What is a Leading Indicator.

Mario writes:
“how do you derive leading indicators for any chart? I have been reading John Murphy, but whatever he says as leading indicators (like MACD) have now turned out to be laggging indicators. Kindly help”

Interesting question.

Investopedia defines this as: “A leading indicator precedes price movements, giving them a predictive quality, while a lagging indicator is a confirmation tool because it follows price movement. A leading indicator is thought to be the strongest during periods of sideways or non-trending trading ranges, while the lagging indicators are still useful during trending periods. ”

Therefore, a leading indicator is useful during trading ranges. Now, how do we know that we are in a range? This information is available only after some time has elapsed. So, we start using leading indicators after we perceive that prices are in a trading range. It is possible that the range may be getting over by the time we decide to use leading indicators. Therefore, a leading indicator may finally result in a whipsaw. All in all, there is confusion.

Since most indicators are derived from price, they cannot step ahead of price and predict it. Predicitve indicators must be non-price methods, like Fibonacci, Cycles, Waves. These tools use price as one of their inputs, while MACD, RSI and so on use price as their ONLY input.

For this reason, Fibonacci, waves, cycles are much in demand because they have this quality of telling us what future prices will be (If they are correct!). It follows that most of the time, these tools are not correct.

With indicators, leading indicators identify turning points, essentially acting as cycles.

How about this: If you perceive a trend has started, use lagging indicators like Moving Averages, MACD. If you assume we are in a trading range, use leading indicators like RSI, Stochastics, MACD. Yes, MACD can be used both as trend following and as a method to identify ‘overbought’ and ‘oversold’ levels. At turning points, you will get chopped, but there will be many trades where you will make money. Finally, your profits should exceed your losses.  Think about it.

Dull days in market

The Nifty continues to inch upward, with a bullish bias. We are around 5200 which is just 20% lower than the all time highs for the Nifty.

The market is also at the psychological resistance of 5180 – 5200.  Since the trend is UP, it is sensible to take trades in the trend direction. Our strategy is to search for dips to buy.A high risk, high reward trade is to buy puts since 5200 is a resistance area. By adjusting your volumes, it is possible to do both trades (for the PUT’s , keep volumes low).

Many charts show base building patterns. Perhaps, it is wiser to focus on individual stocks and ignore the movement of the Nifty.

In the Nifty scenarios, briefly discussed above, one possible scenario is for the Nifty to continue going up without any pause. We are likely to stay away if this happens. A dip or consolidation is required for taking a fresh long trade.

What will the New Year bring?

Well, extended trading hours for sure. We could easily continue with choppy market conditions as we move towards the union budget. A traditional pre budget rally is quite possible. Will that be the end of this up move? Maybe.

A New Year Resolution
One, focus on gaining epertise in one or two trading strategies. Two, write your trading journal, every day.

Have Fun!