Trading indicators can be categorized as leading indicators, lagging indicators, or even both, based on the type of information they provide and their speed of response to price action. Understanding how they work will help you find the best way and time to use certain indicators in the market during technical analysis. The knowledge can also help you better interpret market events based on the indicators you use.
What are leading and lagging indicators?
Leading and lagging indicators are technical indicators that give crypto traders an idea of what may happen next in the market or what has already happened. Both indicators provide traders with information from the market to guide their trading decisions. The biggest difference between the two indicators is the timing of the signal they give.
Leading indicators
Leading indicators are indicators that signal where the price may move next. These indicators use price data to predict future price movements. Leading indicators can help you enter trends early, providing favorable trade entry and exit points. They are often more insightful for technical analysis because they can help you in your quest to enter high probability trades.
Lagging indicators
Lagging indicators are also known as trend following indicators simply because they follow market trends. These indicators focus only on historical data and do not suggest what may happen next in the market. They use the average of past price data to inform traders of market events.
5 Examples of leading and lagging indicators
To better understand how these technical indicators work, consider the following examples.
Leading Indicator: Fibonacci Retracement
Fibonacci retracement levels are horizontal lines used to determine possible support and resistance levels. The indicator can help you determine trade entry, stop-loss and take profit points. Fibonacci retracement works best in a trending market.
If price begins to decline or retrace in an uptrend, traders using the Fibonacci retracement tool will draw the retracement line to connect the last relevant swing high and swing low. Doing so will help them see the invisible support levels in the market, making it easy to identify where the price may turn and the uptrend continue.
Leading Indicator: Candlesticks
A candlestick shows the market’s open, close, high and low prices within a specified period. Each candlestick has specific information it contains. An educated trader understands the information and uses the information to navigate the market. Put another way, each candlestick provides an easy-to-understand picture of the price action.
You can use the length of the candlestick wicks, the candlestick body and whether it is bearish or bullish to determine what is happening in the market and what may happen. The common candlestick patterns include dojis, engulfing candlesticks, spinning tops, hammers and needle bars.
Lagging indicator: moving average
Moving averages identify the trend and direction of a crypto market. The information on the moving average is generated by using previous price points, i.e. the market’s historical data.
Moving average lines generate buy and sell signals when they cross each other, although traders cannot rely on them for the best trade entries. This is because when moving average lines show either buy or sell signals, the price movement must have started some time before then, making you react late to the moving average signal.
Leading and Lagging Indicator: Bollinger Bands
Bollinger bands consist of a moving average, which acts as an intermediate band, and an upper and lower band, which identify whether the price is relatively high or low. Traders consider the upper band as an overbought position and the lower band as an oversold position. Thus, they buy when the market is near or below the lower band and sell when it is near or above the upper band.
Bollinger bands, just like the RSI (see below), are inherently lagging indicators because they move after the price moves. They only react to price movements. However, the outer bands can act as leading indicators as they suggest when price may reverse.
Leading and lagging indicator: Relative strength index
The Relative Strength Index (RSI), another inherently lagging indicator, tells crypto traders when a market is overbought or oversold. The RSI fluctuates between 0 and 100, usually calculated over a 14-day period. A scale of over 70 is considered overbought, and under 30 is oversold. The RSI also provides information on who is in control of the market. Traders usually take a scale above 50 as a buyer’s market and one below 50 as a seller’s market.
The biggest problem with depending on the RSI, just like other trailing indicators, is that the signals usually arrive late. The market must have been bullish for some time before it reflects on the RSI chart.
The RSI can also act as a leading indicator, showing traders what may happen in the market. Let us consider the case of RSI divergence. RSI divergence signals that the current trend has lost momentum and there is a possibility of a trend reversal. This can be taken as an early warning sign and will reveal to traders that a possible reversal is imminent. In the case of an RSI divergence, the RSI shows a change in market momentum before it is reflected in the price, thus acting as a leading indicator.
How to use lagging and leading indicators
From the categorization above, you can see that some crypto technical analysis indicators act as leading indicators, some as lagging indicators, while others are both leading and lagging indicators, depending on how they are interpreted.
Some traders use a combination of leading and lagging indicators when trading. Some traders prefer to use only leading indicators, trading Fibonacci retracement lines, support and resistance, candlestick language and whatever leading indicators they find useful. The categorization is mainly functional, as the choice of how to use them depends on your crypto trading strategy.
Now that you know how leading and lagging indicators work, you can better interpret chart information in relation to your strategy. For example, trying to enter a buy because there is a moving average showing a buy signal is likely to be a late entry. Since the moving average is a lagging indicator, it is not good for determining trade entry and exit points.
On the other hand, trailing indicators are useful when checking historical data and how prices have moved over time. However, nothing prevents you from using the information to predict future market events.
No indicator should be used as a stand-alone indicator. You need to combine it with other tools to make better trading decisions.
As has been shown
After understanding what leading and lagging indicators are, it is safe to say that both indicators are necessary tools for successful trading. The choice of how to use them just depends on how your strategy works best. Of course, we can’t deny that knowing how they work and how to interpret the data they provide will be an advantage for you when carrying out your market analysis.
