How To Improve Your US Stock Returns, Using Two Top-Performing Tools

When the S&P 500 is in a state of flux (like, say, right now), savvy investors take a look at the technical indicators. And, luckily, Bloomberg tracks the performance of 23 of them. Now, of those 23, only nine have been profitable in the past year. So let’s zero in on two of them – the one that’s done the best so far, and the one I prefer – and I’ll tell you how to get the most out of these tools.

Technical Indicators’ profit and loss for the S&P 500, based on a $100,000 investment pot. The top-performing indicator has been the relative strength indicator (RSI). Source: Bloomberg.

1. The relative strength index (RSI)

This one gets the trophy for being the best-performing tool in the past year. The relative strength index (RSI) is a momentum gauge that measures the speed and change of price movements – and it can give you an idea of which way the market’s headed. It essentially weighs up the strength of buyers, compared to the strength of sellers – and seeks to tell you which side is driving the overall trend for an asset. It’s displayed as an oscillator (line graph) on a scale of zero to 100.

The RSI strategy highlighted above, then, goes long (or buys) when the RSI crosses above 30 from below and goes short (sells) when the RSI crosses below 70 from above. It tries to identify a change in market momentum from extreme levels.

The table shows that the RSI has provided only two signals over the past year: one to go long, and the other to go short. Those two trades made a total return of $26,590 – a 26.59% positive return on that initial $100,000 portfolio.

A closer look at the RSI shows the trigger point – in other words, where the indicator crossed below the 70 line in August 2022 and above the 30 line a month later (lower panel). It also shows the level of the S&P 500, where the trades were actually made (upper panel). And it shows the profit and loss over the time period (middle panel).

RSI signals for the S&P 500. Source: Bloomberg.

It’s a useful indicator for knowing when to buy and sell stocks. The RSI’s not going to bombard you with constant messages about what to do with your portfolio. With just two signals made over the past year, the RSI is perhaps best suited to investors who prefer to adjust their exposure only when markets reach extremely overbought or oversold levels – in other words, when you might buy very low or sell very high.

2. The moving average convergence/divergence indicator

Now, the moving average convergence/divergence indicator (MACD) is a bit more bustling, and it’s one of my favorites tools for the big stock indexes. Like the RSI, it’s also a momentum gauge.

This indicator is calculated by subtracting the 26-day exponential moving average (EMA) from the 12-day EMA, which gives you the MACD line. A nine-day EMA of that resulting line is referred to as the “signal line”. And if you plot that line against the MACD line, it sends important “buy” or “sell” signals – essentially calling out when the momentum for stocks is changing course.

The MACD indicator triggered 12 signals (top panel of the chart) over the past year – six to go long (or buy, in green), and six to go short (or sell, in red) the S&P 500, producing a $13,200 return (or 13.2%) on a hypothetical $100,000 investment pot. The middle panel shows the profits and losses from following this strategy. And the bottom panel shows the six bullish signals and six bearish ones over the same period.

The moving average convergence/divergence indicator (MACD) signals for the S&P 500. Source: Bloomberg.

The MACD indicator can be used in a few ways, but one of the simplest ways is the one that’s highlighted: essentially, going long (or buying) the S&P 500 when the MACD1 output line (in white) crosses above the signal line (in red), and going short (or selling) when the MACD1 output line crosses below the signal line.

So what’s the opportunity, then?

The RSI doesn’t usually produce many trading signals for the S&P 500, so following its signals as they happen won’t take you a lot of time, but could yield you some good results. Even with a volatile asset like Bitcoin, the RSI strategy has produced only four signals over the past year – and all four trades have been money-making ones. Buying low (when people are panicking) and selling high (when people are exuberant) can work across all assets. That said, if you’d followed the RSI strategy in some regional banks recently, it would have ended in disaster.

If you like to spread your investing across a longer period of time – for example, with dollar-cost averaging – you could use the MACD indicator to help optimize your timing, rather than simply buying in at regular intervals. The SPDR S&P 500 ETF (ticker: SPY; expense ratio: 0.095%) tracks the big US stock index, so you could consider buying SPY when the go-long signals are triggered.

When you see a sell signal from the RSI or MACD, you know you’ve got a choice: you could sell your SPY investment, buy a “put” through your broker on the S&P 500, or buy the ProShares Short S&P 500 ETF (SH; 0.89%), which increases in value when the index falls. If you’re trade-oriented, you could even short the S&P 500 outright, using futures, but if the trade goes against you, your losses could really add up.

Now, as all the big investment houses will tell you: investing is never without risk and past performance is no guarantee of success. If you look back at the time period one year earlier – from May 2021 to May 2022, trading strategies that followed the RSI and MACD indicators actually lost money. And that’s why it’s important to try to improve your strategies and use more than one technical indicator when you’re making investment decisions.

Luckily, improving on this simple MACD strategy is easy. In the MACD chart, you can see that the indicator moves above and below the zero line (the gray horizontal line in the lower panel).

The thing is: you don’t want to go short the S&P 500 when it’s already oversold (i.e. when the MACD is trading below the zero line). So, instead, if you simply sell your long positions when those signals are triggered (and the MACD line is below zero) – as happened in June and October of last year – you can achieve a sharp improvement in returns. Indeed, just avoiding those two trades over the past year would have saved nearly $10,000 in losses, improving the annual returns of following the strategy by 10% on the $100,000 portfolio to a more impressive 23%.