What are the leading indicators in Forex trading?

Indicators are grouped in two categories: leading and lagging. Leading indicators in FX trading have predictive nature. They produce trading signals that predict reversals or beginnings of new trends. Which is why they are called leading. Lagging indicators follow price movements, in other words, they improve visualization and traders can better digest information. In this guide, we will focus on Forex trading leading indicators.

Core features of leading indicators

• Leading indicators send out signals before a reversal or new trend occurs
• Leading indicators often measure whether an asset is oversold or overbought
• Leading indicators can be prone to false signals
• Momentum indicators are some of the most frequently used leading indicators
• Traders often use leading indicators alongside lagging ones, such as moving averages

Difference between leading and lagging indicators

Leading and lagging indicators are two distinct types of technical tools used by forex traders. To understand the differences between them, we can look at some of their advantages, disadvantages and limitations.

Leading indicators explained

• Leading indicators have key levels that help traders identify trades with a relatively higher probability
• They often indicate whether an asset is oversold or overbought, which serve as entry and exit points for traders. Oscillators predict price reversals
• The price action indicated by leading indicators is by no means guaranteed and can lead to false flags for traders
• Leading indicators are often used in complicated trading models, which can be hard to grasp for novice traders

Lagging indicators explained

• Lagging indicators are often used to confirm the latest price action and give traders more confidence
• Using past price data can reduce the risk of false breakouts
• Waiting for confirmations from lagging indicators can cause traders to miss out on opportunities
• Lagging indicators do not have key levels, as opposed to leading indicators, which is something traders should consider

Stochastic oscillator

The stochastic oscillator is a momentum indicator that provides traders with buy and sell signals by comparing the closing prices of an asset over a certain period of time. The stochastic is one of the most commonly used oscillators by forex traders.

Stochastic oscillator is one of the examples of leading indicators.

Stochastic oscillator definition and core features

• The stochastic oscillator measures price momentum of an asset on a scale of 0 to 100
• Stochastic is one of such indicators that has the characteristics of both leading and lagging indicators – It shows areas on a chart where the price may be overextended by comparing past price points
• There are three types of stochastic oscillators – fast, slow and full
• Stochastic measures price momentum – not the price range
• Moving averages and the RSI are two indicators that are often used alongside the stochastic oscillator to smooth out the values shown by the oscillator
• The default timeframe used by stochastic oscillators is 14 periods
• The stochastic oscillator is placed below the price chart

Stochastic oscillator calculation

To calculate the stochastic oscillator, traders can use the following formula:

%K = ((C – L14) / (H14 – L14)) X 100

Where:

%K = current value of the stochastic indicator

C = Recent closing price

L14 = the lowest price over the last 14 trading sessions

H14 = the highest price over the last 14 trading sessions

%K is also known as the fast oscillator. %D, or the slow oscillator, is calculated by finding the 3-period moving average of %K.

The full stochastic oscillator allows traders to customize the timeframe for %K and %D.

Full %K = Fast %K smoothed with the desired period SMA

Full %D = desired period SMA of Full %K

Stochastic oscillator example in forex

To better understand how stochastic oscillators work in practice, let’s look at an example of the EUR/USD pair. The stochastic is plotted below the price chart.

As evident on the chart, the price momentum can be a rather volatile metric to follow. The stochastic can be useful in validating price trends and anticipating future ones. The middle value of 50 is especially important to consider. When the oscillator value is approaching 50 from below, this indicates an increasing price momentum. When the oscillator value is approaching 50 from above, this indicates a decreasing price momentum.

In general, a stochastic value of 20 is considered to be an oversold signal, while 80 is considered to be overbought.

Awesome oscillator

The awesome oscillator is another momentum fx leading indicator that is used to confirm or disprove market trends. The awesome oscillator can also help determine whether a trend is bullish or bearish, and if it is expected to continue or reverse.

Awesome oscillator definition and core features

• Awesome oscillators, as the name suggest, is part of the oscillator group of indicators, alongside the MACD, RSI, and the Stochastic
• Awesome oscillators are often used in scalping strategies by day traders
• The MACD is commonly used alongside the awesome oscillator
• 5 and 34-day simple moving averages are usually used with awesome oscillators
• The awesome oscillator uses the difference between the simple moving averages of the median price of an asset over the specified time periods
• The awesome oscillator measures trend strength and momentum and like other oscillators, only momentum may not be enough to guess the future price direction

Awesome oscillator calculation

Calculating awesome oscillators is a relatively straightforward process. To calculate the indicator, we must subtract the 34-day simple moving average from the 5-day simple moving average. Therefore, the first step is to calculate the 34 and 5-day simple moving averages.

