How key are leading and lagging indicators to successful trades?
I think they’re the guideposts that can help you make better plans.
Planning is a part of life. Without plans, it’s hard to know what your next step should be. That’s why I tell my students to always go into a trade with a trading plan.
But even the best-laid plans can go in unexpected directions, right? In trading, there are ways to measure plans before and after you execute them. Those tools are what we call leading and lagging indicators.
Leading indicators predict what might happen with a stock. They offer valuable clues into the future direction of a stock or a company’s performance.
Lagging indicators measure what happens after the fact. They’re a great way to check your execution. Did your strategy work out the way you wanted it to?
In this post, we’ll break it all down. You’ll learn how traders use leading and lagging indicators. Read on to get your analytical skills on point!
Table of Contents
- 1 What Are Leading and Lagging Indicators?
- 2 Leading and Lagging Indicators: Examples in Business
- 3 Leading and Lagging Indicators
- 4 Leading Indicators
- 5 Lagging Indicators
- 6 Tracking Results Through Lagging Indicators
- 7 Using Leading Indicators to Drive Success
- 8 How to Spot Leading and Lagging Indicators
- 9 Leading and Lagging Indicators: Conclusion
- 10 One Platform. One System. Every Tool
What Are Leading and Lagging Indicators?
Leading and lagging indicators help you plan your trades. Leading indicators give insight into the future. Lagging indicators measure the past.
A great trading thesis requires both. You need to pick your favorite indicators to come up with ideas about what might happen next. You also need to look back at how stocks played out.
The more you analyze your strategies and results, the stronger you can make both. It’s a cycle that repeats. You want to build your experience and trading intuition.
Coming up with a watchlist and trading plan is half the battle. Once you place your trade, you have to look back at what the market did. And you need to ask why.
Over time, you’ll have a better understanding of why markets move when they move. You can learn indicators, but you have to earn experience.
What Are Leading Indicators?
Leading indicators signal future price movements. They can help you make an educated guess about where a stock might be headed.
They often use past price action to determine future potential action. It’s not perfect, because past performance never guarantees future results. As I like to say, history doesn’t repeat, but it rhymes.
There are many indicators out there. We’ll look at a few later in this article. It’s important to get a feel for how they work and pick the ones that make sense to you.
What Are Lagging Indicators?
Lagging indicators use past price information. They can help traders make educated guesses about the future as well. They can also help you get a good feel for a stock chart.
Lagging indicators help you know where to look on a chart to get the information you need. When you wonder what happened, they usually have the answer.
Indicators are key markers that identify patterns in momentum stocks. Without them, the ups and downs of a chart wouldn’t make sense!
Leading and Lagging Indicators: Examples in Business
Let’s put this into a different context for a bit. Businesses use key performance indicators (KPIs) to measure success. And leading and lagging indicators are both examples of KPIs. They help businesses understand how plans turned out.
For traders, this is important. If you know how a business measures its own performance, you can use the same tools to assess it. That can help you decide if its stock is worth trading.
There’s nothing like a great company news catalyst. But due diligence still matters. If you look at leading and lagging indicators, you can get a sense of a company’s overall health.
Leading indicators are forward-looking. They’re actions that companies take to meet their goals. They’re called leading indicators because they come before implementation. They’re the idea, the strategy, and the plan.
An example of a leading indicator is the number of leads a sales team generates. The amount of sales already in a pipeline is another. As is the number of contracts in negotiation for the upcoming quarter.
They’re things that you can work on now to impact your future. And they will vary depending on the industry the company is in. Online companies tend to focus on how much time a user spends on their site.
If you’re a company like Pinterest (NYSE: PINS), you also need to watch your click-through rate like a hawk. That measures the number of people who click on a link (to buy an item, for example). This is out of the total number of people who land on your web page.
Lagging indicators look back. This is the hard data, the results. They tell you the truth of what happened. And you know what they say: hindsight is 20/20.
An example of a lagging indicator is the number of products a company sold. Its total revenue is another. And its customers’ reviews. The number of repeat customers also matters. It’s cheaper to keep a customer than to pursue a new one.
Customer satisfaction can be an excellent way to measure a company’s success. And these days, you don’t have to search hard to find an answer. The internet is full of reviews, opinions, and customer feedback.
It’s also wise for a company to know what the general public thinks of its brand. Some companies use surveys and focus groups to get feedback on their public image.
Leading and Lagging Indicators
In the trading world, you can choose from many leading and lagging indicators. And it’s important to choose.
When some traders lose, they think if they learn a new indicator, they’ll do better. But sometimes less is more.
You want a handful of key indicators you can use again and again. The more you practice, the sooner you’ll understand them like the back of your hand.
And this includes knowing when a bad trade wasn’t your fault. Sometimes you get the indicators right and you have a good plan, but the market still turns on you. That’s OK.
