The usefulness of these indicators tends to be lower during non-trending periods but highly useful during trending periods
A lagging indicator is one that follows price movements and has less predictive qualities. The most well-known lagging indicators are the moving averages and Bollinger bands. The usefulness of these indicators tends to be lower during non-trending periods but highly useful during trending periods.
This is due to the fact that lagging indicators tend to focus more on the trend and produce fewer buy and sell signals. This allows the trader to capture more of the trend instead of being forced out of their position based on the volatile nature of the leading indicators.
Moving averages are one of the most popular and easy to use tools. They smoothen a data series and make it easier to spot trends, something that is especially helpful in volatile markets. The two most popular types of moving averages are the Simple Moving Average(SMA) and Exponential Moving Average(EMA).
A simple moving average is formed by computing the average (mean) price of a security over a specified number of periods. While it is possible to create moving averages from any of the OHLC (open, high, low and close) points, most moving averages are created using the closing price.
In order to reduce the lag in a simple moving average, an exponential moving average reduces the lag by applying more weight to recent prices relative to older prices. The weighting applied to the most recent price depends on the specified period of the moving average.
Bollinger bands are a technical trading tool and they are also known as volatility indicators. They use the mathematical concept of standard deviations to measure price volatility around a moving average to generate trading signals.
During periods of increased fluctuation, the bands will widen to take this into account, and when the fluctuation decreases the bands are tapered for a narrower focus to the price range.
The upper band is the standard deviation multiplied by a given factor above the simple moving average, and the lower band is the standard deviation multiplied by the same given factor below the simple moving average.
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.Subscribe to Moneycontrol Pro and gain access to curated markets data, exclusive trading recommendations, independent equity analysis, actionable investment ideas, nuanced takes on macro, corporate and policy actions, practical insights from market gurus and much more.