The TSX Composite Index surged 11% in the last 12 months and 34% in five years. These returns might not look exciting enough to generate wealth, but the index is the cumulative performance of 237 stocks. Some stocks in this index doubled investors’ money in three months, and some lost 90% of their value in a few months. How can you identify stocks that can outperform the market and help your money grow? No one metric can assure you market-beating returns.
One key metric to beat the stock market
However, if you already have a few stocks on your watch list that you are bullish on, this key metric can help you beat the stock market. The Relative Strength Index (RSI) is a technical indicator that tracks the momentum of the stock price.
Many times, a good stock with strong fundamentals and growth potential is not a buy because the stock price is overvalued. It could be because some hype or short-term trading inflated the stock price. Even a good stock at an inflated price is a poor investment.
Those who have burnt a hole in their pocket by buying stocks like Shopify and Air Canada at their peak know what it means. These stocks are good investments, but the wrong timing makes their returns negative. While you can’t time the stock market, you can make an educated investment with RSI.
The RSI measures a stock’s 14-day price momentum and shows the relative speed and magnitude. As the RSI keeps moving with the stock price, it warns you of any abnormal movement in stock prices. An RSI of 30 and below shows the stock is undervalued relative to its short-term momentum. An RSI of 80 and above shows the stock is overvalued.
How to use this key metric in investment decisions
There are many metrics, like price-to-earnings (PE) ratio and return on equity (ROE). However, the way to look at them differs from company to company. A loss-making tech company like Lightspeed Commerce (TSX:LSPD) has a negative ROE of -8.3% and no trailing PE ratio. Yet those who invested in the stock in the October 2023 dip earned 40% returns in the Santa Claus rally that continued till December 2023.
Lightspeed is an omnichannel platform that helps retailers and restaurants take orders, make payments, and operate multiple stores efficiently. The company has grown its organic revenue steadily and is focusing on profitability. It also has a strong balance sheet that gives it financial flexibility to fund its losses. On the fundamentals front, the company is on the growth path. However, headwinds like a weak economy and business uncertainty have delayed its long-term growth.
Lightspeed stock currently has an RSI of 39, as the stock fell after it released third-quarter earnings. The last time the stock had an RSI of below 40 was in October 2023. The 39 RSI shows that investors have been selling the stock, putting downward pressure on the stock price.
The first quarter is seasonally low for retail. So you could see more downside. But once the fundamentally strong stock falls below 30 RSI, chances of growth increase as value investors buy the dip.
An RSI of 30 or 35 could be an attractive time to buy a strong stock because any optimism in the market or stock could boost the stock price.
Investor takeaway
This metric can be used on any stock with strong fundamentals. A stock might trade at a lower RSI for a prolonged period in a market downturn. But it will help you make an educated guess of timing the buying point of a good stock. And when you buy a strong stock at a lower price, your upside potential increases, allowing you to beat the stock market.
