Many methods and indicators have been developed to predict market movements and equity markets. However, none of them is fool-proof. These indicators are fundamental (price-to-earning, or P/E ratio, price-to-book value, or P/B ratio), or technical (put-call option, volumes traded, and macro-economic factors).
One thing though is certain though, it is not easy to predict equity markets and stock movements accurately. This is because there are other factors such as emotional factors like fear and greed that may have a great impact or influence on the market sentiments.
Normally these fundamental indicators are often quoted and used. However, there are other indicators that are widely used by traders and fund managers to predict market movements but are not known to many retail investors. These are as follows:
1. Dividend Yield
It is derived by dividing the annual dividend paid on each share by its current price, as shown below:
Dividend yield = Annual dividend/current price X 100%
The yield tells us the return of any particular stock? When the yield is low, its share price may be relatively higher than the dividend paid. Hence, it may suggest that the stock is overvalued.
Buying a portfolio of high-quality, global, market-leading companies with superior valuations and high dividend yields provide investors with an excellent opportunity to consistently outperform the market, providing high income relative to fixed income securities.
On the other hand, a high dividend yield means that the company is trying to woo investors by paying higher dividends. Alternatively, it means the stock price is undervalued.
One may compare the current and past dividend yields to find out if the current yield of a particular stock is low or high. A low dividend yield indicates an overpriced market and vice versa.
Let’s demonstrate this by a simple calculation and assuming that the average dividend yield of a stock has been around 1.5%. On 2 November 2015, the stock closed at 5 dollars. The current dividend yield is 7.5 cents.
Good dividend yields with regular increases tend to mean a healthy income stream for investors. Dividends may help to cushion the share price in the event that the overall market drops.
Historical precedent clearly illustrates that investors are better served by focusing on high dividends yielding companies for two main reasons. Paying dividend forces discipline on the management of the company to invest only in the most profitable projects.
The other possible and probable reason is that high-yielding stocks can fill a glazing need for fixed income in many investor portfolios.
2. Insider Trading
An insider basically refers to those top officials, directors or shareholders, who own a certain threshold or more shares in accordance with the respective stock exchange regulations and have access to the company’s unpublished price-sensitive information about the company.
Not all insiders trading are unlawful, however they may be subjected to the exchange regulations that govern the trading. A member of the board, merchant banker, debenture trustee, broker, portfolio manager, investment advisor, sub-broker or even a relative of any such individuals is also an insider. Therefore, insider trading based on unpublished price-sensitive information is illegal.
Information on insider trading is available on websites of stock exchanges and can be used to predict future prices. Studies suggest that an insider may have many reasons to sell off the stock of that particular company; while one obvious reason for buying can be that he is bullish on the prospects of the company.
3. Technical Indicators
Trading volume indicates the number of shares or contracts traded in any market. It reveals whether a particular price trend is supported by the market players.
If the share price is increasing with higher than normal volume, it indicates investors support the rally and the stock would likely to move upwards. On the other hand, a falling price trend with big volume signals a likely downward trend. However, a high trading volume may also indicate a reversal of trend especially when a drop in the share price with very high trading volume is viewed as a sign that the stock has hit the bottom.
A put option is an agreement between two parties to exchange an asset at a pre-determined rate on or before its due date. The buyer of the put option has the right but no obligation to buy the stock at a specified price on or before a fixed date, while the seller has the obligation to sell at the pre-specified price if the buyer wishes to exercise the option.
On the other hand, a call option gives the buyer the option (but no obligation) to buy a particular asset from the seller at a fixed price on or before a particular date.
The put-call ratio is computed by dividing the number of traded put options by the number of traded call options. If the put-call ratio is increasing, it suggests that either investors fear the market will fall and are hedging their portfolios foreseeing a decline.
A high ratio may indicate an over-cautious stance by market participants and hence chances of the market falling are low. Contrary to that, a low ratio indicates over-optimism, and hence caution should be exercised.
Though these indicators are frequently used by traders and fund managers to predict market movements, they may lead to the wrong outcome if used out of context, as they are not fool-proof. Therefore, you are encouraged to use these together to arrive at a more credible conclusion.
4. Interest rates
Another favourable indicator to look at is about the changes of the interest rates which will have an impact on companies directly or indirectly. As such, it makes more sense to buy shares when short-term rates (treasury bills) are low and sell when they are high.
Moreover, the corporate sector is a net borrower of funds of any economy and any increase in interest rates usually has a negative impact on its financial performance. Higher rates also will have adverse effects especially on those rate-sensitive sectors such as real estate and automobiles.
Generally, the short-term yields (treasury bills) are lower than long-term yields (10-year government bonds) as the latter embraces in much higher uncertainty in the long term. However, if the rates on short-term securities are higher than that on long-term ones, it could be hints of a possible recession.
Written by: James Oh, Certified Professional Trainer (IPMA), UK, (PSMB)M Bac (Hons), LLB (Hons), CA(M)