Lagging Vs. Leading Indicators

Investors often use technical indicators for stock trading which are a part of technical analysis. They are used to analyse and predict the price and volume of a stock. Technical indicators are used by all types of traders including intraday traders or swing traders.

Lagging and leading indicators are used in many fields including management, economics as well as Finance. The lagging and leading indicators described in this article are technical indicators. Mostly, all the technical indicators are either lagging or leading indicators. Both leading and lagging indicators have different aims but are equally important.

Lagging vs Leading Indicator

Leading indicators are those which are future oriented whereas, lagging indicators are retrospective. Concepts remain the same, both leading and lagging indicators are used for technical analysis of the stock. Leading indicators help traders to predict future price movements. By using these indicators, traders can stand out from the crowd, as they are aware of the potential future trends. If the signals given by leading indicators are true, traders can reap the benefit from trends and reversals.

Lagging indicators, on the other hand, are those which provide feedback on prevailing or previous trends. Unlike leading indicators, it informs the traders about current price increases and decreases. These are trend following indicators that give traders confidence and confirmation on trends. Traders can decide on taking a long or short position at a time using these indicators.

Leading indicators respond to the price movement quickly whereas lagging indicators are more accurate than leading indicators. The lagging indicators give confirmation, but leading indicators anticipate the future. Currently, the future price movements may or may not match the assumptions.

Therefore, the chances of fake signals are more in leading than lagging indicators. Leading indicators are better when used for a shorter time. Lagging indicators give better results when the trend runs for a longer period of time.

How to use lagging indicators

Rather than signalling upcoming price movements, lagging indicators reflect the current price actions. Traders use lagging indicators to validate a trend by comparing the price of the stock to its moving average over a given period.

Most of the time, it is used by trend-following traders. Traders use data suggested by lagging indicators to determine which trend is prevailing and whether the trend is strong or weak. This helps them to decide whether to buy or sell a particular stock or security. In most cases, if the moving average or other indicator signals an uptrend then traders take a long position. If the downtrend is reflected, traders exit the position.

Though, lagging indicators are used for suggestions only. How to trade using these indicators solely depends on traders.

Examples of Leading Indicators:

1. Relative strength Index

   RSI oscillator is mainly used to measure the rate at which stock and other assets price movements occur. It is used to give early trade signals, that is why it is a leading indicator. It helps in identifying overbought and oversold territories.

2. Stochastic Oscillator

   A stochastic oscillator is said to be one of the accurate indicators. It identifies the area of the current closing price relative to its range over a certain period. It also identifies overbought and oversold areas as well as give early indications for trend reversal.

3. Commodity Channel Index

   This leading indicator is used to measure the current price level relative to the average price level for a certain time. Along with identifying early trend reversal, it is also used to look for bullish and bearish divergences.

Examples of Lagging Indicators

1. Moving Averages

   Moving average is that lagging indicator that is used to identify the direction of the trend as well as support and resistance area. In moving average, the average price is constantly updated. The average price uses a series of historical data.

2. Moving Average Convergence Divergence

   MACD is that indicator that reflects the relationship between two moving averages of stock prices. It suggests whether the uptrend or downtrend is strengthening or weakening.

3. Bollinger bands

   Bollinger bands are the lagging indicators used to measure volatility. Bollinger bands are created using a 20-day simple moving average. It gives bullish and bearish signals and indicates potential breakout.

To conclude, lagging and leading indicators both are equally important in trading. Both lagging and leading indicators have their strengths and weaknesses. If traders only use leading indicators, they may get caught up by wrong signals. If only lagging indicators are used, traders may lose profits by holding for too long. These indicators balance each other.

Instead of relying upon a sole indicator, traders should adopt a strategy to combine and balance both indicators. This way they can prevent loss due to loopholes of a single indicator.