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Understanding Leading vs. Lagging Indicators - True Edge Trading

Understanding Leading vs. Lagging Indicators

While there are an overwhelming number of technical indicators, It’s important to remember that almost all of them can be put into one of two categories; leading vs. lagging indicators.

Lagging Indicators

Lagging technical indicators get their name due to the fact that they trail, or lag, price. This usually because they are meant to reduce the “noise” inherent in the price or volume activity.

Example of Moving Average Noise Reduction

The chart for EPD shows its price activity in April of 2018 and a 25 period Moving Average based on this price movement. If we are trying to determine the trend of EPD based on price alone, it could be difficult. This is due to the fact that price is bouncing around. But the Moving Average reduces the price noise and makes it much easier to determine that the stock is actually in an upward trend.

While lagging technical indicators can be effective at reducing noise, they can miss sharp moves. This means they can be late to provide timely information. This is the “give and take” of using a lagging or leading indicator. In fact, let’s look at the leading indicator.

Leading Indicators

Leading indicators are often times referred to as predictive indicators. That is because they are designed to help us anticipate a move, usually a trend reversal. Leading indicators are often used to help us determine of a security is “overbought” of “oversold”. If this condition exists, we might expect a trend to reverse.

The RSI Indicator Showing an Oversold Reading on ACN

The chart for ACN shows a Relative Strength Index (RSI) indicator plotted in the pane below price. This indicator is normally considered a leading indicator. So before price reverses in May, the low reading of the indicator “leads” us to determine that it is currently oversold. This means we should expect to see buyers come into the market and drive the price higher.

One word on leading indicators – they can often be wrong. Due to the predictive nature, they may say that a security is overbought with a high indicator reading. But in fact the security is simply trending upward. That isn’t to say that they don’t have value. They can be extremely valuable, and in fact I use leading indicators in my own trading. But it is probably best to use these in combination with other indicators, such as a moving average, in order to reduce the false positives that can occur.

Jeff Drake
True Edge Trading