Lagging Technical Indicators
Three popular lagging indicators
Popular lagging indicators include:
The MACD indicator
Lagging indicators are primarily used to filter out the noise from short-term market movements and confirm long-term trends. They are usually drawn onto the price chart itself, unlike leading indicators which usually appear in separate windows.
Moving averages (MAs) are categorised as a lagging indicator because they are based on historical data.
Buy and sell signals are generated when the price line crosses the MA or when two MA lines cross each other. However, because the moving average is calculated using previous price points, the current market price will be ahead of the MA.
In the below 50-day MA example, the moving average has crossed the price from above, indicating an upward reversal is imminent. However, we can see that the MA is slower to pick up the bullish trend when it does occur.
Moving averages can be calculated over any timeframe, depending on the trader’s goals – but the longer the time frame, the longer the lag. So, a MA of 300 days would have a far longer delay than an MA of 50 days.
It is possible for lagging indicators to give off false signals, but it is less likely as they are slower to react.
Moving averages can be used on their own, or they can be the basis of other technical indicators, such as the moving average convergence divergence (MACD). As it is based on MAs, the MACD is inherently a trend-following or lagging indicator. However, it has been argued that different components of the MACD provide traders with different opportunities.
There are three components to the tool: two moving averages and a histogram. The two moving averages (the signal line and the MACD line) are invariably lagging indicators, as they only provide signals once the two lines have crossed each other, by which time the trend is already in motion.
But the MACD histogram is sometimes considered a leading indicator, as it is used to anticipate signal crossovers in between the two moving averages.
The bars on the histogram represents the difference between the two MAs – as the bars move further away from the central zero line, it means the MAs are moving further apart. Once this expansion is over, a ‘hump’ appears on the histogram which is a sign the MAs will tighten again, and a crossover will occur.
Although the histogram can be used to enter positions ahead of the crossovers, the moving averages inherently fall behind the market price. So, in general it is a lagging indicator. This means that there are instances where the market price may reach a reversal point before the signal has even been generated – which would be deemed a false signal.
The Bollinger band tool is a lagging indicator, as it is based on a 20-day simple moving average (SMA) and two outer lines. These outer bands represent the positive and negative standard deviations away from the SMA and are used as a measure of volatility.
When levels of volatility increase, the bands will widen, and as volatility decreases, they will contract.
When the price reaches the outer bands of the Bollinger, it often acts as a trigger for the market to rebound back towards the central 20-period moving average.
There are strategies that suggest the bands have leading indicator properties, but alone they do not give out leading trading signals.
Bollinger bands can give no indication of exactly when the change in volatility might take place, or which direction the price will move in. They are merely a sign that a breakout could soon take place, giving bullish and bearish signals.
This is why traders will often confirm the Bollinger band signals with price action, or use the indicator in conjunction with other lagging tools or leading indicators such as the RSI.
Leading and lagging technical indicators summed up
A leading indicator is a tool designed to anticipate the future direction of a market
A lagging indicator is a tool that gives signal once the price movement has already started
Leading indicators react to prices quickly but this makes them prone to giving out false signals
Lagging indicators can be more accurate but this is because they are far slower to react
A lot of popular leading indicators fall into the category of oscillators, including the RSI, stochastic oscillator, Williams %R and OBV
Lagging indicators are drawn onto the price chart itself and include moving averages, the MACD and Bollinger bands
Relying solely on either could have negative effects on a strategy, which is why many traders will aim to find a balance of the two