In the world of Technical Analysis, where indicators are very common, a way of rate indicators and evaluate their value is essential.
We suggest choosing indicators by their predictive value - Leading indicators vs. Lagging indicators.
Lagging indicators are group of indicators who are generally Trend-Followers. That is, after a trend is prevailing for a certain amount of time (bars), the indicator identifies it and declares the trend. After a trend reverses, it will try to react and notify of the change in trend. These indicators are usually late in their entries - because they wait for trend to begin before it is declared. Even the earliest ones are hit by their extra-sensitivity which leads to whipsaws and big losses in ranging periods. These indicators are profitable in pairs with strong trends, and useless if price is ranging or flat.
Leading indicators are the master class of indicators - indicators that have predictive abilities and do not wait for trend to begin but predicts it. This group includes Bollinger Bands which provide strong reversal signals, Stochastic Oscillator, which attempts to discover overbought and oversold period, the DYNAMIC RANGE INDICATOR™, and more. These indicators are extremely powerful for several reasons. Not only they give you very early signals about trends likelihood of reversal, by their earliness they also provide us with comfortable places of putting Stop Loss orders, so our capital is preserved in case of loss.
Another reason is that most of the leading indicators are based on Support and Resistance, which are the most solid and proven mechanisms of Technical Analysis, and have been tested since the 1900s. That makes them a particularly high-quality signal to trade.
Leading Interpretation of Lagging Indicators
It is possible to interpret Lagging indicators in a way that produces leading signals. For example: Using a bounce of price off the Moving Average to generate signals. In this case, the Moving Average serves as Support or Resistance, and where price bounces of that level, it gives us a good signal to join the trend right after the retracement. Not only we have entered at a good turning-point, our stop loss is usually shorter and our Risk:Reward ratio is more reasonable.
DYNAMIC RANGE INDICATOR™ is a great Leading Indicator, producing profitable buy and sell signal. Read more about it here!