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Part II. Leading Indicators – Oscillators

Leading Indicators – Oscillators - Forex School

Commander in Pips:
 So, today we will talk about leading indicators. First we will discuss the common approach – which indicators usually treated as “leading”. Then we will explain why it is not quite correct and give us better understanding about “leading” term of indicators.

Pipruit: That’s nice.​

Which indicators usually treated as “leading” - Forex School
Commander in Pips: So most common approach to leading indicators tells that Oscillators are leading indicators. Oscillators are a type of indicator that have limited range of changing. Other words – these are scaled indicators. Excellent examples of oscillators are Stochastic and RSI. The second typical issue of oscillators – they usually are either in buy or sell mode, except for moments when it stands in a middle range. It has been argued that Oscillators give early signals of trend shifting, so because of that they are “leading” indicators.

Commander in Pips:

So, let’s plot three oscillators that we’ve discussed in previous part and see, what kind of signals they generate. These will be RSI, Parabolic SAR and Stochastic:

Chart #1 | GBP/USD Weekly, RSI, Stochastic and Parabolic SAR
GBP/USD Weekly, RSI, Stochastic and Parabolic SAR - Forex School
Here you can see, that all three indicators give the same signals at the same time, although parabolic SAR has small lag behind stochastic and RSI. But in general – these signals have come almost simultaneously. In December 2004 this was a Sell signal that led to a solid move down. Right at the end of this down thrust all three indicators showed a Buy signal in August 2005 and the market has shown nice move up, although it wasn’t as impressive as previous downward move. The same has happened again in December 2005. So this picture tells that these three different indicators give very harmonic signals.

But sometimes they could give very confusing and conflicting signals. Take a look at chart #2. If you have intended to follow these signals, you at least have been confused by them. Stochastic comes out from overbought area and gives sell signal, RSI stays flat, while Parabolic SAR shows Buy mode.

Pipruit: And why is it that way?
Commander in Pips: In general the major difference are due to math. If you remember the formulas, you can say that stochastic assesses position of current price in high to low range of some period. So, it does not include in calculation price difference between side-by-side trading periods. But regarding this issue RSI does – it counts price difference between near time periods. Parabolic SAR, in fact, just a count number of price changes in one direction with predetermined step. So, they are quite different. That’s the reason.

Pipruit: And so what?​

Chart #2 | EUR/USD Weekly, RSI, Stochastic and Parabolic SAR
EUR/USD Weekly, RSI, Stochastic and Parabolic SAR - Forex School
Commander in Pips: Well, it means from classical approach to “leading” indicators, that they are very sensitive even to small fluctuations in price. And although they could be, say, “ahead” of market – they are very erratic and prone to bogus signals. This is the dark side of speed – fake signals. If we also take into consideration the difference in math, then we understand that this is a fiscal suicide to use just oscillators in trading.

Pipruit: Ok, I’ve got it. But, Commander, I do not like this kind of leadership very much. I suppose that it’s better to avoid it. Or, rather, we can use oscillators, even have to use, I might say, but not rely on their leadership properties too much.
Commander in Pips: You’re absolutely right. Although oscillators could give us contradictive signals – this is not the reason totally reject them. If that happens (contradictive signals) – we just should sit on our hands and do not make any trade – wait for when the situation will become clearer. That’s all. But oscillators are a very useful and important tool in arsenal of any trader.

Ok, since we’ve finished with common approach of indicators leadership - now we will discuss the correct thoughts, at least I think that they are correct.

Pipruit: Cool, let’s get started…​

Correct leading indicators and tools

Commander in Pips: Ok, before we will start, answer one very simple question – how do you imagine the perfect leading indicator?

Pipruit: Well, It should show trend shift ahead of time with 100% probability, and generate a signal in advance of current price action. Also, since a signal has been generated, it should not be impacted by following price action.
Commander in Pips: Oh, some hope! I think you will get such indicator if you will get a job in with the Fed Reserve, near its chairman. But in general you’re right. That is what we want from an ideal leading indicator. Unfortunately such kind of indicator does not exist. But there are some trading tools that have one or another property of such indicator.

But before we will discuss them, I just want to note, why I do not recognize oscillators as leading indicators. Because they need price action before they will give signal, and this signal changes with each price tick. How then we could call them “leading” as they only response to past price action, even if they do it fast? All oscillators from my view of categorization are lagging. And what are leading indicators then?

Leading indicators of support resistance

1. Fibonacci retracement levels. Since any retracement has started – price action will hold inside the initial swing that uses for Fib retracement levels calculation. Hence, these levels will stand unchanged during the whole time of retracement. So – we know where will be potential support or resistance ahead of time and these levels do not depend on price action during retracement. This is a leading indicator.

2. Classic support and resistance lines. Here is the same issue – previous extremes and other areas, where market has changed direction will act as support and resistance. So we know them in advance also. They are not as good as Fib retracements, but still, they are leading indicators.

