Last Updated on 11 September, 2023 by Samuelsson
Some technical indicators tend to show their signal before the associated price move, and they are called leading indicators; others tend to show their signal after the price has moved, and they are called lagging indicators.
WHAT’S THE DIFFERENCE BETWEEN LAGGING AND LEADING INDICATORS?
Leading Indicators
A leading indicator is a technical indicator whose signal precedes the price action that it tracks. It gives a signal about price reversal before the reversal occurs. Leading indicators may be good for catching new trends early, but they can give a lot of false signals. So they can be misleading at times. Leading and lagging indicators are types of technical indicators that either give traders an indication of what could happen next within the financial markets, or provide information on what has already happened. Leading and lagging refer to whether the indicator moves before or after another metric, such as price action.
Some leading indicators are volume-based, while some are price-based. The volume itself tends to lead price. Other examples of volume indicators that are leading include on-balance volume, accumulation distribution index, demand index, and a few others. The price-based leading indicators include momentum indicators or oscillators like RSI, Stochastics, CCI, Williams %R, and others. Both leading and lagging indicators are useful and may provide traders with the information they need to make trading decisions.
Lagging Indicators
A lagging technical indicator is one whose signal comes after the price action has taken place. Lagging indicators tend to show the trend after it has started. While they are not good at showing trends early, they may be good for confirming the new trend. But they often bring you late to the party. Lagging indicators are tools used by traders to analyze the market using an average of previous price action data. Lagging indicators, as the name implies, lag the market. This entails that traders can witness a move before the indicator confirms it – meaning that the trader could lose out on a number of pips at the start of the move. Many consider this as a necessary cost in order to confirm see if the move gathers momentum. Others view this as a lost opportunity as traders forgo getting into a trade at the very start of a move.
Trend indicators like moving averages, ADX, and parabolic SAR are lagging in nature. The same is also true for some volatility indicators like the Bollinger bands.
How to Use Leading and Lagging Indicators in Trading
As you have seen, leading indicators can help you catch the entire trend but will often lead you to make wrong calls. On the other hand, if you use only lagging indicators, you will most likely enter your positions late. So the best thing is to use a combination of the two.
Furthermore, when using a leading indicator, you may look for divergences instead of the traditional indicator signal cross. (Such in the image below, where we see a bullish divergence between price and the stochastic indicator.)