The formula for simple moving averages is:

SMA = (High price + Low price)/2

Where the highs and lows are separate for the 34 and 5-day averages, respectively.

Awesome oscillator = 5-period SMA – 34-period SMA

After that, the awesome oscillator can be placed on a histogram, where the centerline value is 0.

Awesome oscillator example in forex

To get a better understanding of how the awesome oscillator works in forex, let’s look at a visual example of the indicator plotted below the EUR/USD price chart.

The awesome oscillator is a versatile indicator that can be used in various strategies. The two most popular AO strategies are zero-line crossovers and Twin Peaks.

The zero-line crossover strategy is based on the awesome oscillator’s location on the centerline:

• If the awesome oscillator falls below the centerline, this indicates that a bearish run is up ahead and traders can use this information to go short on the pair
• If the awesome oscillators go above the centerline, this indicates an upcoming bullish run and traders can use this information to go long

However, this strategy may not always bear results and can lead to false positives. This is why it is important to use other indicators alongside the awesome oscillator.

The Twin Peaks strategy looks for comparable oscillator values that are placed side-by-side on the neckline. These can be either in the positive or negative direction:

• If the two peaks form above the neckline, this can signal an upcoming bearish run
• If the two peaks form below the neckline, this can signal an upcoming bullish run

For a formation to be considered as a twin peak, the awesome oscillator must not cross the centerline between the two peaks. Traders can confirm trend reversals if the second peak is followed by a formation of a different color (red after green, vice versa).

Relative strength index (RSI)

The relative strength index, or RSI, is another oscillator that seeks to determine whether an asset is oversold or overbought. The RSI assigns a value between 0 and 100 to measure the strength of price momentum on the market.

RSI is a lagging indicator in a sense that it shows signals after price moves. However, it has a predictive nature, which makes it a leading indicator.

RSI definition and core features

• The RSI is a momentum indicator that is plotted below the price chart
• The standard RSI timeframe is 14 periods
• The MACD is commonly used alongside the RSI, with the former sending buy and sell signals and the latter sending oversold/overbought signals
• RSIs are useful in evaluating trend strength and identifying reversals
• A drawback of the RSI and other oscillators is that markets can remain overbought or oversold for extended periods of time, which can mislead traders who only use this indicators

RSI calculation

Calculating the RSI is a two-step process:

RSI = 100–100/((1+(Average gain/Average loss))

The formula uses positive values for average gains and losses, which represent the percentage gains and losses over the look back period. Periods of gain are input as zero in the average loss.

For example, suppose the market closed with an average gain of 1% seven days out of the 14-day period, and an average loss of -0.5% on the remaining seven days. The formula would look like the following:

RSI = 100–100/[1+(1%/14)/(0.5%/14)]

RSI = 100–100/2

RSI = 50

This indicates a moderate trend strength. Using the 14-period data, we can move onto the second step:

RSI = 100 – [100/(1+((Previous Average Gain X 13) + Current Gain)/((Previous Average Loss X 13) + Current Loss))

RSI example in forex

Let’s look at a visual example of the RSI, with the indicator plotted below the EUR/USD price chart.

The example in question shows the strength of bullish and bearish trends for the EUR/USD pair over a 1-month price chart.

It is important to note that the RSI values are divided into three subcategories:

• 0-30 – oversold
• 30-70 – neutral
• 70-100 – overbought

Trendlines are a common method of using the RSI. The lines connect points that indicate trend reversals, which can serve as buy and sell signals for traders.

Ichimoku indicator

Ichimoku Cloud, or simply Ichimoku, is a collection of indicators that show a combination of support and resistance levels, trend strength and momentum. The indicator consists of multiple variables that are represented by lines of different colors.

Ichimoku indicator definition and core features

• Ichimoku is a combined technical indicator that consists of support and resistance levels, trend strength and momentum indicator lines
• Ichimoku is a leading indicator that can be used to gauge future support and resistance levels
• The Ichimoku indicator is placed on the price chart, as opposed to most leading indicators, that are plotted below
• 6-hour timeframes are most commonly used with Ichimoku
• Due to its combined nature, Ichimoku send out multiple signals, which can be confusing for inexperienced traders
• The Ichimoku chart is geared towards finding high-probability trades
• The indicator consists of a conversion line, baseline and leading and lagging spans

Ichimoku indicator calculation

Ichimoku is a complex indicator that consists of multiple lines. The standard timeframes used by Ichimoku are 9, 26 and 52-periods. The indicator uses the highs and lows from these periods. The formula for Ichimoku is as follows:

Conversion Line = (9-period high + 9-period low)/2

Baseline = (26-period high + 26-period low)/2

Leading Span A = (Conversion Line + Baseline)/2

Leading Span B = (52-period high + 52-period low)/2

Lagging Span = Closing price (plotted 26-periods behind)

Ichimoku indicator example in forex

To visualize the Ichimoku indicator, let’s look at the EUR/USD price chart with the indicator plotted alongside it.

