Unique Indicator With 85% Accuracy Signaling a 'Buy'

Fundamental data is often ignored by traders because price-to-earnings (P/E) ratios and dividend yields may seem to have little influence on short-term market action. A number of studies have shown that buying low P/E stocks or stocks that offer higher-than-average dividend yields can be a profitable strategy for long-term investors who measure their holding periods in years. This is usually considered to be the domain of value investors.

Traders realize that earnings are updated by companies only once every three months and dividends change even less frequently. Because traders are looking at ideas that can be profitable in days or weeks, these slow-moving variables are rarely looked at. However, both of these fundamental data points include the current price in their calculation, which means that P/E ratios and dividend yields actually change, at least slightly, throughout every trading day.

Testing the idea of buying value stocks for short-term gains shows promising results and these variables can be used by traders to gain a short-term edge in the markets. First, traders need to think of the data differently than they usually do.


Value investors may define a low P/E ratio as less than 10, or they may want to buy stocks with dividend yields that are at least twice as high as the interest rate available on a 10-year Treasury note. This interpretation will not identify short-term trades since a P/E ratio might stay under 10 for years, for example.

Instead of looking at absolute levels of the P/E ratio or dividend yields, traders can define the indicator as high or low on a relative basis by adding Bollinger Bands to the data. The trading rules are:
1. Buy when the P/E ratio is below the lower Bollinger Band and the dividend yield is above the upper Bollinger Band.
2. Sell when the dividend yield is below the lower Bollinger Band and the P/E ratio is above the upper Bollinger Band.
This idea is shown in the chart of Citigroup (NYSE: C) below.

In the chart, we can see that C has been in an uptrend since July, while its dividend yield has been falling and the P/E ratio has been rising. Over the time shown in the chart, the yield would always be considered low, staying between 0.1% and 0.16%, while the P/E ratio moved from about 7 to 11. (more)