Leading Indicators are often taken for granted by most traders nowadays. Many say there’s no such thing as a leading indicator. They even take pride in saying they only use pure price action and volume. This most of the time leads to high-risk trading.
To better predict the movement of the markets today, one of the best ways is to study what actually leads them; that is, Leading Indicators.
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Hey, welcome to this video on leading indicators examples. However, there is no such thing as an indicator that always leads the market, so you have to put it in the context of an entire trading method, just like you do with everything. There’s no one indicator that’s going to be the crystal ball as to what’s going to happen in the next five minutes or five months in the market. That’s not how it works. We use it as a piece of the evidence.
Leading Indicators Example
So one of my most popular videos is on the SMI indicator or stochastic momentum index. We’ve got that down here and I’ll use that one today because, in the traditional technical analysis, momentum indicators are generally accepted as leading indicators. And I like to add the word potential to that because most of the time, they don’t lead to the market. So you have to understand what type of patterns do, when they do, and so forth. So, first of all, let’s look at something very interesting that people don’t understand. First of all, that’s not an indicator. Stochastics is not an indicator. SMI is not an indicator. CCI, when we just plot it here, in other words, that’s really not the indicator. Let’s look at what the indicator really is.
Now that’s the indicator. So it might be semantics, but my point in showing you this is, and this is just part of the formula and this is the SMI, the stochastic momentum index, indicators are mathematical formulas. So let’s just get real clear on that. First of all, that’s what they are and that’s all they are. So it is true that they do not always tell the future. But let’s put it this way. What do indicators do? They indicate! The answer is actually in the question. They indicate. Indicators are not money makers. There’s no one indicator in the world that will directly and by itself make you money. If they did, we wouldn’t call them indicators. We’d call them money makers.
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So they indicate something based on math. Here’s one example. What it’s taking is it’s taking data from whatever market you’re trading relative to whatever time interval you’re trading. And it’s putting everything into one side of the formula, crunching it based on the formula, and then spitting a number out the other end. So what that means is that an indicator actually is never wrong, indicators are correct 100 percent of the time because it is math. So one of the reasons that I do like to use a couple of indicators is that it gives me an objective number to work with a value of the energy of money flow that is going to that market.
And it’s always right because it’s based on math. It is math! It is not based on math, it is math. And, therefore, it allows me to create an objective rule-based system based on a mathematical formula; actually a combination. So let’s go back to the chart now. We’ve got our SMI here, stochastic momentum index. Remember, momentum is one of the most commonly accepted leading indicators. And we’ve got the market going down here. Now at this place, you will see what is commonly referred to as a divergence. So we have a lower low on price, higher low on the stochastic momentum index. Now, what does that really mean? What’s behind that? We’ve all heard what divergence is, or at least most of us who’ve been around for a while. And so a divergence is nothing new, but a divergence by itself, frankly, they don’t always work.
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So again, this is what I mean by, sometimes in certain situations, these indicators can give you leading ideas. Now, here’s what this is. First of all, what momentum means is the market’s going down and it’s going down on strengths. So think of a train going down the tracks and let’s say that train is going 90 miles. Well, let’s say it’s going 60 miles an hour and it’s got 30 cars behind it. Hence, it’s kind of velocity and mass. That is the equation for momentum ranked just the basic physics of it in the real world. In the same way in the market, when you’ve got the market moving with velocity and mass, it’s more likely to follow through.
So back to our training example, if you are to apply the brakes to a train that was going 60 miles, having 30 cars behind it, the train is not going to stop right away. There’s a leading indicator of just the pure physics of momentum. After you apply the brakes, that train is still going to continue to go north a mile after you apply the brakes, cause that’s the physics of momentum. So, in a similar way in the market, when the market is moving with velocity, a lot of mass; massive waste volume, then we can say it will probably sustain and when the brakes are applied, it’s going to start slowing down. Now, where is the brake applied?
Best Leading Indicators for Day Trading
So here is our signal that we’ve had a momentum shift. Price does make a lower low, in other words, the train is still going, in this case, south. But the brakes were applied back here and this maps it for us. That’s one of the nice things about indicators, they just map that dynamic flow on a chart. That’s why it’s actually very easy to see. Now you could do the same kind of thing if you’re a tape reader, but that actually requires quite a bit of skill and experience. So this is a shortcut.
But that’s not all because what we want to do is we also want to say ‘how extended are we in this trend?’ We all know the saying ‘the trend is your friend until the end’. If you get a momentum shift like this early in a new trend, it is probably not going to really mean much. You might get a little ABC complex retrace and then continue down in the direction of the trend. So the longer you wait; we’ve got a failed nine wave count here, and five in the way that count-wave is average. So, anytime we get beyond five, now we are saying statistically, this is a trend that has lasted longer than is normal. And now we wait for strengths to come out of that downtrend to help us determine when the trend will end. So this is the signal that it will end.
Best Combination of Indicators for Day Trading
Now, something very important, ‘where does the market go?’ Kind of going sideways for a while. So, the learning moment here is that just because momentum did come out of the market and sure we did stop trending, we did not get below that bar. That does not mean the markets then going to go screaming up; a downtrend is not always followed up by an uptrend. Uptrends aren’t always followed by downtrends. Trends can end, in fact, I would say trends more frequently end by just going sideways for a while and not reversing. This is why I turned.
Reversal trades are so tricky. They do have the best reward to risk ratio when they work, but they don’t actually work out often. So the win-loss ratio is low. I wanted to give you one more example because I showed you how to determine the end of a trend. Well, how do you get in early to a new trend because that is a more common way of a better win-loss ratio? Here, we’ve had a market just kind of, basically, not doing too much and even in here, right? It’s still kind of going sideways. But look at momentum. What is momentum doing from here to here? It’s still about the same and then it goes crazy? It goes way above that level. In other words, momentum, in this case, the SMI is breaking above this level here on the indicator before price really makes significantly higher highs.
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Price is still just going sideways. So what’s happening is accumulation. In Top Dog Training, we like to take the first cycle low and a new uptrend, which is wave two right there. And we can do that inside of price consolidation knowing that momentum has already come in. But now, here it is again, ‘how do we know to get out there?’ Well, momentum now has come out of the market, so price made a higher high, but the indicator, lower high. There are your common diversions. Therefore, it’s just a matter of time before we do start coming to an end.
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