i. Indicators give buy and sell signals to traders
ii. Two types - leading and lagging.
iii. Different indicators have different purposes. It is important to use the right indicators for the right purpose.
iv. All indicators do not lag.
Indicators are nothing but calculations applied to the price. There are different types of indicators and each indicator should be used for the right purpose only. Most indicators are lagging indicators, but there are some if used right, that can be leading indicators.
Everything you need to know about technical indicators
Indicators basically are tools that technical traders make use of in order to get buy and sell signals and to capitalize on the price swings.
Technical indicators are mainly sets of calculations and formulas that are applied to past price and volume data and the output being signaled on which traders take trades.
But, are all technical indicators the same? No. There are mainly two types of indicators, leading indicators, and lagging indicators.
Leading indicators are those types of indicators that take into consideration what is happening at the moment, which can influence the price.
Lagging indicators deal with things that have already happened in the past. It studies the past in order to find something that can indicate something in the future.
Different indicators have different purposes
I am sure that by now you will have understood what indicators are and the all indicators aren’t the same.
Now, before I move on, I want to ask you a question, how can you determine the winner of a football match or even a cricket match?
I am sure you would look to study past data of how players performed against various teams and in different match conditions and you will try to analyze the different factors in order to arrive at a conclusion. This is what a lagging indicator does.
Now, what if I ask you which player is going to be substituted in the football match.
To answer this, yes, you can fetch data of how the team manager normally makes substitutions and you can find out which player has the manager always substituted between the match. But this approach might not always work.
In order to know which player will get substituted, you will have to see which player is performing badly in the match and might be a liability for the team.
This can be done only if you are watching the match and you know which player is playing up to the mark and which one is not doing good at that moment. This is exactly what leading indicators do.
So, before you apply any indicator to the price chart and you want to get trade signals that you can act on, you first need to know about the indicators that are there at your disposal and you also need to know what exactly you are looking for.
As I have already mentioned that all indicators are not the same. Different indicators have different functions, inputs, and outputs. If one indicator lags then it is not necessary that another indicator will also lag.
Understand what you are dealing with and also figure out what you are expecting for and then only should you move forward.
Use indicators the right way
You might have the best tools possible at hand and might have all the other necessary resources at your disposal, but if you don’t know how to make use of all of it, then it is just going to be a waste.
If someone gave you a measuring tape to measure the weight of something then I am sure you will laugh at them.
In the same way, if a trader sees someone using an indicator for the wrong purpose, then maybe he wouldn’t like what he saw.
Like I mentioned above, different indicators have different inputs and outputs and they should be used only in the right conditions that are favorable to them.
Let us consider moving averages. Do you think moving averages will be better in ranging market conditions over trending markets? Absolutely not. Moving averages are made to be a trend riding tool and should only be used that way.
Now, if you want an indicator for ranging market conditions then you should use the RSI indicator for divergences.
Yes, you can spot a divergence on the RSI indicator that made you enter on a reversal and it is quite possible that this reversal became a fully-fledged trend. Win-win situation isn’t it?
Now that you know which indicators should be used in which market conditions, you should know whether the indicator is a leading one or a lagging one.
RSI divergence is a leading indicator as it gives you a trade signal based on what exactly is happening in the market at that particular moment. You can then take this signal and enter into trades, have the right trade plan for it, and maybe make a decent profit for yourself.
When it comes to moving averages, it could be both a leading and a lagging indicator based on how you use it.
If you take a moving average crossover signal, then this will be a lagging indicator. But if you use moving averages to trade pullbacks and continuations, then you have a leading indicator at hand.
Don’t fall for such myths
My main intention for this blog post was to tell you to stop falling for myths, be it trading or in life in general. There will always be someone or the other saying things and giving rise to myths.
There could be two things here, either they haven’t used it yet and don’t even know what they are talking about or maybe they used it but not correctly, hence did not get what they were expecting and chose to say negative things about it.
Whenever you hear any such claims made by people, you should first understand on what grounds are such claims made and if possible, you should test things out for yourself and then arrive at a conclusion.
Now, I have heard people say a lot of negative things about moving averages, divergences, and other things in trading, but did it stop me from using it or getting into it? Nope.
Instead of falling for such myths, I looked to test these myths for their credibility on my own and if I find out that it is nothing more than a myth, well, I may just use it to profit in the markets.
What if you fall for such myths and do not try it out yourself, you might just miss out on the very thing that can make you a consistently profitable trader. This is too big a risk to take.
What do you think?
I am hoping that you realize what exactly is happening and you understand that you should not blindly believe what others say and you must try things out on your own before you arrive at any conclusion.
Do let me know what you think about indicators and whether you use them in trading or not.
Share this blog post with other traders and save them from falling for such myths.
Feel free to reach out for any questions or anything in general through the comments section and I will get back to it for sure.