A leading indicator, also called an oscillator, is a motion or force that moves back and forth between two points. It is a technical analysis tool that is used as a trend indicator for identifying trends when they are not clearly identifiable. It is most commonly used when the currency or underlying stock has traded in a specific direction for some time and it appears that it may reverse, although it may not be obvious upon first glance.
These leading indicators are used to find a breakout into an upward or downward trend and are often meant to identify reversals. They will potentially signal a buy or a sell when the market is oversold or overbought and the previous trend has run its course.
Stochastic, Parabolic SAR, and the Relative Strength Index (RSI) are all oscillators. Each indicator/oscillator can signal a possible reversal, where a previous trend has ended and the price is ready to move in a different direction.
Below is an example of how all three indicators lined up to give us the proper signals: On the 1-hour chart of EUR/USD below, we added Parabolic SAR, Stochastic and RSI indicators.
There are sell signals between the hours of 8:00 am EST and 9:00 am EST on 12/18/08. All three sell signals occurred within one hour of each other. This would have been an excellent trade. As you can see, the Parabolic SAR indicator gave us a good sell signal and the RSI indicator remained in the overbought position for a long time and then ventured out. Usually when an indicator remains in the overbought or oversold level for a long time, it means that a strong trend will occur upon breakout. The Stochastic was not really in the overbought position, but still showed us the crossing of the two time intervals in a downward trend.
A sell could have taken place between 8:00 am EST and 9:00 am EST. Let's say we sold at 9:00 am EST, just to make sure there was a trend occurring and so we didn't receive any false signals. We would have sold at a price of 1.457 on the open of the new candle.
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