How Successful Investors Get RICH

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Topic: How To Invest

Use investment climate indicators properly for maximum investment success

Investment climate indicators can be useful tools when evaluating the market. But they are just part of the big picture.

To succeed as an investor, you need to look at the overall picture, rather than confine your view to your favourite selection of easily accessible investment climate indicators.

You have to take a broad view in making investment decisions. Technical analysis and other narrow views do sometimes seem to “work” for lengthy periods, of course. But they only work for a minority of the time, and they never work consistently. Instead, they run hot and cold. As with all random events, their successes occur in bunches.

How Successful Investors Get RICH

Learn everything you need to know in 'The Canadian Guide on How to Invest in Stocks Successfully' for FREE from The Successful Investor.

How to Invest In Stocks Guide: Find 10 factors that make your investments safer and stronger.

Don’t make the mistake of zeroing in on just one of the many investment climate indicators out there

All too often, investors search for certainty on how to make investment decisions. This can lead them to hone in on a single fact or indicator. This focus can pay off—for a while—if you are fortunate enough to zero in on the right fact or indicator.

In investing, however, “facts” can turn out to be based on mistaken assumptions. Indicators based on these assumptions can seem to work for a while, then shift abruptly from useful to harmful. The markets of the 1990s produced some outstanding examples.

In the early days of the 1990s Internet stock boom, many investors assumed that Internet pioneers were sure to produce huge gains for those who got in early. These investors figured that an early start would give pioneers an unbeatable competitive position. They overlooked the enormous capital investment that Internet growth attracted. This capital influx sped up the rate of technological advances. More important, it spurred the development of new business concepts. This stopped many pioneers from achieving profitability or building a strong competitive position.

Something like this has been going on as long as people have invested. Some investors routinely shift from one misleading focus to another. The only way to prosper consistently is to look at a variety of facts. That’s what we do when we analyze investments. It helps us avoid putting too much emphasis on any mistaken assumptions.

Take the results of back testing investment climate indicators with a big grain of salt

One clear problem is that the outcome of using a rule depends on when you use it. If a rule spurs you to buy (a particular kind of stock, or the market as a whole), it will work best (if at all) when prices are rising. If it spurs you to buy when prices are falling, it will work against you. It might spur you to make investments that generate above-average losses.

That’s a particularly big risk with highly volatile stocks, since they multiply the impact of bad decisions.

Most investor rules come into being through “back testing” of some observed market tendency, which may start out as a hunch. The originator of the rule goes back to see if it paid off or not during some historical period, such as the past five or 10 years. However, due to the random factor, you can get a totally different result if you back test periods with different start or end dates.

The more we looked at the way market rules performed in various periods, the clearer it became that their results were largely random. Sometimes they “worked” (made money for users) and sometimes they didn’t. A rule could back-test well during one five-year period, but cost you money in the previous five years, or the next five.

Worse, sometimes all of the profits from a given rule occurred during a standout performance that only lasted a year or two, or less…even just a few months or weeks.

When you let random factors play a role in your investment decisions, you’re lucky to achieve average performance.

Use investment climate indicators in conjunction with other tools and you will make better stock picks

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, fits-on-a-T-shirt 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 technical 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 to make better stock picks, regardless of investment climate indicators

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

What are the top investment indicators you turn to first during your own analysis?

What investment climate indicators have led you to make poor investing decisions?


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