There are endless ways to measure the health of a stock and the market as a whole. A TV personality may tell you to look at book value, while the Motley Fool Stock Advisor reviews might tell you it’s all about the Price-to-Earnings (P/E) ratio.
What constitutes investment advice is broad, but it will always tell you that it’s impossible to say which single indicator is the most accurate. That said, there are a few key indicators worth watching.
The Golden Cross and the Death Cross
To understand this soothsayer of the future of a stock, we’ll need to look at an advanced stock chart tool. Among the many options to make your chart look fancy, you’ll see an option to overlay the fifty-day moving average and the 200-day moving average lines onto your chart. They may also be labeled as “50 DMA” and “200 DMA.”
The moving averages are a reflection of the stock’s average price over the past fifty or 200 days. They will be plotted as lines across your chart. Whenever the fifty-day moving average crosses above the 200-day moving average, this is known as the “golden cross.” Have a look at nearly any chart with these two indicators selected, and you’ll see a clear indicator that the golden cross generally precedes a run-up in the stock price.
However, making money on the way up isn’t the only way to make a buck on wall street. If you overlay these moving averages on a stock that is in decline, you’ll see that when the fifty-day crosses below the 200-day, it is usually a harbinger of bad things to come for a stock–this is known as the “death cross.”
Both the golden cross and the death cross are great ways of detecting when a stock is likely to start trending up or down, which might help you decide how long you should hold an ETF or other investment.
Price to Earnings Growth Ratio
As an excellent way to understand whether a stock is overpriced or underpriced, the price-to-earnings growth ratio (PEG ratio) tends to be fairly accurate. The formula is rather simple: you take the annual earnings growth percentage and compare it to the P/E ratio.
So, if a company is growing its earnings at 20% per year and they have a twenty P/E ratio, the PEG ratio is 1.00. If the company is growing at 20% per year but is only trading at a P/E ratio of ten, the PEG ratio is 0.5. When a company trades at a PEG ratio below 1.00, it is considered cheap. When it trades at a ratio higher than 2.00, it is considered to be expensive.
While there are many extenuating circumstances that may cause a stock’s PEG ratio to fall out of line in one direction or another, in most instances, it will tend to correct towards a PEG of one over time. One exception is extremely high-growth stocks where the exponential growth is difficult to calculate, leading to some truly eye-popping P/E and PEG ratios.
RSI
Relative Strength Index (RSI) is another chart overlay that can help you understand the price movement in a stock. It is especially valuable for understanding when a stock has become temporarily overbought (the price is too high) or oversold (the price is too low). This can lead to a quick gain when the stock bounces off its recent high or low price, headed in opposite the direction.
The RSI is a separate chart that shows the relative strength of a stock. It also has a large correlation to the positive or negative trading volume of the stock. The scale for RSI ranges from zero to 100. When a stock’s RSI goes above seventy, it is considered overbought, and when it goes below thirty, it is considered oversold.
This typically means a correction is coming in the stock price and usually quite swiftly, sometimes a matter of hours or, at most, a few days. Placing a bet to profit from this quick swing is an excellent way to make a tidy profit, but beware of selling your shares too soon. If you own a stock that is currently overbought, the price action may calm down, and the stock may soon continue its rise to the stratosphere after a short speedbump.
Cashing Out
There’s no easy way to predict the life of a stock—entire lives are centered around trying to do just that. With a careful eye and the tips above, however, you can give yourself a leg up on understanding the market!
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