Do the market indicators really work?

  Recently, a friend of mine was questioning, how can a stock not follow the performance of the company and follow a market indicator. I, myself have asked this question at one time.

  Yes, if you are a long term investor in a stock and your company performs well, your stock will perform well, most of the time and yes, market indicators will predict direction for the short term. Any time you open a position, you will be questioning yourself if the entry point is good. If the stock has been on down trend for the last few days, there is good chance you are buying for a bargain and conversely if the stock has been on uptrend for few days you might be paying premium. So, why not use an indicator if one is available to predict this condition.

  Over bought/over sold indicator are tools used by traders to find buying or shorting opportunities or to predict the market direction.

Williams % R and Relative Strength Index  are couple of technical indicators you can find on many stock charts and are very easy to understand. They oscillate between 0 and 100. While 80 to 100 indicate the underlying equity is overbought, 20 to 0 indicate oversold condition. These are based on most recent trading days, usually set for past 14 days and can be changed as you want. Following is a 6 month chart of Caterpillar with Williams % R, courtesy of stock charts:

\                                                 Source: stockcharts.com

  The above picture shows that indicator predicted right most of the times. But you can also see that the indicator hit over bought condition around December 30^th and stayed there for past 17 days, and during that period, stock has appreciated more than 10%. So it simply tells you to be on look out for buying and selling opportunities. It can’t predict exact buy and sell points because markets can stay overbought and oversold for a while.

Conclusion: If you like a stock and want to buy, it’s not a bad idea to buy the stock in phases during oversold conditions and to sell the stock in phases in overbought conditions, if you are thinking of selling your stock. Besides, if millions of traders or programs try to buy and sell the stock using this indicator, it is bound to work even betterJ.