Using stock market indicators today is a good start to stronger portfolio returns going forward—but they are just the beginning

Early in my investment career, before I had much money of my own to invest, I took a strong interest in market indicators and ruler (also known as investor rules of thumb, investor guidelines, market lore and so on). Who could resist? Market indicators seemed to provide a shortcut to making money in the stock market. To top it off, most were simple enough to fit on a T-shirt.

The more I looked into investor rules, the clearer it became that the best ones were not delivering consistent value for investors, and the worst ones were increasing investor risk. The problem is that the stock market indicators today use only a tiny fraction of all the information that can have an impact on the price of an investment. You may think your favourite indicator zeroes in on all the key factors you need. You may be right, of course, but there are many ways to go wrong.

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Stock market indicators today: Look at a wide range of data and make more informed investment decisions

Your investing education really begins after you start to recognize just how much you don’t know. When you reach that point, you’ll start to look at a much wider range of data and indicators.

Stock market indicators that tell a negative story all have the same basic structure. They take some measure of market strength, or value, and compare it to the historical averages. They all touch on at least one of these three factors: how long the market has been rising; how far it has gone up during that rise; or the P/E ratio—the ratio of a stock’s price to per-share earnings. These three types of indicators all measure the same thing, and that’s why they tell the same story.

When they first set out to formulate an investment strategy, many investors decide to focus their stock market research on a handful of measures. For instance, they may want to see a p/e ratio (the ratio of a stock’s price to its per-share earnings) below 15.0, say, along with an earnings growth rate of 20% or more a year, and perhaps a 2% dividend yield.

This approach worked a lot better in the pre-computer age, when investing was more labour-intensive. Few people wanted to dig through old newspapers, annual reports and other material to get at the data. So, more gems were left to be found by those willing to do the work.

Today, if you find a stock with this (or any comparable) combination of favourable ratios, it probably comes with some more-or-less hidden drawback not covered by your system. Instead of steering you away from investments that you don’t understand, or that harbour hidden risk, this system will steer you toward them.

Following stock market indicators today can lead you away from investment quality

Early in their investment careers, many investors pick up on the idea that the best way to control stock-market risk is to figure out which way stock prices are headed next, then invest accordingly. This, though, turns out to be much harder than it sounds. It’s easier—and more profitable—to focus on investment quality and diversification.

You’ll do even better if you follow our three-part Successful Investor strategy.

Here’s a simple refinement you can add to our three-part strategy. It will improve your results all the more. Buy stocks regularly during your working years, regardless of the market outlook. Sell stocks gradually in retirement, when you need money to supplement your income from dividends and other sources.

Stop relying solely on market indicators if you want to make the best investment decisions

Stock market indicators aim to let you narrow down the range of information that you use to make an investment decision. When you come right down to it, you have two ways to try to profit from stock market indicators. The most common, and the favourite of many investors who are just starting out, is what you might call “the crystal-ball approach.” That’s when you look around for a simple-to-understand indicator that provides a clear buy-or-sell signal.

The crystal-ball approach will give you random results—a series of wins and losses. In the long run, however, a random approach to investments is more likely to hurt than to help you, just as in any other area of life.

Instead, our Successful Investor approach to indicators is to use them as specialized tools, rather than decision-making devices. Before you rely on a market indicator, you need to consider the information it employs and decide if that slice-of-all-available-info is important enough to provide a clue to the outlook for the market or individual stocks.

Use our three-part Successful Investor approach alongside stock market indicators today to profit over the long term

• Hold mostly high-quality, dividend-paying stocks.
• Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
• Downplay or stay out of stocks in the broker/media limelight.

Sometimes out of sync movements take place in the market that go beyond what’s happening in the economy. How do you handle these situations?

How do stock market indicators impact your investment strategy?