Leading vs Lagging Indicators: What’s The Difference?
Leading and lagging indicators help traders measure the future and current performance of a currency pair, respectively. These indicators can help make successful trading decisions. In this article, we learn everything about leading vs lagging indicators and which is a better fit in trading forex.
What are leading indicators?
Leading indicators predict the future price movement of currency pairs by using the current price data. It provides traders with ideal exit and entry price levels before a strong trend in the market begins.
What are lagging indicators?
Lagging indicators are a confirmation tool that provides market signals after a price trend has occurred, making it easier for traders to identify, gauge and measure the market trends. It uses historical and current prices to provide traders with ideal exit and entry levels after the price movement confirmation in the market.
Leading and lagging indicators example
Let’s assume you want to trade EUR/USD in the forex market with the help of a leading and then a lagging indicator to place successful buy or sell orders. We will be using the Relative Strength Index, which indicates oversold or overbought market conditions as the leading technical indicator. Suppose EUR/USD is trading at 3, with a support level fixed at 2.5 and a resistance level at 4. The RSI will be calculated based on the average price loss and gain over the time period considered (let us take that as 14 days in our case). Assuming the 14 day loss and profit for EUR/USD was = (1,-2,2,2,3,-4,1,-1,0,5,-3,2,5,5) / 14 = 16/14 = 1.14 An RSI value above 0.5 means that the currency pair is trading higher than usual (overbought) and can reverse at any time. This would mean that as a trader, you would want to exit your position at the current trading exchange rate of 3 to avoid losses from the downtrend ahead. Now, if you want to use the lagging indicator to trade the same currency pair, let us consider a Simple Moving Average for the same. We will be considering the same time period of 14 days and calculate the average price of EUR/USD in the last 14 days. Assuming the currency pair traded at these levels in the last 14 days, average price = (2.5,2.5,3,2,3,3,3,3,3,4,2,4,4,4)/14 = 43/14 = 3.07 Since the current currency pair price of 3 is very close to its average currency pair price of 3.07, as a trader, you will enter the market, which is currently in an uptrend, to profit from the continued market direction.
Leading vs Lagging indicators: The major difference
- Leading indicators predict the future market price movements with the help of past price movements.
- Lagging indicators confirm current market trends with the help of past market trends.
- Since leading indicators provide traders with market forecasts, they react to current market prices very quickly and signal ideal entry and exit levels.
- Lagging indicators are slow reactors to the market price because they confirm trends instead of predicting future trends.
- Leading indicators are solely based on current market data as they provide market signals based on how overbought or oversold a market condition is.
- Lagging indicators are solely based on historical market data as they provide market signals based on an already existing trend.
- Leading indicators are more useful for day trading as they indicate more accurate results in the short term by providing traders with market movements in the near future.
- Lagging indicators are more useful for swing trading as they indicate more accurate results in the medium to long term by providing traders with confirmed market signals that continue to be in the same direction for a few weeks, months or even years.
Most common leading indicators
1. Fibonacci retracement
Fibonacci Retracement is a technical indicator that identifies the support and resistance levels in the forex market. Fibonacci indicator signals a market reversal and provides traders with an ideal entry level during an uptrend reversal and exit level during a downtrend reversal. It uses the Fibonacci percentage numbers to predict price movements
- 100% Fibonacci Retracement indicates a future market price reversal
- 0% indicates a future market trend confirmation
- 61.8% indicates a weak future trend
- 38.2% indicates a strong future trend
2. Relative Strength Index
Relative Strength Index (RSI) is a momentum indicator that helps traders identify if the market is currently (but temporarily) oversold or overbought. It provides traders with a reversal signal along with the ideal time to enter or exit a trade accordingly.
- Oversold market conditions signal traders to place a long order as an uptrend is expected.
- Overbought market conditions signal traders to place short or sell orders as a downtrend is expected.
3. Donchian Channel
Donchian Channel is a trend-following indicator that provides traders with bullish and bearish market signals. It comprises three lines, an upper band, a lower band and a midrange band. The higher the price fluctuation of a currency pair price, the higher the Donchian Channel’s width and vice versa.
- The upper band in the channel indicates the highest currency pair prices in a particular period.
- The lower band in the channel indicates the lowest currency pair prices in a particular period.
- The midrange band is the average of the currency pair prices over a particular period.
When the current market prices are closer to the upper band, it indicates a bullish continued trend and signals traders to enter the trade. However, when the current market prices are closer to the lower band, it indicates a bearish continued trend and signals traders to exit the trade.