Pipruit: So, does it mean that we could use a trend line as a leading indicator of potential support or resistance?
Commander in Pips: I think so. Although personally I do not use trend lines much, in fact, they could be used in this manner. They are also a type of leading indicator – you have the speed of trend line, so you may calculate its value at any time in the future. So the third is:

3. Trend lines – as horizon as slope.

What else?

Pipruit: Well, maybe Fib extensions. They also could lead to support or resistance at their target.
Commander in Pips: Well done, you’re absolutely right.

4. Fib extensions. By using them, we can easily estimate the targets (when C point has been formed already in AB-CD pattern), and despite the follows price action – extensions will be stable and ahead of time from current price action.

Pipruit: Ok, I see. So, there are not any leading indicators, I mean oscillators or something like that?
Commander in Pips: There are some.

1. Detrended oscillator (DOSC) and Momentum Indicator. You may use it for estimation of future levels of overbought and oversold. If you do not remember, what DOSC or Momentum is – revisit the corresponding chapter.

Pipruit: Commander, I remember what DOSC and Momentum are, and how to apply them. But why is it a leading indicator? Where is its leadership?
Commander in Pips: That’s right. If you remember, we use historical extreme values of momentum as levels of overbought and oversold on the market. Other words, when momentum reaches this level, we treat market as overbought an oversold, right?

Pipruit: Right, and what then?
Commander in Pips: So, you know these extreme levels ahead of time since they are historical, and because they are relatively stable. Close price n-period ago you know as well. So, you easily can estimate what close price should be today at which market will reach an overbought or oversold level…

Pipruit:
 Wow, and this is really true. How I can’t get it by myself. So, then we get the formula as follows:

Today close price = Momentum extreme level (known) + Close n-periods ago (known).
Commander in Pips: That’s right, so you know even before the start of today’s trading session, at which level market will be overbought or oversold. And you could apply it at any time frame!

The same calculation you may do with DOSC indicator.

Commander in Pips: The next indicators are not spread wide, only some expensive software programs (such as CQG, Genesis Trade Navigator and some others) have them, but still they exist:

2. DiNapoli Oscillator predictor (OscP). This indicator shows levels of overbought and oversold one period ahead of time. It looks very akin to Bollinger Bands indicator, but they are not the same, because they have absolutely different math. Here is what it looks like:

Chart #3 | EUR/USD Daily and DiNapoli Oscillator Predictor
 EUR/USD Daily and DiNapoli Oscillator Predictor - Forex School
See, the current session is not over yet, but the oscillator already shows levels of overbought (OB) and oversold (OS) for today’s trading day. You can see them in the left bottom corner – OB = 1.4623 and OS = 1.4014. And these levels will remain stable during the whole day, despite price action. Now imagine that you use this oscillator on weekly or monthly time frame? You have levels that hold constant during the whole week/month and where the market will meet resistance or support if it will get there. So, this is also a leading indicator.

Commander in Pips:

3. DiNapoli MACD Predictor (MACDP). This is derivative indicator from simple MACD. It shows the precise price at which MACD will show line crossing and trend shifting. Also this level is known 1 period ahead of time. Look at chart #4 – when MACD shows trend shifting by line crossing, the red line (that is MACDP) crosses the chart line. So, MACDP shows 1 period ahead of time the price level at which the trend will shift due MACD indicator.

Chart #4 | EUR/USD Daily and DiNapoli MACD Predictor
EUR/USD Daily and DiNapoli MACD Predictor - Forex School
So, as you can see my approach to leadership is quite different to the common one. I need indicators that really have some leadership properties – be stable ahead of time despite at the most recent price action. So, using them, I know ahead of time – where will support stand, at which price will the market be overbought or oversold and when a trend will shift. These are leading indicators.

Although may be you will not be able to get OscP and MACDP, still you may use most part of them. Fib retracement and extensions are available for you, so are trend lines. Also you may apply formula that we’ve specified, for estimation oversold and overbought price with Momentum indicator.

This lesson in Forex Military School owes a great deal to Joe DiNapoli's methods, and uses a number of Joe's proprietary indicators. Trademarks and Copyrights: Oscillator Predictor, MACD Predictor are trademarks of Coast Investment Software Inc.

Comments

rashidin5178
7 years ago,
Registered user
Pivot Level?

Hi Sive,

Here you do not mentioned about pivot level for leading indicator? Is it pivot level does not in leading indicator's category?:confused:

Thanks and Best Regards
Sive Morten
7 years ago,
Registered user
> Hi Sive,

Here you do not mentioned about pivot level for leading indicator? Is it pivot level does not in leading indicator's category?:confused:

Thanks and Best Regards

Hi Rashidin,
Thanks, yes, you're right.
I forgot about it, but probably that is good, since pivot chapter ahead. If I post here about pivot - this will be unclear since we have not studied it yet.

But you're right, pivots are leading indicators also.
ForexBoss48
2 years ago,
Registered user
Sive one question where can I add the DiNapoli indicators
Hamza Samiullah
a year ago,
Registered user
Nice Explanation...
One-fm
7 months ago,
Registered user
The Dinapoli indicators are great tools, how can I get them for either MT4 or 5?

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