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What are leading and lagging indicators?


Leading indicators are those that help you to predict a new trend before it really gets going. Another term for leading indicators is “oscillators”. Lagging indicators confirm that a trend is happening, but only after it’s started. Lagging indicators are also called “momentum” indicators.


In general, leading indicators are the ones for getting in on profitable trends before other people, but they are not always reliable. Lagging indicators on the other hand are more reliable, but at the expense of a built-in delay.


What’s an example of a leading indicator (an oscillator)?


The Commodity Channel Index (CCI) is an example of a leading indicator. The CCI indicates whether a market (currency pair) has been overbought (prices are likely to plateau or decrease) or oversold (prices are likely to increase). It is based on a relationship between the price of a currency pair, the moving average of that price and “normal deviations” from that price. A normal deviation here means a limit within which you can expect pricing changes to occur.


What’s an example of a lagging indicator (a momentum indicator)?


The MACD (Moving Average Convergence Divergence) indicator that you met on the previous page is one example. At a different level, the Relative Strength Indicator can also be considered to be a lagging indicator. It’s designed to confirm overbought or oversold conditions in currency pairs and is calculated using the formula:


RSI = 100 – (100/(1+RS)),


Where “RS” is itself calculated by using a set number of days, and dividing the number of days that the currency closed up, by the number of days that it closed down.


What’s an example of a volatility (price spread) indicator?


Bollinger Bands indicate the volatility of an exchange rate, in other words the degree to which it “jumps around”. Graphically, a Bollinger band is formed by an upper line and a lower line, both moving from left to right. When an exchange rate is volatile, the band widens. When it is less volatile, the band contracts. Overbought situations are indicated when prices move closer to the upper band. Oversold conditions are indicated when prices move towards the lower band. Like support and resistance levels, the more prices approach either the upper or the lower land and then move back, the stronger these upper and lower levels become. Bollinger bands can also be “squeezed” as volatility all but disappears, before price breakout occurs either upwards or downwards.