How Do You Know When To Buy Stocks? These 5 Indicators Can Help

We take a look at 5 key indicators you can use to help you decide when to buy and sell stocks in your portfolio

Timing the stock market can be a daunting task, even for seasoned investors. However, there are several indicators and tools available that can provide valuable insights into whether it's a favorable time to buy or sell stocks.

By examining both fundamental and technical indicators, you can make more informed investment decisions. In this blog post, we will discuss two fundamental ways—the Buffett Indicator and the S&P 500 P/E Ratio—and three technical indicators—the S&P 500 Market RSI, the CNN Greed/Fear Index, and the AAII Investor Sentiment Survey.

These indicators, when used together, can help you identify potential opportunities in the stock market.

Before delving into specific indicators though, let's briefly differentiate between what fundamental and technical indicators actually are.

Fundamental indicators focus on the underlying value and financial health of a company or the market as a whole. On the other hand, technical indicators analyze patterns and trends in stock prices and trading volumes.

Both types of indicators have their merits and provide valuable insights into market conditions. With those definitions out of the way,

Let’s get started!

The Buffett Indicator

The Buffett Indicator, also known as the Total Market Cap to GDP ratio, compares the total market capitalization of all publicly traded stocks to the gross domestic product (GDP) of a country.

It helps determine whether the stock market is overvalued or undervalued. When the ratio is high, it suggests that the market may be overextended, and caution should be exercised. The overall thinking is that if the market value of the market is much higher than all the countries output (measured by GDP), then this can’t make much sense (as how can the people think the value of companies is so high when we can plainly see what the total economy is doing?).

Some of the push back to this menthod would be that as more and more companies are globalized today vs. in the past, it may not be entirely fair to confine the denominator to just US GDP.

That said, the reason it is called the Buffett indicator is after the famous investor, Warren Buffett, who famously has talked about it as one of the general tools he uses to take a temperature of the market and general valuation. You can check the current Buffett Indicator and what it says about the market here.

S&P 500 P/E Ratio Vs. History

The Price-to-Earnings (P/E) ratio of the S&P 500 index is the second fundamental indicator that you can use to get a pulse check on whether the market is overvalued or undervalued.

The way it works is that it compares the current stock prices of companies in the index to their earnings per share (EPS). By comparing the current P/E ratio to historical averages, you can gauge whether stocks are relatively expensive or cheap.

Websites like Yahoo Finance or MarketWatch offer readily available P/E ratio data for the S&P 500 or if you need one, here is a handy site that can show you the trends all the way back to 1926.

The Relative Strength Index

Our first technical indicator is the Relative Strength Index (RSI).

This indicator that measures the speed and change of price movements in a stock or index and helps to basically tell how many people are currently buying or selling any stock or the market overall.

An RSI reading above 70 suggests overbought conditions, indicating a potential market correction, while a reading below 30 indicates oversold conditions, possibly signaling a buying opportunity.

Financial platforms like TradingView or StockCharts provide RSI data for the S&P 500 or here is a helpful site that will show you the current RSI.

The CNN Greed / Fear Index

The CNN Greed/Fear Index measures the sentiment and emotions of investors in the stock market. It ranges from 0 (extreme fear) to 100 (extreme greed). When the index is in fear territory, it could indicate an oversold market

and present a buying opportunity. Conversely, high levels of greed may indicate overbought conditions and suggest caution. The CNN Business website regularly updates the Greed/Fear Index.

The AAII Investor Sentiment Survey

The AAII Investor Sentiment Survey reflects the sentiment of individual investors towards the stock market.

It measures the percentage of bullish, bearish, and neutral investors. When the percentage of bullish investors is significantly higher or lower than historical averages, it could indicate a potential turning point in the market.

The American Association of Individual Investors (AAII) publishes this survey data on their official website.

Final Thoughts…

While timing the market perfectly is challenging, these five indicators can assist you in evaluating the overall market conditions and making more informed investment decisions.

By combining fundamental indicators like the Buffett Indicator and the S&P 500 P/E ratio with technical indicators like the S&P 500 Market RSI, the CNN Greed/Fear Index, and the AAII Investor Sentiment Survey, you can gain a comprehensive view of the stock market.

Remember, it's essential to consider these indicators in conjunction with your long-term investment goals. Investing with a long-term perspective and using these indicators as aids can help you navigate the stock market more effectively.

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