Leading vs. Lagging Indicators

There are two types of indicators: leading and lagging. A leading indicator gives a signal before a new trend or reversal occurs. These indicators help you profit by predicting what prices will do next. Leading indicators typically work by measuring how “overbought” or “oversold” something is. A lagging indicator gives a signal after the trend has started. Lagging indicators work well when prices move in relatively long trends. They don’t warn you of any upcoming price changes, they tell you what prices are doing (rising or falling) so that you can trade accordingly. You would “catch” the entire trend every single time IF the leading indicator was correct every single time. But it won’t be. When you use leading indicators, you will experience a lot of fakeouts. Leading indicators are notorious for giving bogus signals that could “mislead” you.

The general approach is to use lagging indicators during trending markets and leading indicators during sideways markets.