There are two types of indicators that traders usually use while trading. One is the lagging indicator, which uses the past price action to estimate the entry and exit points. The other is the leading indicator, which is the opposite of the lagging indicator, which gives traders an estimation of future price action with the help of past price action. While the traders can get confused with which indicator is to be used, it simply depends upon the nature of their trade, as each indicator can affect their trade differently.
What are the Lagging Indicators?
Lagging indicators represents indicators that are created based on past historical prices without any future price prediction. For example, most of the standard MetaTrader technical indicators are lagging indicators because they do not predict future price movement, only indicating the current price action or price levels behavior.
Just like the name, the lagging indicators confirm the momentum only after the trader has made a move. It only uses the average of the price actions in the past to help traders analyze the financial market. Due to its lagging properties, traders tend to lose few pips at the beginning of the trade. This is why many traders think that it is of no use. While some think that it helps them confirm the decisions or move they are making in the market.
Following are some examples of the commonly used lagging indicators in the stock market:
- Simple Moving Averages
- Relative Strength Index
- Stochastic Oscillator
- MACD (Moving Average Convergence Divergence)
What Are The Leading Indicators?
Leading indicators represent indicators that forecast the future price, such as technical indicators that make projections for future prices based on mathematical models or economic indicators such as GDP, CPI, Retail Sales, etc.
Just like lagging indicators, leading indicators also use past price actions. But unlike them, leading indicators help in analyzing future price movements. This helps the traders to estimate the beneficial entry points in the market. But the future predictions can go wrong, and these anticipated forecasts can change their route. It is because what happened in the past can not ascertain the future movement of the price. Therefore, traders tend to lose if such predictions do not go as they analyzed. While this could happen, traders may also come across trend reversal signals or false breakouts in the movement.
Following are some examples of the commonly used leading indicators in trading:
- Support and Resistance
- Client Sentiment
- Retail Sales
Advantages and Limitations of Leading and Lagging Indicators
Advantages: Leading indicators help to analyze beneficial entry points in the market. Also, it can help anticipate the key levels of the price action, so the chances of entering the high probability trade are high.
Limitations: The predicted price actions do not go as forecast; they can be opposite sometimes. So, the trader is always advised to put his own trading skills as well into use along with the indicators. Also, this indicator can sometimes confuse beginners as they do not possess prerequisite skills.
Advantages: Lagging indicators help the trader to confirm the recent price actions. Also, the risk of false breakouts and trend reversals is less.
Limitations: Due to its lagging properties, traders tend to lose some pips as they wait for the indicator to confirm the movements. Also, key levels cannot be anticipated through lagging indicators.
Leading Indicators vs. Lagging Indicators Trading
As stated above, each indicator has its own advantages and limitations. Each indicator can be applied as per the requirements of the trader. Also, the traders should not entirely depend upon these indicators; they must bring their own knowledge into use. That is why it cannot be said which indicator is better.
They are equally important indicators, depending upon the situation of the trade. Following is an example of how leading and lagging indicators can differ in trading EUR/USD. Here you can observe that the leading indicator is best suitable for this situation, but that does not make the lagging indicator any less important.
Traders who want a quicker response from the indicators may choose the leading indicator over the lagging indicator. However, the lagging indicator can also be made more responsive if the time period is reduced. Also, traders are suggested to look out for any movement in the market that is opposite of what the indicators suggest. The losses from these incidents can be prevented if they use a tight stop loss.
When seeking a solid affirmation from the indicators, traders can bend towards the lagging indicator. Such traders favor capitalization and plan on staying in the market for a longer period. Also, they further delay their entry and enter only after executing a solid risk management technique.
Frequently Asked Questions
Are leading signals better than the lagging signals as they can provide faster signals than the lagging indicators?
It is always said that future predictions are always uncertain, and the future can change. It is the same situation when it comes to the leading signals. While they may forecast future price momentum, their predictions are not firm, and the traders tend to forget this fact. So, it does not make leading indicators any more superior to the lagging indicators. On the contrary, they both are equally important, and they both need the support of the trader’s skills and knowledge.
For better results, what combinations of the moving averages can be used?
As mentioned before, it depends on the preference and situation of each trader and trade, respectively. The commonly used moving averages are 20, 50, 100, and 200. However, the traders tend to alter these averages with the help of Fibonacci numbers and use 21, 55, 100, and 200 instead. For example, if the trader is looking for faster signals, he can use 21 MA and 55 MA combinations. On the other hand, the combination of 100 and 200 is more suitable in estimating the market trend.