Leading vs Lagging Indicators

Difference Between Leading and Lagging Indicators

A leading indicator is an economic factor that tends to change before the economy starts to change and helps investors and market participants to predict changes in the economy whereas a lagging indicator is a measurable economic factor based on the changes in the economy; this means that when there is a change in the economy there will be definitely a change in the lagging indicators. It is the lagging indicator that are used by traders to arrive at transaction signals of a trend.

Indicators are economic factors that enable to measure of current market conditions and to forecast market trends. To arrive at a certain indicator statistical computing needs to be performed. Indicators enhance the economic forecasting for market makers, organizations, economists, and investors alike.

What are the Leading Indicators?

Leading indicators have behavior to change before the economy changes. It might not be wrong in saying that these indicators result in a change in the economy. These indicators changes before the economy start to make its move. Due to its preemptive nature, economists and traders rely on leading indicators to arrive at conclusions regarding forecasting significant shifts in the market.

Since these are just indicators, at times the indicators aren’t accurate. But, when put together with other data from the market, these indicators can be a key factor in forecasting the economy. Leading indicators are aggregated data that is collated by qualified sources and focuses on specific segments of the economy.

An example would be the Purchasing Managers Index (PMI) which is closely monitored by economists and traders to forecast the Gross Domestic Product (GDP).

Another example would be the number of jobless claims which stands as an indicator of a weak economy. A rise in jobless claims would eventually have a negative impact on the economy and the market. Inversely, if jobless claims dip, it showcases that the companies are doing good which would result in a stronger market.

Leading-vs-Lagging-Indicators

What are Lagging Indicators?

Lagging indicators are economic factors that have behavior to change post changes in the economic scenario. Movements in lagging indicators become evident only after the economy has moved in a particular direction and it starts to follow a particular trend. A lagging indicator does not help in predicting changes in the economy however it helps in determining the after-effects of the change in the trend of the economy. Since these indicators are an outcome of a change in the economy, traders and economists can use the lagging indicators to generate signals.

Quantitative Investment Strategies which are rule-based securities, function on the basis of the signals that are arrived at with the help of lagging indicators. The impact of an economic change and its trend is mimicked by the lagging indicator which trails the movement of the price of the underlying asset.

An example would be the moving average of any security. The moving average can be determined only after a change in the price of the security. The moving average has a flaw since there is a high possibility that the significant move may have occurred at a time that is not included in the calculation. This would result in entering the trade at a later stage which may not be profitable.

Leading vs Lagging Indicators Infographics

Let’s see the top differences between leading vs lagging indicators.

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Key Differences

The followings are the key differences:

  • Leading indicators focus on the future situation of the economy whereas lagging indicators focus on the past movements of the economy.
  • Leading indicators tend to change before a change in the economy whereas lagging indicators tend to change after a change in the economy.
  • The accuracy of a leading indicator cannot be guaranteed however the accuracy of a lagging indicator can be relied upon.
  • Leading indicators are monitored to predict any future movements in the markets. Lagging indicators are monitored after movements in the market.
  • Leading indicators are input-oriented whereas lagging indicators are output-oriented. This means that leading indicators are hard to measure whereas lagging indicators are easy to measure.

Leading vs Lagging Indicators Comparative Table

Basis Leading Indicators Lagging Indicators
Meaning A leading indicator is an economic factor that tends to change before the economy starts to change. A lagging indicator is an economic factor that changes only after the change in the economy has already taken place.
Usage Leading indicators are used to forecast significant shifts in the economy. Leading indicators serve as a red flag or heads up for upcoming market disruption. Lagging indicators are used to determine the after-effects of the shift in the economy. They serve as proof of market movements.
Accuracy Leading indicators cannot be always accurate and can be misleading. Lagging indicators are based on economic events and hence can be relied on its accuracy.
Time Leading indicators exist before a change in the economy. Lagging indicators exist after the change in the economy.
Trend The trend followed by leading indicators might result in a change in the economy. The trend followed by the economy results in a change in the lagging indicators.
Basis Leading indicators show the possibility of a major change in the future which is based on individual movements of a segment of the economy. Lagging indicators confirm the changes in the economy and are based on the facts and figures.

Conclusion

  • Any indicator can lead to a wrong conclusion, so it is important not to focus solely on one change.
  • Both are economic factors that are based upon the economic changes.
  • Market makers and economists rely upon both indicators to arrive at decisions or to forecast any significant changes in the economy in the future.
  • Leading indicators give a heads up or a red flag for the economists and traders regarding a major market shift in the near future.
  • Lagging indicators serve as proof of a pattern or trend followed by the economy over a period of time.
  • Both indicators are based on the data available in the market which is collated by qualified sources.

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