Lagging vs Leading Indicators : advantages and Disadvantages

To make informed decisions in the stock market, investors track many business, economic, and stock price indicators. There are two types of indicators: leading and lagging indicators. Lagging indicators tell us about an event only after it has occurred, whereas leading indicators indicate what is likely to occur.

The sharemarket is not the only place where leading and lagging indicators exist. They are also used in areas like finance, management, and safety. Consumer sentiment and bond yields, for example, are the leading indicators. However, the unemployment numbers, measures inflation like wholesale price index and consumers price index, amount disbursed loans and sales of cars are all prominent lagging indicators.

The GDP (gross Domestic Product) statistics are a good example. When we talk about GDP estimates, they are leading indicators. If GDP from previous years is being considered, they are lagging indicator. These GDP statistics are known as coincident indicators because they cannot be compared with leading and lagging indicators.

Leading indicators vs. lagging indicators : Advantages and Disadvantages

a) Although lagging indicators can be easier to spot, they do not capture the current trend. These indicators can tell you if there has been a reversal in stock price direction. It might not be possible to make gains, or even stop losses, by that time.

b) While leading indicators can help investors in the share market stay ahead of the curve, they may also be misleading.

c) It is important to understand that these indicators are calculated using data and algorithms. An incorrect indicator could result from a factor's imperfections.

d) False Signals are a problem with leading indicators because they can respond quickly to stock price changes.

e) However, false signals can be sent by lagging indicator too since there is inertia when responding to reversal trends

Commonly used lagging indicators on the share market

1) Exponential Moving Average (EMA): This tool gives more weight to the most recent observations. This is how it differs from the simple moving average, which gives equal importance all data points. EMAs are possible for any time. To improve the accuracy of an EMA for a stock, it is a good idea to collect as much historical data possible. The direction of change is slower for EMAs with longer periods.

2) Moving average convergence/divergence (MACD): This is a tool that helps investors identify the bullish and bearish nature of a particular trend. It's a function of two EMAs. It can be used to indicate the momentum or duration of a particular trend, among other things.

3) Average Directional Index: This technical analysis tool allows you to gauge the strength and direction of a trend. It is represented by a number between 0 and 100.

Leading indicators of the share market are often used

1) Relative strength indicator (RSI: This is a lagging indicator which tells investors when a security has been overbought or sold in the market.

2) Stochastic oscillator - This indicator predicts market turning points by comparing the historic price range of a security with its closing price

Williams %R: This indicator shows the security's proximity with the high or low during a specific trading period, which in most cases is two weeks.

The four most important points of the difference between leading and trailing indicators

1) Lagging indicators give fewer false signals, which could mean that there is a lower chance of stop-out losses.

2) The second key difference between leading indicators and lagging indicator is that the latter is more accurate due to the fact that it is based on post-facto data collection and calculations.

3. Because of the slow nature of lagging indicators signals, it is possible that the signals don't arrive in time to capture a larger portion of the move.

4) There is another major difference between leading indicators and lagging indicator . The former is more useful for day trading , while the latter is more useful for swing trading .

Lagging indicators vs leading indicators: Which type is better?

It is difficult to choose between leading and lagging indicators at one time. Combining inferences from all three can help you create a winning trading strategy. Investors operate by using both types of indicators to make moves in the market. This means that one does not have to make a hobson’s choice between leading and lagging indicators.