Lagging or Leading Indicators.

Nirav asks: “As you have said that Moving Avg. is a laggin indicator as it uses past price data. So does it mean that all the indicators are ladding indicator as they use past prices? And if they are lagging indicator than which are leading indicators or what can be used as a leading indicator or to forecast the trend? Are price patterns or candelstick formation are the leading indicators? ”

My Notes:
Technical indicators are derivatives of price action. This is good and bad, both. It is good because the indicator will more or less reflect what price does. It will not go its own way. It is bad because, they are likely to lag price action. This means that while indicators tend to be correct, they also tend to be late.

Indicators can be divided in two parts. Trend indicators like moving averages, MACD, identify the direction of the market, the trend. These are almost always lagging, meaning that the trend has already started when the indicator gives a signal. When there is a long trend, this does not matter much, since the indicator will capture a good part of it, inspite of being late. But, when the trend is short, the indicator gets in late and gets out late causing whipsaws.

Momentum indicators like, ROC, stochastics, RSI are leading indicators. Rather than measure price directly, momentum indicators measure the ratio between buying and selling strength. They alert traders on overbought/oversold, divergences and crossing of middle lines, all of which are leading signals. The alert is given before the actual event. As most traders know, many of these signals do not work out, while those that do let you sell at the very top and buy at the very bottom.

Candlesticks are also leading indicators.

It is the task of the trader to understand the nuances of trend, momentum and candlesticks patterns in different trading environments. This is usually many years of study. Patience has its own rewards.