Indicators which give early signals of entry and exit are known as leading indicators. Leading indicators are those created to precede the price movements of a security giving predictive qualities.
In technical analysis, indicators are of two types namely leading and lagging.
A leading indicator leads the price, meaning it usually signals the occurrence of a reversal or a new trend in advance whereas a lagging indicator on the other hand lags the price meaning it usually signals the occurrence of a reversal or a new trend after it has occurred.
a) Leading Indicators:
Indicators which give early signals of entry and exit are known as leading indicators. Leading indicators are those created to precede the price movements of a security giving predictive qualities. These indicators give us more opportunities to buy and sell. They can get you into a profitable trade earlier than Lagging Indicators, however they are less reliable and can often lead to false signals.
They represent a form of price momentum over a fixed look-back period, which is the number of periods used to calculate the indicator. One of the major advantages of leading indicator is that it gives early signs of entry and exit than other indicators such as MACD. The drawback is that sometimes it gives a false signal of buy and sell. Leading Indicators also do not identify trend, unlike the lagging indicators.Some of the common indicators which lead are:
> RSI ( relative Strength Index)
b) Lagging Indicators:
Lagging Indicators are stock trading technical indicators which indicate the change in the trend or momentum after the actual market action. These trading indicators are the mathematical derivatives of price and volume. Some of them are derived from other indicators. These indicators generate buy and sell signals after the actual change in the trend. So we will be entering the trade after some portion of trend is already over.
This late entry increases the initial stop loss. This will negatively affects our money management and risk to reward ratio. Since these trading indicators give trade signal after the actual change of trend, they tend to give less number of false signals. The loss due to the stop loss being taken out is reduced. They complement other technical indicators and helps in confirmation of the trend.Some of the common indicators which lag are:
> ADX Indicator
> Bollinger Bands
(The author is Associate Vice President | Analyst-Derivatives at Motilal Oswal Financial Services Limited.)Disclaimer: The views and investment tips expressed by investment expert on Moneycontrol.com are his own and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.
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