All that matters is that you know why something happened. If you manage your risk well, you’ll live to trade another day. Losing is a guaranteed part of the game. Accept it and move on.
Let’s take a look at some of the most common leading and lagging indicators traders use.
Fibonacci numbers are mathematical numbers found in nature and financial markets. Leonardo de Pisa (aka Fibonacci) discovered them in the 13th century. He was the best math guy in the Middle Ages.
The most common number traders look at is the 61.8% level. If a stock breaks out and then consolidates or retraces its steps, how do you know where it will stop? Some traders look at Fibonacci levels for support.
They expect a downtrend to reverse once it hits a common support level. If it doesn’t bounce back up, it’s time to move on!
Support and Resistance Levels
Many traders look for key levels when they’re setting up a trade. Finding a key level involves looking at charts in longer time frames.
If you look at a stock’s daily or weekly charts, you’ll notice a pattern. There will be a price range on the lower end and the upper side. It’s where the stock touched many times before changing directions.
If you draw a line through these price points, you’ll find your support and resistance levels. When a stock breaks above or below this range, it can make big moves fast.
You’ll hear me talk all about key levels and building a trading plan when you tune in to my no-cost Pre-Market Prep sessions. I’m there for you every trading day at 8:30 a.m. Eastern.
Moving Average Convergence Divergence (MACD)
Subtract the 26-period exponential moving average (EMA) from the 12-period EMA. That’s how you get the MACD. You’ll see the graph at the bottom of a trading chart. Swing traders use the MACD to choose their entry points.
When the MACD crosses over its signal line, traders jump in to buy. When it crosses below its signal line, it’s a sign to sell. The MACD helps traders see how bullish or bearish momentum is.
Traders also pay attention to how quickly crossovers occur. This can give them a sense of whether a security is overbought or oversold.
Many traders prefer that the cross is at or below zero when they enter a trade. But crossovers generally indicate momentum is coming even if it’s above the zero mark.
Relative Strength Index (RSI)
The RSI measures the strength of momentum price changes. You’ll usually see it at the top of a chart.
It moves up and down within a range that’s split in half from top to bottom. When the line moves within the top range, the security is bullish. If the line moves within the bottom range, it’s bearish.
The standard in trading is that once the RSI reaches above 70, the stock is overbought. It has a higher risk of coming back down. If the RSI drops below 30, the stock is oversold and has a good chance of bouncing back up.
Some traders use the RSI in divergence trading. In this case, the direction of the stock and the direction of the line in the RSI figure don’t move in the same direction.
This can mean that the stock price trend is lagging behind the RSI indicator … And that it will change directions to match it soon.
Tracking Results Through Lagging Indicators
You can also compare a stock’s performance to the performance of an index like the S&P 500. This will tell you if a stock moves with the market or against it.
If a stock isn’t moving with a market index, it could mean that the company is in a hot sector. Sometimes a sector can outperform an index.
If you’re long biased, it’s generally better to trade when market indexes are in the green. But every now and then, you’ll find stocks breaking out against the market trend.
Using Leading Indicators to Drive Success
It’s important to use the right tools to make a trade. I can’t stress this enough. You don’t want to be the degenerate trader throwing dollars at any stock that moves.
Screaming “YOLO!” won’t help the outcome of any trade.
You have to know your plan before you get into a trade. And yes, you must have a plan!
Choose your favorite indicators. Build a watchlist. Make a trading plan. Then analyze the results. Did you pick the right leading indicators to work with? How do you know?
How to Spot Leading and Lagging Indicators
It takes practice. Every successful trader puts in hours and hours. There’s no way around it. Read lots of books.
And look at lots of stock charts. Then look at even more stock charts!
Seeing how charts move can sharpen your intuition. That way, when a leading or lagging indicator pops up, you’ll trust yourself to make the right decision. Indicators are there to support your thesis. They’re not guarantees, and they won’t make the trade for you.
It ain’t easy getting started. We all struggle when we’re learning something new. It helps to have a team behind you…
The SteadyTrade Team can show you the ropes. You’ll get hands-on mentorship, twice-daily live webinars, and access to a great community of dedicated traders. Sign up for the SteadyTrade Team here!
Leading and Lagging Indicators: Conclusion
Leading and lagging indicators are helpful tools for newbies and experienced traders alike. They’re the markers on your trading roadmap.
You need to understand past performance if you want positive future results. Trading is a process of analyzing the data and taking calculated risks. Then reassessing your strategies. It takes time to build a system that works for you.
Remember that leading and lagging indicators won’t do the work for you. You have to understand what’s happening first. Learn what makes a stock trend change. Understand the importance of VWAP — it’s a versatile indicator that’s one of my favorites!
Learn the nuts and bolts of the market. Then form a thesis and make your trading plan!
What are your top leading and lagging indicators? How long have traded with the same indicators? Leave a comment below!