Leading and Lagging Indicators in Trading (2024)

A leading indicator aims to provides information before another metric. Indicators that point to where the price could move next are seen as leading indicators, as in most cases, price action​​ is what the indicator is compared to. If the price is dropping and an indicator starts rising before the price does, that may be considered a leading indicator, because the indicator is forewarning of a price rise.

For example, Fibonacci retracements and extension tools are considered leading indicators because they attempt to forecast where the price may go next before it happens. Remember that leading indicators aren’t always correct; sometimes the price will move in the direction the indicator points, and sometimes it won’t. It should only be used as guidance for your trading strategy and not relied on exclusively.

Most technical indicators are lagging indicators, as they only look at historical data and aren’t suggesting which way the price will go next. However, lagging indicators can lead price in some contexts, such as divergence.

Divergence occurs when the price makes a new high above a prior swing high but the indicator does not, or the price makes a new low below a prior swing low but the indicator does not. This is a leading indication that the price action may be slowing down and the trend is close to reversing. Read more about trading trend reversals​​.

The following chart shows several divergence examples using the Relative Strength Index (RSI) on a trading chart for our Big Tech share basket, which is an exclusive product offered at CMC Markets.

The relative strength index​​​ (RSI) is a technical indicator that can act as both a leading and lagging indicator. In its absolute sense, it is a lagging indicator, because the price has to move first for the indicator to start moving in that direction. It basically moves with the price, with a slight delay.

That said, it can be a leading indicator. When the RSI reaches extreme levels, it can signal that the price is overextended and may soon reverse in the other direction. But because the indicator lags price, traders could consider waiting for the price to actually start reversing before acting on the signal. As discussed above, divergence can also transform the RSI into a leading indicator, providing insight on when trends may be running out of steam and are ready to reverse.

Moving averages are considered lagging indicators because the average simply follows the price, with a delay. For example, if the price is dropping and then comes back higher, the moving average could start moving higher after the price does.

Moving averages can also be leading indicators as they may signify where the price may find support or resistance in the future. The price will often move back to the moving average because of mean reversion, which is where the price moves back to more normal or average levels after pulling away from the average.

The following chart shows that a simple moving average (SMA) is both lagging and leading in that it moves with price, but in a delayed fashion, and it also acts as a moving target (leading) for where the price could go next because of the tendency for the price to return to the average.

The stochastic oscillator​​ is mainly used to highlight when the price may be overextended and could reverse. In this capacity, it acts as a leading indicator.

Once again though, in absolute terms, the stochastic is a lagging indicator as it is comparing the current closing price to the closing prices of prior price bars/candles, and therefore, the indicator will also slightly lag behind price.

The stochastic oscillator highlights overbought and oversold areas for potential buy and sell actions in ranging assets, or assets that are moving relatively rhythmically higher and lower.

As with the other indicators discussed so far, Bollinger Bands​​ are inherently lagging because the indicator only reacts after the price moves. However, Bollinger Bands have a moving average and outer bands that can act as a leading indicator, as they help to identify areas where the price may stall or reverse.

On the chart below, we can see that the Bollinger Bands are slightly delayed in reacting to price fluctuations. That said, the bands can help to identify areas of dynamic support and resistance​​ as the price moves.

When building a trading strategy, some traders opt for a combination of leading and leading technical indicators. Some prefer only leading, while others use lagging. Pure price action traders prefer to not use indicators at all and instead focus on analysing the price charts manually.

It is not so much how an indicator is classified (leading or lagging) that matters, rather how the indicator is used and interpreted by the individual. Both types of indicators have their uses and tell traders something about the price action. Leading is not better than lagging, or vice versa. When using any type of technical indicator or trading strategy, it is important to incorporate risk controls on each trade in case the price doesn’t move as expected.

Risk controls include the use of a stop-loss order, which exits the trade if the price moves in the opposite direction by a specified amount. However, stop-loss orders do not take into account market volatility, such as slippage or gapping on price charts. Another form of risk control is position sizing. Proper position sizing ensures that not too much capital is put at risk on each trade. Capital can be spread out over multiple trades, or if all the capital is used for one trade, a stop-loss could be placed so that only a small portion of that capital is at risk of being lost.

One of the main drawbacks of any indicator is the possibility of producing false signals. A false signal is when the trader interprets an indicator but the price doesn’t move as expected. For example, if an RSI is overbought and starts turning lower, this could be interpreted as a sign to sell or short sell. Yet, the price may continue going higher. This is a false signal, which is another reason for why risk controls are required when trading.

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