Indicators Lag, Price Action Leads

Making money hand-over-fist in the Forex market sounds like a great idea. It is a great idea! But there’s one slight problem… The majority of Forex traders (some say 95%) are losing money in the market.

I’m not telling you this to scare you, I’m giving you this information so you know that Forex trading is a serious business. I believe that one of the main reasons why the failure rate is so high is that many traders think they’re in a casino. They have a chart full of pretty indicators, complete with flashing lights, bells and alarms that go off and make exciting noises! Even worse, they call their successful trades “winners” and their bad trades “losers” just like they would if they were betting at a casino in Las Vegas (I’m guilty of this as well). This mentality is not the kind of thinking you should be doing.

When it comes to Forex trading methods, there seem to be thousands of them available, both in print and on-line. When you look at them one thing becomes overwhelmingly clear: Most of them deal with indicators. It’s hard to find many trading methods that deal with pure price action.

But what if you didn’t use those indicators? Stochastics, MACD, RSI, moving averages and a load of other indicators are presenting you with lagging information. They may look pretty on your charts, but they don’t really help you predict where the price is going in the future.

What do I mean by the term “lagging indicator?” I mean that they are using a mathematical formula to show you what has happened in the past, and they have no bearing at all on what price is going to do in the future. This can be easily illustrated with one of the most popular indicators, the Stochastics oscillator.

The formula for Stochastics is really quite simple…

K = 100[(C – L14)/(H14 – L14)]
D = 3-period moving average of K

C = the most recent closing price
L14 = the low of the 14 previous candles
H14 = the highest price traded during the same 14 candles.

I know most of you aren’t math geniuses, so I’ll translate for you. If the previous 14 candles (or whatever other number you plug into the indicator settings) tend to close near their high then the Stochastic indicator is rising, and if prices are tending to close near their low then Stochastics are falling. This is all the indicator does, and all the indicator knows.

We can just glance at our candlestick charts and see how quickly the price has been rising or falling. This indicator isn’t telling us what’s going to happen, and it isn’t telling us anything that we don’t already know!

So if indicators are so worthless, why do people use them?  They use them out of habit and ignorance. Indicators used to be a powerful tool, but those days have passed. To see what I mean by this we have to take a look at the history of these indicators. Look at the decades these common indicator were invented and see if you can figure out why they were useful in their time…

  • Stochastics: 1950′s
  • MACD: 1960′s
  • RSI: 1970′s

Do you see the connection?  All of these lagging indicators were in use before modern computer systems took over the trading world! While there were certainly computers around during this 30 year period, they were limited to the trader that worked on the trading floors of billion-dollar companies. The computers were expensive, and therefore out of reach for the common trader.

If you, the little guy, wanted to see a financial chart in the 1950′s, other than the generic charts printed in the newspapers, you had to plot and draw them yourself! This took a tremendous amount of time and effort. In a situation such as this being able to use a few simple math formulas to see the data in a different way was a blessing. It was a great way to analyse data in its time, but now we have a better way. We have computer software that generates candlestick charts on demand!

The problem is that even though new tools like computers were invented, people never moved away from the old way of doing things. To make matters worse a new generation of traders came around, and knowing nothing of the olden days when lagging indicators had a purpose, they started using them the only way they knew how. They took their new computer generated charts, slapped the old indicators on them, and started using them as a way to predict the future. They never realized that they could just look at their charts and see (much more clearly) the same information the indicators were telling them.

OK, I’m finished ranting about indicators now. Let’s move on and start learning about the underlying principle of Forex price movements… Supply and demand.

By |2019-10-01T20:16:03-06:00February 14th, 2013|Forex Course|0 Comments