4. Williams %R
Williams %R or Williams Percent Range is a momentum indicator that measures overbought and oversold market conditions. It ranges between 0 to -100 and helps traders find ideal long or short market positions.
- When the indicator’s reading is between 0 to -20, it shows an overbought market condition and signals traders to exit the trade due to an expected downtrend.
- When the indicator’s reading is between -80 to -100, it shows an oversold market condition and signals traders to enter the trade due to an expected uptrend.
Williams %R compares the previous closing price to the highest and lowest price level in that period to identify market signals.
- When the previous closing price is near to the high price level, it indicates a future uptrend.
- When it is close to the low price level, it indicates a future downtrend.
5. Awesome Oscillator
Awesome Oscillator (AO) identifies the strength or weakness of a currency pair’s market trend. It measures the current market momentum with the general momentum to confirm if a trend is going to continue or reverse. When the current market momentum aligns with the overall uptrend momentum, it indicates a future uptrend and when it aligns with the overall downtrend momentum, it indicates a future downtrend. However, if the current momentum is opposite to the overall momentum, it provides future reversal signals.
Most common lagging indicators
1. Parabolic SAR
Parabolic Stop and Reverse (SAR) is a short-term momentum indicator that provides traders with ideal stop-loss price levels. The stop-loss levels can be determined by identifying when the market is going to potentially reverse and follow a different trend. In this indicator, a dot is placed below the current price when the market is trending upwards and above the price when the market is trending downward to identify future trends.
- When the market trends within the SAR values, it indicates a continued market trend.
- When the market prices move beyond the SAR value, it indicates a market trend reversal.
2. Simple Moving Average (SMA)
Simple Moving Average is a series of currency pair prices in a particular period which is added and then divided by the number of time periods to calculate the average price. When the current market price is close to the average price, it indicates a trend continuation and provides traders with an ideal entry level during an uptrend and exit level during a downtrend. On the other hand, if the current price has deviated from the average price, it signals that the current market trend is not strong and could reverse anytime.
3. Exponential Moving Average (EMA)
EMA is a technical indicator that is an extension of SMA. The only difference is that EMA puts greater weight on the most recent price levels and signals market momentum accordingly.
- EMA predicts a current uptrend/downtrend when current market prices are near the exponential average price (depending on if the previous trend was an uptrend/downtrend, respectively). In this situation, it signals traders to enter a trade during an uptrend and exit a trade during a downtrend.
- EMA predicts a current uptrend/downtrend reversal when the current price is not close to the exponential average price. In this situation, it signals traders to enter a trade if there is a current downtrend and exit if there is a current uptrend.
4. Keltner Channel
Keltner Channel is a type of technical indicator that identifies the current trend’s future direction. It is a continuation signal that provides traders with long-term market momentum. The Keltner Channel is made of three lines:
- The upper band is the exponential moving average of the currency pair
- The upper band is placed twice above the EMA
- The lower band is placed twice below the EMA
When current market prices trade near the upper band, the Keltner Channel confirms a bullish trend continuation and signals traders to place entry orders. Whereas, when current market prices trade near the lower band, the Keltner Channel confirms a bearish trend continuation and signals trades to place exit orders.
5. Stochastic Oscillator
Stochastic Oscillator is a momentum indicator that compares the previous closing price of a currency pair to a price range between the support and resistance level. When the previous closing price is near to the resistance level, it indicates that there is a current uptrend in the market and when it is close to the support level, it indicates a current downtrend. The comparison signals traders with ideal entry and exit levels in the market.
Which is better: Leading or Lagging indicator
Leading indicators provide traders with strong market forecasts, whereas lagging indicators provide strong trend confirmations. Using either of the two indicators increases the chances of false signals. This is why it is advised to use both indicators together in order to use historical and current price trends as a combination to determine future market trends with confirmed market signals. Start your forex trading journey with Blueberry Markets for a seamless trading experience. Sign up for a live trading account or try a risk-free demo account
Frequently Asked Questions
How do you tell if an indicator is leading or lagging?
Leading indicators look into the future with the help of historical and current price trends. In contrast, lagging indicators look backwards by understanding the past market trend and indicating confirmation of the same.
Which is better to use, leading or lagging indicators? Why?
Both leading and lagging indicators come with their own advantages. It is best advised to use the two indicators together to avoid false market signals and make successful trading decisions.
What is the best forex leading indicator?
RSI is the most popular leading indicator as it indicates overbought and oversold market conditions and provides traders with ideal entry and exit price levels.
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