Trading Crash Course | The importance of lagging and leading indicators in trading cryptocurrency

[TL; DR]
🔹 Leading indicators predict the price movements of cryptocurrency and other securities.
🔹 Lagging indicators are based on the average price data and confirm existing trends.
🔹 RSI, Stochastic Oscillator and Fibonacci retracements are key leading indicators.
🔹 Bollinger bands, simple moving average and MACD are examples of lagging indicators.




Introduction
Understanding technical indicators enables traders to make informed trading decisions. Apart from appreciating how the different indicators function and how to use them, traders should align them to their trading strategies.

Traders who use more than one indicator should combine lagging and leading indicators. In this guide, we will differentiate between lagging and leading indicators. We shall also discuss when to use lagging and leading indicators.

Overview of lagging and leading indicators

Technical indicators have various roles to play. Mostly, they indicate the direction and momentum of trends as well as the overbought and oversold market conditions. Therefore, they help traders to predict the potential prices of cryptocurrencies and reversal zones.

Leading trading indicators

Leading indicators use previous price actions to predict the future trends and prices of securities. Therefore, traders use these to forecast the movement of prices. As a result, they take appropriate action such as entering or exiting trades at the most appropriate times.

In most cases, the traders aim to open trades at the beginning of a trend and ride it to the end. By doing this, they maximize their gains from trading activities. Some of the indicators such as the Stochastic Oscillator indicate the asset’s overbought and oversold conditions which influence their trading actions.

If an asset is in the overbought zone it means that it is overvalued and the price is likely to fall at any time. Therefore, traders who are alert close their trading positions once the price action confirms that trend.

Oversold means that the asset is undervalued and its price is likely to increase at any time. Astute traders, therefore, buy the undervalued asset in anticipation of a rally in the near future.

In the case of the Relative Strength Index (RSI), the overbought condition occurs when the reading is 70 and above. Conversely, the oversold market condition exists when the reading is 30 and below.

It is important to note that leading indicators are mostly categorized under oscillators which indicate overbought and oversold market conditions. The RSI and the stochastic indicators are the leading indicators that are suitable for beginners as they are easy to use.

Examples of leading indicators

There are many leading indicators which include support and resistance, Fibonacci retracements, on-balance volume, candlesticks and stochastic oscillators. Let’s look at two of these.

Support and resistance levels
Support level is the point at which falling prices do not usually go below. In other words, it is a “floor” we find below the current price. Resistance level, on the other hand, is a level where increasing prices will not usually rise above. This is the “ceiling” when the price of an asset is increasing. If the price breaks past the resistance or support level it is a breakout which shows a strong momentum.

Traders use the resistance and support levels to predict pending price reversals. For instance, if the rising price approaches a resistance level, traders anticipate a downward price reversal and may exit their trades.

As observed in the diagram, the price of an asset bounces at support and resistance levels.

Fibonacci retracement levels
Fibonacci retracement levels are hidden resistance and support levels. To get these levels you draw a line joining a low point of one period to a high point of another period on the trading chart. Once you do that the Fibonacci levels which include 23.6%, 38.2%, 61.8% and 78.6% appear. They become potential support or resistance levels of future price movements.

Lagging indicators
Lagging indicators, also called trend-following indicators, use historical data to confirm existing trends. As such they do not predict future price movements. For example, they confirm current trends and their momentums. Basically, they use the average of past price data. Therefore, they help traders to understand the current market conditions.

Their greatest contribution is to indicate that the existing market conditions are not false signals. This gives the traders confidence to use certain trading strategies. It is essential to understand that lagging indicators are slow in showing price changes that take place in the market.

However, it is not very possible to rely on lagging indicators because you miss out on many opportunities as you enter the market well after trends have started. Also, the trader may keep his/her investment in a cryptocurrency when a price reversal would have long begun.

Notably, lagging indicators work well in strong trends that last a long time. This is because even if a trader enters a trend at a later stage he/she still benefits. Nonetheless, the best strategy is to mix both leading and lagging indicators.

Lagging versus leading indicators
Traders use various combinations of technical indicators depending on the existing market conditions and their preferred strategies. However, there are traders who do not use technical indicators since they depend on price action.

On the other hand, there are traders who rely only on leading indicators and price action. Nevertheless, it is important for traders to combine lagging indicators and leading ones for better trading experience.

Mainly, leading indicators point to future trends before their onset resulting in traders entering or exiting positions at the most profitable points. However, since lagging indicators are based on averages of past data, traders can use them as benchmarks against the current market performance.

Therefore, traders should use leading indicators to identify trends and lagging ones to confirm these current trends. With this combination they make more reliable decisions than otherwise.
Also, it is worth noting that leading indicators function well during trending markets. As such, they give false signals during sideways markets. On the contrary, lagging indicators work well during ranging markets and are not suitable for trending ones.

Examples of lagging indicators
Just like the case of leading indicators, there are many lagging indicators which include moving averages, Bollinger Bands and Moving Average Convergence Divergence (MACD). Also, remember that there are indicators which are both leading and lagging such as Relative Strength Index (RSI).

Simple moving averages (SMA)
This is a good example of a lagging indicator. As the name suggests, this is derived from the average prices of an asset for a number of periods. However, there is SMAs for short periods and longer ones.

Generally, if the price is above the SMA the market is in an uptrend and traders can spot possible trade entry points.

As you notice, for the greater part the price is above the SMA. Thus, the market is in an uptrend.

Conclusion

In short, the leading indicators predict the trends and strengths of price movements. On the other hand, lagging indicators confirm existing trends and reversal points. Candlesticks, Fibonacci retracements and support and resistance levels are examples of leading indicators. Moving averages, Bollinger Bands and MACD are examples of lagging indicators.



Author: Mashell C., Gate.io Researcher
This article represents only the views of the researcher and does not constitute any investment suggestions.
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