that doesn’t work out how you had hoped.
Lagging Indicators (or Trend-Following Indicators)
Lagging indicators provide you with more certainty that your trade is correct, but they do so at the cost of being late to the trend. In other words, you take less risk of being wrong about where the trend is going, but you take more risk of being late to the party. Thus, you may miss out on some of the biggest moves of the trend because you got caught at a time when the trend had already played out. You are left holding the bag, and you would have done more if you had jumped in earlier.
You must decide which indicators or combination of indicators are right for you, and then you must act on them based on the information provided to you. Try to limit the number of indicators that you use, but make sure you keep it consistent how you use the different ones from one trade to the next.
The conventional approach is that traders use lagging indicators during trending markets — when the market is moving up or down — and leading indicators during sideways — or ranging — markets.