What it means
Think of the dashboard of a car. The speedometer, fuel gauge and warning lights do not drive the car, but they tell you what is happening so you can act.
Business and economic indicators play the same role. Economists group indicators into three types.
Leading indicators tend to change before the economy does, such as new building permits or consumer confidence. Coincident indicators move with the economy, such as industrial output, and lagging indicators change afterwards, such as the unemployment rate.
Inside a company, managers use key performance indicators (KPIs, the chosen measures of success) such as sales growth, gross margin, customer churn and cash conversion. In investing, technical indicators such as moving averages and the relative strength index are calculated from price and volume.
Each type answers a different question and should be matched to the decision at hand. The value of an indicator depends on understanding how it is built.
Some are noisy and jump around from month to month, and some are revised later when better data arrives. It is wise to look at trends over several periods instead of reacting to a single reading.
No single indicator tells the whole story. Using several together, and checking them against common sense, reduces the chance of being misled.
A good habit is to write down what each indicator is expected to show and what action would follow if it moved. Data quality is the last point to check.
Know who produces the figure, how often it is released, whether it is revised and what it leaves out, because an indicator is only as reliable as the numbers behind it.
In practice
Real-world examples.
Example
A retailer tracks monthly footfall, average basket size and conversion rate as its key indicators. When footfall holds steady but conversion falls from 25% to 20%, the manager investigates staffing and stock levels. The signal points her to a problem before sales figures drop sharply. She asks the sales team for a recovery plan.
Example
An economist studying the housing market watches mortgage applications and building permits. A sustained fall in both leads her to warn clients that construction activity may weaken in coming months. She also cautions that the data are often revised. Her report shows the range of possible outcomes, not a single forecast.
Example
A private investor uses a moving average to help time purchases of an exchange traded fund. He buys only when the price is above its 200-day average. The rule keeps him out of long downturns, though it also causes some missed gains. He reviews the rule once a year to see whether it still suits him.
Formula
Calculation
Simple moving average = Sum of prices over the period / Number of periods
Suppose a share closed at $48, $50, $52, $54 and $56 over five days. The sum is 48 + 50 + 52 + 54 + 56 = $260.
The five-day simple moving average is 260 / 5 = $52. If the latest price of $56 is above the $52 average, many traders read this as a sign of upward momentum, while a price below the average might be read as weakness.Case study
Seen in the real world.
Ironbridge Components is a fictional manufacturer that wanted an early warning of falling demand. The finance director chose three indicators: new orders, the order backlog and customer inquiries.
Over three months, new orders slid from 1,000 to 850 a month, a fall of 15%, while the backlog shrank by a fifth. The finance director reduced planned production by 10% and delayed a $300,000 equipment purchase.
In this illustrative case, sales fell a few weeks later, but the company had not built up unsold stock and kept its cash. The director noted that the indicators would not always work so neatly and continued to review them with the sales team. A one page dashboard went to the board every month.
Watch out
Common mistakes.
- Relying on one indicator, when several measures together give a safer picture.
- Reacting to a single month's change, when many indicators are noisy.
- Confusing a leading indicator with a guarantee, when it only raises or lowers the odds.
Questions
People also ask.
What is a leading indicator?
It is a measure that tends to change before the economy or business does, giving early warning of what may come.
What is a KPI?
It is a key performance indicator, a measure chosen to show how well a team or business is doing against its goals.
How many indicators should I track?
Enough to cover the main drivers of the decision, but few enough to review regularly, often between five and ten, and each one should be tied to a decision someone can take.
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