Do you use market indicators like the put/call ratio to make an investment or trading decision?

In this week’s issue, I want to share with you three mistakes that I made using market indicators and why you shouldn’t rely on market indicators alone to make decisions about the market direction and stocks. 

News media outlets and market pundits love to quote indicators like the put/call ratio to make a sweeping generalization about the market and its potential direction. And honestly, from time to time, I find myself paying more attention to these than I should.

The problem with market indicators like this is that they are usually “secondary”, secondary to price and volume, and can be misguiding when used in isolation.

Today, I will discuss:

• 3 examples of me making those same mistakes early on
• What I’d recommend people do instead when they are starting out.

Mistake #1

There’s no magic indicator that is going to get you into and out of the market at the exact right time and expecting them to do so is a recipe for disaster.

One example of how I used to do this is by using follow-through days to time my entries back into the market following a general market correction.

While this generally works, it can have many false starts and point you in the wrong direction, especially in a bear market. I used to blindly take a bullish position in the market on a follow-through day with the expectation that I had found the bottom and that this was the start of a new bull market.

I would plunge back into the market and load up on stocks only to get my head ripped off by a false start.

Mistake #2

Another mistake I used to make is using sentiment indicators like the put/call ratio without taking into consideration the context of the overall market we are in. There are many sentiment indicators out there like the National Association of Active Investment Managers (NAAIM), the Fear and Greed Index, and The American Association of Individual Investors Bear Index to name a few. I used to sometimes refer to these indicators as some sort of ultimate sign that the market was over-bought or over-sold and that I should immediately change my investment or trading decisions when the indicators got to contrarian levels that usually marked a pivot in the market. Many times, the market would continue on without me in the direction of my original position.

Mistake #3

The last mistake that I made and sometimes still make is expecting the price to follow moving averages exactly. Often, I would pick a moving average say the 50-day simple moving average, and buy or sell support and resistance with the expectation that the moving average will hold. This could not be further from the truth. If you have done this, then you’ve probably experienced some disappointment as your expectations about what the market or stock should or not do didn’t come to fruition.

What you should do instead

Instead of using indicators as a hard and fast rule, here’s what you could do. Use them as “secondary” to price and volume action in the markets and look for confluence. Confluence is when one or more of these indicators line up to support your hypothesis about the market. This is how you use the information and your intelligence to stack probabilities in your favor. Lastly, always be open to the possibility that you don’t know something and you're wrong. One way to do this is to ask yourself better questions like: What could make me wrong about my position?

Whenever you're ready, there are 2 other ways I can help you:  

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