Lagging indicators guide for Forex traders

Technical indicators are essential for conducting a technical analysis. Indicators are grouped in two main categories. You can find leading and lagging indicators to trade Forex. Leading indicators give trading signals to traders before reversals or new trends are established.

Lagging indicators improve market visualization and make analysis easier. We’ve picked some of the most widely used lagging indicators for our guide. Let’s learn what they are and how to use them.

Core features of lagging indicators

• Lagging indicators trail the price action of an underlying asset and are useful for generating trading signals for market participants
• The predictive features of lagging indicators are not as strong, therefore, they are often used in conjunction with other indicators for maximum accuracy
• Some lagging indicators serve a dual function and can also be used as leading indicators in some scenarios
• Lagging indicators make information easier to digest

Difference between lagging and leading indicators

Lagging and leading indicators are two distinct types of technical indicators that are often used in Forex trading. Forex trading lagging indicators improve information digestion by making visually presenting what is currently happening in the market. Leading indicators predict future price action. For instance, a Stochastic oscillator predicts that price will reverse after the oscillator reaches overbought/oversold conditions. Predictions do not always come true. Price might start trending, leaving the oscillator in an overbought/oversold state for an extended period.

SMA indicator

Simple moving averages, or SMAs, are some of the most frequently used fx lagging indicators. In forex trading, SMAs are used by both long-term and short-term traders. However, Exponential Moving Average (EMA) indicators are more popular than SMAs.

SMA definition and core features

• Simple moving averages are used to smooth out the market noise caused by price volatility to present a clearer picture of evolving price trends over a set period of time
• The time frames used for simple moving averages are variable, but the most popular period is over 20-days
• The SMA can also be used to plot support and resistance lines, depending on the type of trend traders are trying to identify
• Simple moving averages can be susceptible to sudden spikes, which can send out false signals to traders
• The longer the time frame of a simple moving average, the greater the lag

SMA calculation

The formula for calculating simple moving averages is as follows:

SMA = (A1 + A2 +…+ AN)/N

Where:

AN = The price of an asset at period N

N = The total number of periods

For example, for a sample size of 20 periods, a 10-day simple moving average would calculate the average closing prices for the first 10 days of the sample set and use it as the first data point. The next data point would add the price from day 11 and calculate the average. The same would be done for any number of periods.

A 200-day simple moving average is a popular option used by traders, but it comes with its fair share of downsides. Too many traders could be using it simultaneously, in which case there is a risk of limited price growth.

EMA indicator

The exponential moving average, or EMA, is a type of moving average that places a greater emphasis on the most recent price points, unlike the simple moving average, which assigns an equal weight to all periods used in calculation. EMAs are highly popular lagging indicators fx traders use.

EMA definition and core features

• EMA is a subset of moving averages that places a greater value on recent price points for more accuracy
• The indicator is placed on top of the chart, much like other moving averages
• The exponential moving average is often used alongside the moving average convergence/divergence (MACD) indicator
• The timeframe most commonly used by short-term traders is between 12 and 26 days, while long-term traders prefer 50-200 day EMAs
• When the price of a pair crosses its 200-day EMA, it is indicative of a major trend reversal
• EMAs, much like other moving averages, are most suitable for markets with strong, easily-identified trend formations. EMAs are trend trading indicators

EMA calculation

To calculate an exponential moving average, traders need to have the following data available to them:

• The current price of the asset at the point of calculation
• The EMA from the previous day
• The timeframe for the EMA
• A multiplier (which is commonly set at 2)

Once we have this information, we can move on to the formula, which is as follows:

EMA = Price(T) x K + EMA(Y) x (1-K)

Where:

T = price today

Y = yesterday’s EMA

K = 2/(N+1)

N = number of days in the EMA

EMA example in forex

To better understand how exponential moving averages function in forex trading, let’s look at EMA lagging indicators examples. We will use 20, 50, 100 and 200-day EMAs in this GBP/USD example.

The exponential moving average follows the price chart much more closely than the simple moving average.

While this example shows four different EMAs plotted on the price chart, most traders use two different timeframes to construct a crossover strategy.

20 and 50-day EMAs are especially popular among traders. When the 20-day EMA crosses the 50-day EMA from above, it may indicate the start of an uptrend. If the 20-day EMA crosses the 50-day EMA from below, this implies increased selling pressure and may be followed by a downtrend.

MACD indicator

The moving average convergence/divergence is another trend-following technical indicator that is widely used in forex trading. The MACD shows the relationship between two EMAs, where one uses a long timeframe and the other uses a short one. The long EMA is subtracted from the short EMA.

MACD definition and core features

• The MACD is a trend-following momentum indicator that compares two EMAs with different timeframes
• The MACD can serve as both a lagging and a leading indicator
• Long EMAs often use a 26-period timeframe, while short EMAs use a 12-period timeframe
• The MACD is often used alongside the stochastic oscillator
• The MACD is plotted below the price chart
• A 9-period EMA of the MACD line is called the signal line, which is plotted on top of the MACD line and sends out buy and sell signals for traders
• The MACD is used to signal whether an asset is overbought and oversold and to determine a potential price reversal

MACD calculation

Calculating the MACD is a relatively straightforward process. We start by calculating the 12-period and 26-period exponential moving averages (EMAs).

