To optimize your technical analysis, it is important to have a well-rounded arsenal of tools at your disposal. Technical indicators help an analyst identify ideal entry and exit points on securities, and determine or validate the likely direction and momentum of an investment.
Leading versus Trailing Indicators
There are hundreds of technical tools used by traders. However, it is impractical and distracting to attempt to become familiar with them all. Most traders identify a few “leading indicators” and a few “trailing indicators” they like and stick to those.
Leading indicators are tools intended to help in projecting a profitable trading opportunity as soon as possible. Traders often set alerts so that they are notified when a monitored investment reaches an ideal entry or exit point based on analysis from a leading indicator.
Trailing indicators evaluate data, trends and momentum as action is in progress. Because of this, it is often difficult to gain ideal entry or exit just by using a trailing indicator. However, a combined approach of leading/trailing indictors, charting and other analysis yields insights that support decisions and enable you to validate what you initially see. Conservative traders would likely watch for trailing indicator validation after a trendline break or other such occurrence.
Leading Indicator Examples
Your broker or trading platform likely categorizes trading tools into “leading” and “trailing” categories, and/or more specifically into certain sub-types.
The following is a list of some of the more popular leading indicator tools. Each tool is discussed in more depth in a separate post.
- Relative Strength Index (RSI)
- Momentum Oscillators
- On-Balance Volume
Trailing Indicator Examples
The following are some of the more popular trailing (also called lagging) indicators used by traders:
- Moving Average Convergence-Divergence (MACD)
- Bollinger Bands
- Average Directional Movement (ADX) and Directional Movement Indicator (DMI)
Using Technical Indicators
Technical indicators are best used in conjunction with standard charting methods. Brokers typically allow you to add technical indicators below a chart, or you can “overlay” them onto a chart to compare trends within indicators to the price trend. In fact, one of the best ways to utilize technical indicators is to compare technical trends and momentum to price. Spotting divergence between price and indicators is helpful in identifying potential trend breaks early. Learn more about trading with divergence in a separate post.
Each indicator has its own features. However, standard elements include a graph or layout that illustrates direction and/or momentum (usually with lines) over a period of time. Tools often have “signal lines” that establish a basic divider between bullish and bearish indications.
Conclusions and Recommendations
As noted, it is best to integrate technical indicators into a broader approach to technical analysis. As you read and learn more about each indicator, select one or two leading indicators and one or two trailing indicators. Attempting to use multiple indicators of the same type is redundant and confusing. However, you might need to play around with several to figure out which you like best, which seem most intuitive for you, and which are most helpful to your decisions.
While certain indicators are naturally better than others, traders normally establish preferences. The right tools for you depend somewhat on your individual trading strategy and the way your mind works. Ideally, you gain comfort with certain indicators and your use of them transitions from conscious to subconscious, or instinctive. For instance, I typically scan the full screen with my chart and preferred indicators and can naturally perceive a sense of direction and potential movement.