Date: April 11, 2017
Types of Indicator
There are basically two types of Indicator, the Leading Indicator and the Lagging Indicator. There are advanced indicators such as trading bands and volume or volume adjusted indicators.
Leading Indicator
Leading indicators are designed to lead price movements. Most represent a form of price over a fixed look-back period. A small price change will affect the leading indocator. Example the Relative Strength Index (RSI), and Stochastics. Benefits of leading Indicator include providing Early Entry/Exit Signals and provide good signals in Trading markets. The drawbacks are Whipsaws in trending market provides bad signals and does not provide good signals in Trending Markets.
Lagging indicator
Lagging indicators follow the price action and are commonly referred to as trend-following indicators. Rarely, if ever, will these indicators lead the price of a security. Trend-following indicators work best when markets or securities develop strong trends. Examples are Moving Averages and MACD. Benefits of Lagging Indicator include eliminating whipsaws and it follows trending markets price. Drawbacks are Slow Entry and Exit Signals.
Trading Bands
Trading bands are upper and lower border lines created from an indicator, normally moving averages. . The basic trading band would be a moving average with two other moving averages plotted below and above the moving average in parallel. The distance between the moving average is normally in a percentage. A good trading band would have the prices traded withing the trading band (within the upper and lower lines). A more advanced trading band, such as the bollinger band, uses standard deviation of the moving average to create the upper and lower band.
Volume
Volume, if used as a primary indicator will not be useful. However, if combined with other Indicators, it will be an important indicator. Normally, Volume is used to confirm or validate an Indicator or Chart pattern.
Leading vs Lagging Indicator
The chart above shows Singapore’s STI Daily Chart from Dec 22, 2000 to May 2 2001. From Dec 22, 2000 to March 9, 2001 (3 months) the prices formed a trading range (meaning that the trading sideways) and from March 9, 2001 onward, the prices form a trending range, which is a downtrend.
Note that during the trading range, the Moving Average (Lagging Indicator) gives many signals and most of them are loosing trades. The Stochastics (Leading Indicator) however, shows buy signals at the near bottom of the range and sell signals at the near top of the range. This shows that the leading indicator works better in a trading range, and the bigger the trading range is, the bigger the profits.
However, during the Trending range, the moving average gives a sell signal during the beginning of a downtrend, and then a buy signal when a reversal occurs. The Stochastic however, gives a buy signal during the beginning of the downtrend, and provide few more buy signals during the downtrend. This indicated that the lagging indicator works better in a trending range.
