The effectiveness of trading indicators has long been a contentious issue among traders. While some traders insist that indicators are useless and a complete waste of time, others view them as market oracles that can be utilized to constantly make money in the market.

However, the truth is that both sides of this debate are incorrect. Trading Indicators provide the best signals when used properly. Let’s investigate how this operates.

Indicators as technical tools

Like any professional, traders employ tools to aid in decision-making and work completion. Indicators for trading are only one of several tools available to traders, along with charts, order books, and news, to name a few.

One tool will not suffice to complete the task, as you could expect for the majority of other tasks. Instead, you would frequently combine different tools. And we are all aware that certain tools function well in various settings. Naturally, trading indicators follow the same rules.

While some indicators may perform admirably in markets that are neatly progressing with occasional, obvious price reversals, the same indication typically produces terrible results when the market shifts and becomes more “choppy.” The moving average indicator, which is frequently employed by trend-following traders but is infamous for generating misleading signals in volatile markets, would be a typical indication in this situation. 

Figure   Moving Averages (MA) are renowned for giving erroneous signals in choppy market situations, but they perform well in trending markets. Many trend-following traders use moving average crossover strategies (red circle), which are also very common.

Other indicators, like the Relative Strength Index (RSI), can shed light on whether markets are overbought or oversold and are therefore frequently helpful in forecasting price reversals. However, it’s also true that a market, particularly during powerful movements, can remain in an overbought area according to the RSI for a considerable amount of time. As a result, this is likewise a risky signal to rely on as an oracle that can always be believed.

In any market, the Relative Strength Index (RSI) is frequently used to indicate “overbought” or “oversold” circumstances. An RSI number above 70 indicates that a market is overbought, whereas a score below 30 indicates that a market is oversold. Keep in mind, however, that markets can remain in either overbought or oversold territory for a long time.

You now see that it is not as straightforward to declare that one indicator works while another does not. In actuality, all signs occasionally perform and occasionally stop performing. Sadly, no one has yet found the elusive indicator that consistently makes money in all market situations. And even if it did exist, it would stop working as soon as enough people became aware of it.

As a result, trading indicators only work when used appropriately. It’s crucial to understand that there are some significant distinctions between the indicators in order to understand that. The most significant of these variations is that some indicators are seen to lag behind price changes while others lead them.

LEADING INDICATORS

Leading indicators are for you if you believe that the whole goal of trading is to enter the market before a new trend emerges. These are additional signs that may be used in addition to historical price history, which, as we all know, is not always a reliable prediction of future pricing.

Along with other oscillator indicators, the RSI and Stochastic indicators, which are also referred to as oscillators, are typically regarded as leading indicators. This is due to the fact that these indicators, which determine whether the present trend is gaining or losing momentum, might predict a shift in trend direction before it really occurs. You’re undoubtedly wondering now why leading indicators like these two aren’t used by everyone.

Leading indicators can indicate a shift in trend direction, but they don’t always work, is the response to that question. To put it another way, leading indicators are susceptible to misleading signals, which is why they shouldn’t always be relied upon and should only be used with caution.

But many of these erroneous signals may be removed using certain strategies, which leads us to lagging indicators.

LAGGING INDICATORS

As you might have guessed, lagging indicators are those that follow market price changes. Because they can tell you whether or not the market is heading in a particular way, these indicators are sometimes referred to as trend-based indicators.

It’s important to keep in mind, however, that a trend indicator won’t give you a signal until the new trend has already begun, making it hard to predict the precise tops and bottoms of the market. You would instead be going for the portion of the motion that is in the center, in between a bottom and a top.

However, one intriguing application of lagging indicators is to validate signals from a leading indicator. For instance, after receiving a purchase signal from one of the leading indicators, you may wait for a lagging indicator to validate the signal by demonstrating that the market is truly trending upward.

By waiting for secondary confirmation from a lagging indicator, you can reduce some of the numerous erroneous signals generated by leading indicators. Whether trading strategies are created using this method for the forex, stock, or crypto markets, they have the potential to be highly effective trading methods.

Moving Average (MA) and other well-known indicators like Bollinger Bands (BB) and the MACD are among the most famous lagging indicators (Moving Average Convergence-Divergence).

Conclusion

The most crucial lesson to learn about trading indicators, though, is that no one indication can, by itself, ensures that you will always trade profitably. Instead, there are several indications, each of which has advantages and disadvantages. While some of them might function effectively at some periods, at other times they might utterly fail.

Therefore, combining several indicator types, particularly leading and lagging indicators, to create a strong trading strategy that eliminates as many false signals as possible is the ideal method to employ technical trading indicators. You have a possibility of providing yourself a real competitive edge in the market by doing that, one that is founded on statistical probability rather than luck and intuition.

Have fun trading!

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