EMA = Price(T) x K + EMA(Y) x (1-K)

Where:

T = price today

Y = yesterday’s EMA

K = 2/(N+1)

N = number of days in the EMA

MACD = 12-period EMA – 26-period EMA

After calculating the MACD, we can place it on a histogram and plot the 9-period EMA as the signal line. The signal line is customizable and can be fitted to the demands of your strategy. Each bar shown by the histogram is the distance between the signal line and the MACD line. When the MACD goes above the signal line, the bars will be green, when it goes below the signal line, the bars will be red.

MACD example in forex

To visualize how the MACD works is forex, let’s look at an example of the indicator plotted below the GBP/USD price chart.

The MACD plotted below the price chart shows the points where it crosses the signal line from above and from below. The value assigned to the MACD can either be above or below 0. When above, the shorter EMA is higher than the long one, and vice versa. When the MACD is above the signal line, this can indicate an uptrend, when it is below the signal line, this indicates a downtrend.

Bollinger® bands

Bollinger Bands are technical indicators that consist of trendlines that are plotted two standard deviations away from a SMA of the price of an asset. Bollinger Bands are used to identify whether an asset is overbought or oversold on the market.

Bollinger Bands definition and core features

• Bollinger Bands are usually plotted two standard deviations away from a simple moving average of the price, though this can be customized and SMA can be substituted by an EMA
• Bollinger Bands are plotted along the chart and not below, like other lagging indicators
• A 20-day simple moving average is most often used with Bollinger bands
• The Bollinger bands will expand or contract, depending on the volatility on the market
• The upper and lower bands are designated price targets that the bands are supposed to touch to generate buy and sell signals
• Support and resistance lines are often used alongside Bollinger bands to identify buying and selling points

Bollinger bands calculation

Most trading platforms will offer indicators, such as Bollinger Bands, in a finished state and ready to apply. The simple moving average is the first metric that needs to be calculated. To find the indicator value, let’s look at the formula:

BOLU = MA (TP, n) + m * σ [TP, n]

BOLD = MA (TP, n) – m * σ [TP, n]

Where:

BOLU = the upper Bollinger band

BOLD = the lower Bollinger band

MA = moving average

TP = typical price = (High + Low + Close)/3

N = number of days in smoothing period (20)

M = number of standard deviations (2)

σ [TP, n] = the standard deviation over last n periods of TP

Bollinger bands example in forex

To see how Bollinger bands work in practice, let’s look at the indicator plotted alongside the GBP/USD chart.

The periods when the price frequently touches the upper Bollinger band can indicate overbought signals, while periods when the price touches the lower band indicate an oversold signal.

ADX indicator

The average directional index, or ADX, is an indicator that measures the strength of a prevailing market trend. ADX is useful in evaluating the price momentum of an asset to understand whether a significant trend is forming or not.

ADX definition and core features

• ADX is a directional movement indicator that measures the strength of a trend and assigns a value of 0 to 100
• ADX is used in conjunction with the directional movement index (DMI), which consists of the positive and negative directional indicators, -DI and +DI
• ADX is often used alongside the MACD indicator
• The ADX indicator is plotted below the price chart and falls within the range of 0 to 100
• Use of daily charts is most suitable for ADX
• The standard timeframe used for ADX is 14 periods
• ADX solely measures the strength and not the direction of a trend

ADX calculation

Calculating the ADX indicator involves multiple steps. The first step is to calculate the positive and negative directional movements as follows:

• Calculate the true range, +DM and -DM for each period
• The resulting values need to be smoothed using Wilder’s smoothing technique
• Divide the 14-day smoothed +DM by the smoothed 14-day true range to find +DI14. Multiply the result by 100
• Divide the 14-day smoothed -DM by the smoothed 14-day true range to find -DI14. Multiply the result by 100
• The absolute value of +DI14 minus -DI14, divided by their sum and multiplied by 100 is the value of the directional movement index, or DMI
• The final step is to calculate the ADX line. The first ADX value is equal to a 14-day average of the DMI. Subsequent ADX values are smoothed by multiplying the value of the previous 14 days by 13, adding the last DMI value, and dividing the sum by 14

ADX example in forex

To see how ADX works in practice, let’s look at an example of the GBP/USD pair, with the ADX plotted below the price chart.

The ADX values show the strongest and weakest trends on the market. The general rule of thumb is that:

• ADX between 0 and 25 is a weak trend with a high likelihood of a false breakout
• ADX between 25 and 50 is a moderate trend
• ADX between 50 and 75 shows a strong trend
• ADX between 75 and 100 shows a very strong trend with a high likelihood of a breakout

The ADX values between 75 and 100 can be rare and usually follow significant market developments, such as important economic news reaching the market.

FAQs on lagging indicators in forex

Are lagging indicators safe?

Lagging indicators use past price data to create relevant values in the present. The main purpose of lagging indicators is to make past and current price action easily digestible visually for traders. And, yes, they are safe to use. Keep in mind that every indicator should be used in a specific situation. Each indicator is built for specific market conditions.

Are lagging indicators accurate?

Lagging indicators display their values based on past performance, which makes them accurate. However, be noted that there are some indicators that repaint their values and there are ones that don’t. Repainting indicators change their values after price makes a move to make indicators more attractive for the investors or to make technical analysis easier. In general, lagging indicators are highly accurate.

What are lagging indicators examples?

FX trading lagging indicators are highly popular among traders. Some popular examples are: Bollinger bands, moving average convergence/divergence (MACD), simple and exponential moving averages, ADX, etc.