Trading indicators can be categorized as leading indicators, lagging indicators or even both, based on the type of information they provide and how quickly they respond in relation to price action. Understanding how they work will help you know the best way and when to use certain indicators in the market during technical analysis. Knowledge can also help you better interpret market events based on the indicators you are using.
What are the leading and lagging indicators?
Leading and lagging indicators are technical indicators that give cryptocurrency traders an idea of what could happen next in the market or what has already happened. Both indicators provide traders with information from the market to guide their trading decisions. The main difference between the two indicators is the timing of the signal they provide.
Leading indicators are indicators that indicate where the price could move next. These indicators use price data to predict future price movements. Leading indicators can help you enter trends early, providing favorable trading entry and exit points. They are often more insightful in technical analysis because they can help you in your quest to enter high-probability trades.
Lagging indicators are also known as trend-following indicators simply because they follow market trends. These indicators focus only on historical data and do not indicate what might happen next in the market. They use the average of past price data to inform traders of market events.
5 examples of leading and lagging indicators
To better understand how these technical indicators work, consider the following examples.
Leading Indicator: Fibonacci Retracement
Fibonacci retracement levels are horizontal lines used to identify potential support and resistance levels. The indicator can help you identify trade entry, stop loss and take profit points. Fibonacci retracement works best in a trending market.
If the price starts declining or correcting in an uptrend, traders using the Fibonacci retracement tool will draw a retracement line to connect the last relevant swing high and swing low. Doing so will help them see the unseen support levels in the market, making it easier to determine where the price could reverse and the uptrend could continue.
Leading Indicator: Candlesticks
Candlestick shows the market opening, closing, high and low prices during a specific time period. Each candle has specific information that it embodies. A trained trader understands the information and uses it to find his way in the market. In other words, each candle provides an easy to understand picture of price action.
You can use the length of the candle’s wick, the body of the candle, and whether it is bearish or bullish to determine what is and what could happen in the market. Common candlestick patterns include dojis, plunging candles, spinning tops, hammers, and pin bars.
Lagging Indicator: Moving Averages
Moving averages determine the direction and direction of the cryptocurrency market. The information for the moving average is generated using past price points, that is, historical market data.
Moving average lines generate buy and sell signals when they cross, although traders cannot rely on them to get the best trading entries. This is because by the time the moving average lines show buy or sell signals, the price action must have started a while ago, making any response you make to the moving average signal lag.
Leading and Lagging Indicator: Bollinger Bands
Bollinger bands consist of a moving average, which acts as a middle band and an upper and lower band, which determine whether the price is relatively high or low. Traders consider the upper band to be an overbought position while the lower band is considered to be an oversold position. Thus, they buy when the market is close to or below the lower band and sell when it is close to or above the upper band.
Bollinger bands, just like the RSI (see below), are lagging indicators in nature because they move after price moves. They only react to price action. However, the outer bars can act as leading indicators as they suggest when the price could reverse.
Leading and Lagging Indicator: Relative Strength Index
The Relative Strength Index (RSI), another indicator that is lagging in nature, tells cryptocurrency traders when the market is overbought or oversold. The RSI fluctuates between 0 and 100, and is usually calculated over a 14-day period. A scale above 70 is considered overbought, and below 30 is considered oversold. The RSI also provides information about who is controlling the market. Traders usually take a scale above 50 as the buyers market and one below 50 as the sellers market.
The main problem with relying on the RSI, just like other lagging indicators, is that the signals usually come late. The market must be bullish for a while before it reverses on the RSI chart.
The RSI can also act as a leading indicator, showing traders what could be going on in the market. Let’s look at the case of the RSI divergence. RSI divergence indicates that the current trend has lost momentum, and there is a possibility of a trend reversal. This can be taken as an early warning signal and will reveal to traders that a possible reversal is imminent. In the case of RSI divergence, the RSI shows a change in market momentum before it reverses in price, thus acting as a leading indicator.
How to use lagging and leading indicators
From the classification above, you can see that some technical analysis indicators for cryptocurrencies act as leading indicators, some as lagging indicators, while others are leading and lagging indicators, depending on how they are interpreted.
Some traders use a combination of leading and lagging indicators when trading. Some traders prefer to use only leading indicators, trading with Fibonacci retracement lines, support and resistance, candlestick languages, and whatever leading indicators they find useful. The classification is mainly functional, the choice of how you use it depends on your cryptocurrency trading strategy.
Now that you know how leading and lagging indicators work, you can better interpret chart information in relation to your strategy. For example, trying to enter a long trade because there is a crossover of the moving average shows a buy signal likely to be a late entry. Since the moving average is a lagging indicator, it is not good for determining entry and exit points for a trade.
On the other hand, lagging indicators are useful when checking historical data and how prices have moved over time. However, nothing prevents you from using the information to predict future market events.
No indicator should be used as a standalone indicator. You should combine it with other tools to make better trading decisions.
After understanding what the leading and lagging indicators are, it is safe to say that both indicators are essential tools for successful trading. Choosing how to use it depends solely on how your strategy works best. Certainly, we cannot deny that knowing how they work and how to interpret the data they provide will be an advantage for you when doing your own market analysis.