Leading and Lagging Indicators

We have explored more than a few indicators in this lesson, some of which you may find practical for use, and some which you may prefer not to use. At the end of the day, technical analysis is all about making informed decisions on the future of the price based on price alone.

You should know that indicators can be categorized into two types:

1. Leading Indicators – Those that indicate a future movement in the market.
2. Lagging Indicators – Those that tend to confirm a movement, rather than predict it.

A good example of a leading indicator is an oscillator like the Relative Strength Index. The relative strength index shows us how the market’s strength is too bullish or too bearish, suggesting a future reversal.

A good example of a lagging indicator is one like the simple moving average, or moving average convergence divergence, which shows how different historical data points relate to the current price. With a moving average, there is a natural tendency to lag the market because the numbers that go into the calculation are…well, lagging. Two moving averages with 50 and 100 datapoints show us the past, and may lag the beginning of major market movements.

Suggestions for Traders

By using both leading and lagging indicators, traders will find that they make better, more accurate trades with leading and lagging indicators. For one, lagging indicators require that traders wait out for the currency price to confirm a movement by starting a new trend.

On the other hand, a leading indicator will allow traders to see into the market, and know with some accuracy whether or not the market is soon to move. Below, we’ll use a leading indicator (the RSI) and a lagging indicator (moving average crosses) to showcase how this works:

Boom! See the chart? The moving averages, which are lagging indicators, told us that an uptrend was coming. We confirmed this with the relative strength index, which was well under 30.

In this chart, though, we get a signal from one indicator, but not another:

The lagging indicator said it was time to make a trade, but our leading indicator said otherwise at a reading of 50. Therefore, traders would have avoided this trade, and it would have been the correct call