The cloud is the most important part of the Ichimoku chart. If the price breaks above the Ichimoku cloud, this indicates a significant uptrend in the market. If the price falls below the cloud, this can be a sign of a bearish sentiment.

A stronger signal happens when baselines cross. At this point, traders can open long positions if the market is in an uptrend. The inverse of this can be used when opening short positions.

Pivot points

Pivot points are leading indicators for Forex trading used to identify reversals. Unlike oscillators and other leading indicators, pivot points are static and remain so throughout the entire trading session.

Pivot points definition and core features

• Pivot points are static indicators that measure the state of trends on the market
• Pivot points are used on very short timeframes – typically between 1 and 5 minutes
• Moving averages and Fibonacci retracement levels are most commonly used alongside pivot points
• Pivot points are placed on the price chart
• Pivot points are used to determine points on the chart where bullish sentiment turns bearish and vice versa

Pivot points calculation

Calculating pivot points is relatively simple. High, low and closing prices are all that is needed to find pivot points. These price points are taken from the previous trading session.

Pivot points use the following formula:

P = (High + Low + Closing)/3

R1 = (P × 2) – Low

R2 = P + High – Low

S1 = (P × 2) – High

S2 = P – High – Low

Pivot points example in forex

To better understand how pivot points work in practice, let’s look at an example of them plotted on the EUR/USD price chart.

Pivot points are easy indicators to keep track of due to their static nature. This also allows the indicator to accommodate strategies of any level of complexity – making it one of the most versatile technical indicators out there.

Traders often use pivot points in breakout strategies. The two resistance levels aside from the pivot points gives traders levels of resistance to spot a breakout. If the price breaks through these resistance levels, traders can enter the market and go long or short based on the signal provided by the pivot points.

OBV indicator

On-balance volume, or OBV, is another examples of leading indicators. It’s a technical momentum indicator that uses trading volume to predict future changes in the price of a pair.

The theory behind on-balance volume is that trading volume affects market outcomes.

OBV indicator definition and core features

• Unlike other indicators that use price and momentum, OBV uses volume flow to make future predictions
• OBV is a measure of traders’ sentiment that can result in a bullish or bearish run on the market
• 1-hour timeframes are most commonly used in OBV strategies
• OBV is placed below the price chart
• OBV is often used alongside basic trendlines – with the former showing reversals and the latter showing support and resistance levels
• OBV can be prone to producing false signals from time to time, which is why it is typically used alongside other indicators

OBV indicator calculation

Calculating OBV depends on the currency closing prices:

• If today’s closing price is higher than yesterday’s closing price – OBV = previous day’s OBV + today’s volume
• If today’s closing price is lower than yesterday’s closing price – OBV = previous day’s OBV – today’s volume
• If today’s closing price is equal to yesterday’s closing price, the OBV is left unchanged

OBV indicator example in forex

To better understand how on-balance volume works on a price chart, let’s look at the EUR/USD pair on a 1-hour timeframe.

OBV divergences can be used to acquire buy and sell signals from OBV:

• A bullish divergence can form when OBV moves higher when the price moves lower, or posts a higher low when the price posts a lower low
• A bearish divergence can form when OBV moves lower when the price moves higher, or posts a lower low when the price posts a higher high

FAQs on leading indicators in forex

Are leading indicators accurate?

Leading indicators can be somewhat less accurate than lagging indicators, as lagging indicators rely heavily on price data, they show what has already happened. Many leading indicators run the risk of sending out false, unreliable signals to traders, which can lead to costly mistakes. Leading indicators work best in certain market conditions, and false signals appear when conditions change. For example, if you are trading using a range trading leading indicator and markets start trending, you’ll get false signals.

Are leading indicators good?

Leading indicators used alongside lagging ones are important parts of a well-balanced trading strategy. Technical indicators are essential in deciphering price charts and finding entry and exit points for individual trades. Leading indicators are great for technical analysis. However, keep in mind that each indicator should be used in certain situations and market conditions.

Are leading indicators profitable?

Indicators alone cannot determine the profitability of a trading strategy. However, proper usage of leading indicators can be critical in finding solid opportunities in the market and making consistent profits.