Trading Basics: Indicators


Indicators help traders with the interpretation of markets. For example, they help to identify trends and price levels (i.e. levels on the chart where the price reacts). They are usually simple and can be calculated with trivial formulas. As a result, indicators are never 100% correct, therefore they should not be used in isolation, but traders should rather find a confluence of multiple indicators, which increases probabilities that the price goes to the expected direction (either up or down).

Why They Work

First, traders use indicators to make trading decisions in general, which drives the price. 

Second, psychology drives the price, including sentiment, fear, uncertainty, and doubt because human emotions influence traders’ decisions, which can be quantified by some indicators. 

Third, indicators which are based on statistics and probability work more often. 

Leading vs Lagging

There are two types of indicators, which are important to recognize. The first is leading indicators and the second is lagging indicators.  Although both leading and lagging indicators are based on historical prices, leading indicators attempt to predict price, and lagging indicators assess the current state of an asset but introduce a delay. 

The lagging indicators should be used rather to confirm the trading direction, than to enter the market. Note, entering the market based on only the lagging indicators could be late, because of the delay.

For example, leading indicators are RSI or MACD, lagging indicators are EMA crossovers.