When to use leading vs lagging indicators

Leading and lagging indicators are two classifications of technical analysis tools to describe whether different indicators plot current prices or predict upcoming movements. In this article, we’ll define both leading and lagging indicators and explain how to tell the difference when studying a specific technical indicator with examples for both.

Leading indicators vs lagging indicators

While it’s quite clear what the difference between a leading and lagging indicator is, it can become more difficult to discern when judging a single indicator. An easy way to determine whether an indicator is leading or lagging is by looking at what data it reports.

A leading indicator measures the power or number of causes to predict future outcomes, such as how many drivers wear seatbelts or drive over the speed limit to determine how many injuries may occur in automobile accidents. A lagging indicator is much more direct in that it directly includes price action in its formula. In the same example, a lagging indicator would simply measure the number of injuries reported by authorities in a given period.

Because of this difference, leading indicators are often displayed in a separate window below the price chart, and lagging indicators are commonly overlaid on the price chart. Now that we’ve generally compared the difference between a leading and lagging indicator, let’s look at both in more detail.

Leading indicators

Leading indicators provide information on predictive metrics concerning future trends and outcomes. They can be used to develop trading strategies and also help traders locate ideal positions for stop losses and take-profit orders.

While leading indicators can help predict market movements, they are not always reliable. Many traders use leading indicators to inform their strategies but wait until their signals are confirmed by lagging indicators to execute trades.

Leading indicator examples

Popular leading indicators include oscillators like the relative strength index and the stochastic oscillator. Leading indicators can also be fundamental, such as polls of consumer sentiment or unemployment reports.

For example, a rise in unemployment may indicate that companies expect to make fewer profits in the near future. Although it can be difficult to guess whether layoffs at a company will prevent the dip in profits or not. The outcome of leading indicators is still tricky to predict, which is why they don’t have as high of a success rate compared to lagging indicators.

Relative strength index (RSI)

The relative strength index measures the momentum of a market to signal if it is overbought or oversold. Like most leading indicators, the RSI is an oscillator measured on a scale of zero to 100. An RSI above 70 indicates the market is overbought, and an RSI below 30 indicates oversold conditions.

Using the RSI, a trader may open a short order when the market is shown as overbought or a long order when shown as oversold. However, it’s important to use other means of technical and fundamental analysis to identify which specific factors are pushing the market into overbought territory and whether they will change.

Stochastic oscillator

The stochastic oscillator is another leading indicator that compares recent closing prices to the previous trading range. Like the RSI, the stochastic oscillator fluctuates between zero and 100. But on this indicator, a reading above 80 indicates overbought conditions and a reading below 20 indicates an oversold market.

The stochastic operates on the idea that momentum changes before volume or price action. Like all leading indicators, false signals can occur with the stochastic oscillator. It’s important to confirm possible trends identified by the oscillator with other forms of technical analysis before opening a trade.

Read an in-depth comparison of the RSI and stochastic oscillator here.

Lagging indicators

Lagging indicators measure past performance and can be used to assess the likelihood of historical patterns repeating themselves again. Traders can use lagging indicators to evaluate the effectiveness of strategies and decisions.

Lagging indicators often focus on comparing price action to other metrics at the heart of leading indicators, confirming whether the signals they provided resulted in the expected price movements.

Lagging indicator examples

Lagging indicators are retrospective measurements of historical performance. Fundamental examples of lagging indicators include performance metrics such as return on investment or profit margins. They point to how successful past business efforts have been, and they can confirm whether actions taken in those periods were successful or not.

In trading, lagging indicators are most used to identify long-term price trends amid sporadic short-term movements. As you’ll see in the following examples, most lagging indicators are based on historical data and plotted over the price chart.

Moving averages

Moving averages are a simple indicator that calculates the average price over a period to identify the general trend in price action. Moving averages are often used as the basis of more complex lagging indicators, like the MACD.

The MACD, short for moving average convergence divergence, helps identify whether the current trend is bearish or bullish. It is comprised of two moving averages subtracted from one another to create the MACD line, and a signal line displaying an average of the MACD line.  

The distance between the two lines may signal a reversal or reinforcement of the prevailing trend. When the lines diverge from one another, momentum for the current trend increases. When the lines converge, momentum is slowing down. When they cross over one another, a reversal is indicated.

Like all indicators, the MACD can signal false reversals. So, it’s critical to use additional analysis to confirm signals from the MACD.

Bollinger bands

Bollinger bands work to visualize the volatility of a market and whether the current trend will continue or reverse. The indicator plots three lines over the price chart, creating two ‘bands.’ The upper and lower bands are two standard deviations away from the middle moving average, one above and one below.

In times of low volatility, the standard deviations are close to one another, creating a narrow band, and they widen during high volatility. If the price nears either the top or bottom band, a reversal may occur as the price moves closer to its true average range.

How to trade with leading and lagging indicators

You can trade with both leading and lagging indicators using technical analysis on City Index, follow these steps to get started.

1. Open an account or log-in if already a customer
2. Search for the market you’d like to trade in our award-winning platform
3. Apply leading or lagging indicators to the price chart with just one-click
4. Choose your position and size, and your stop and limit levels
5. Place the trade

Alternatively, you can open a City Index demo account to practice trading live markets risk-free or learn more about technical analysis in our trading academy.

Leading vs lagging indicators

You should now understand how both leading and lagging indicators operate and the general differences between them. Below is a table comparing some of the main characteristics of indicators and how they differ between leading and lagging indicators.