What is the difference between leading and lagging indicators?

[Benjamin Schmitz]

[Steve Walters]

Indicators, also known as economic indicators or technical indicators, are anything used to confirm or predict trends in the economy or the financial markets. With economics, the statistics published by the world’s governments are the indicators used by investors to determine the future direction of a broad variety of asset classes. Not all indicators give the same information though. There are both leading indicators and lagging indicators, and the information they provide to investors is different. With leading economic indicators, investors use them to predict future market moves and events. Investors often consider consumer confidence one of the best predictors of future economic activity. In equity markets, investors see bond yields as a good leading indicator since bond traders concern themselves with the future strength or weakness of global economies. Other good leading indicators include the purchasing managers index (PMI) and overall money supply. A lagging economic indicator is not predictive, but is confirming since they follow events which have already occurred. These lagging indicators are still important to investors as a confirmation of an ongoing, changing or developing trend. One of the most closely watched lagging indicators is employment and unemployment. Generally it takes employment and unemployment several quarters to catch up to changes in the broader economy. The consumer price index (CPI) is another good lagging indicator that tracks changes in the inflation rate. We call a third economic indicator the “Coincident Indicators” because they don’t predict or confirm, instead they change at the same time as the economy. Some consider Gross Domestic Product (GDP) the most important coincident indicator. Another important coincident indicator is personal income, which typically rises in a strong economy. With technical indicators we can also talk about leading and lagging indicators. Here a leading technical indicator precedes a price move or change in the trend, while a lagging technical indicator is one that follows price moves, confirming rather than predicting. One of the most popular leading technical indicators is the Relative Strength Index (RSI), which is an oscillator that predicts when an asset is overbought or oversold. Often a divergence between the direction of the RSI and the direction price is taking is a good prediction of a change in the direction of price or trend. Another popular leading technical indicator is the Stochastic Oscillator. Most leading technical indicators are oscillators plotted in a bounded range and are fluctuating based on the set parameters of the oscillator. In terms of lagging technical indicators, the most popular are moving averages and Bollinger Bands. This indicator is most useful during trends as they confirm the continuation of the trend and prevent traders from getting forced out of a trade due to volatility. The most popular use of these lagging technical indicators is to produce buy and sell signals through crossovers and divergences. Traders consider both signals confirmations of a change in the trend.

[Abraham]

Being input-oriented, leading indicators predict future events. Such metrics include the steps to take for a successful business and the product development process. But these measures aren’t foolproof.  Consider them what might happen instead of what must happen. The fact that they’re unique to different institutions makes them hard to benchmark.
In contrast, lagging indicators show past activities, for example, expenses, client engagement, and revenue. On the downside, the pointers appear too late to be acted upon. Additionally, the signals don’t give the reason behind an occurrence or the ways to counter it. You may not be able to stop clients who have defected to your rival. 
Both indicator types improve market understanding. Note that some indicators fit in all the categories. Take the case of employee recruitment. For HR, hiring the finest talent becomes a lagging indicator because they have taken the correct measures when choosing the candidate. Conversely, the company views it as a leading indicator because it translates to better future performance.
 

[Ryan Hall]

Hey Benjamin,

Lagging indicators are indicators used to analyze the market, utilizing an average of previous price action data. They’re called the “lagging indicators” because they lag the market. This implies that traders can see the move happen before the indicator confirms it. As a result, the trader can incur losses at the start of the move.

A leading indicator, on the other hand, is an indicator that estimates future price movements based on current price data. Because this indicator lets traders forecast future price movements, traders can place trades at the start of the move. One of its main disadvantages is that traders forecast future movements before they actually happen, so if the price moves in the opposite direction, the trader will lose money.