The purpose of this lesson is to divide the technical indicators we have learned before into two categories:
- Leading indicator or oscillator
- Lagging indicator, trend following indicator, or momentum indicator
- Although when we use these indicators to guide our trading, we can learn from each other’s strengths and weaknesses when choosing these indicators, but the two types of indicators are likely to conflict with each other. We are not saying that we should use one or the other indicator alone, but you should understand the potential shortcomings of each indicator.
Leading indicator (oscillation indicator)
The expression form of the shock indicator is an indicator that the indicator value fluctuates up and down between the set horizontal values or around a center line. Oscillation indicators can remain at an extreme level (oversold or overbought) for a long time, but they will not maintain the trend and the direction will remain unchanged.
RSI indicator, parabolic turn indicator and stochastic indicator are all oscillating indicators. Each indicator may send a potential reversal signal, and this may herald the end of the previous trend and the change in the direction of price movement.
Now, let’s look at some examples.
We use all three indicators on the GBP/USD daily chart. Remember what we said before, how to use RSI indicator, parabolic turn indicator and random indicator related knowledge?
As shown in the figure below, all three indicators send a buy signal at the end of December. If you seize this trading opportunity, you will have about 400 points in the account.
Subsequently, in the third week of January, the RSI indicator, the parabolic turn indicator and the stochastic indicator all issued sell signals. Judging from the three-month-long decline in price since then, if you choose to go short when the signal is issued, you may have received a considerable return.
In mid-April, the three indicators subsequently issued a sell signal again, and since then, the exchange rate has fallen rapidly again.
Now, let us look at another example of the combination of three leading indicators. This time, you will see that the signals sent by these indicators are not perfect.
As shown in the figure below, you will see that the above indicators may give conflicting signals.
For example, in this example, the Parabolic Shift indicator issued a sell signal in mid-February, while the signal from the stochastic indicator was the opposite. Which signal should you follow for trading?
Of course, at this time, the RSI indicator has no idea like you, because it does not send any signals about buying or selling.
As shown in the figure above, you can easily see that the above indicators sent quite a few false signals.
In the second week of April, both the Stochastic indicator and the RSI indicator gave a sell signal, while the Parabolic Shift indicator gave no signal. The exchange rate continued to climb, and if you choose to short at this time, you may have suffered a lot.
If you only buy more signals from the stochastic and RSI indicators and ignore the sell signals from the parabolic turn indicator, you may also suffer losses again in mid-May.
What happened to such indicators?
The answer lies in the method of calculating the above indicators.
Stochastic indicators are calculated based on the highest and lowest prices over a period of time; the RSI indicator is calculated based on the closing price of the price; the parabolic turn indicator has its own unique calculation method, which may cause the signal sent to be more confusing .
This is the characteristic of the shock indicator. They assume that a particular price movement always results in the same reversal. Of course, this is impossible.
In addition to recognizing that leading indicators may send wrong trading signals, we cannot avoid these indicators sending wrong trading signals.
If you find that the signals they send are inconsistent, you’d better do nothing, not just bet on your instincts. If the graph does not meet all your criteria, don’t force trading.
Still wait for the next time, when all indicators meet your trading standards and then choose to trade.