What is a Predictive Indicator?
A predictive indicator is a ratio, index, report or other measurement that signals a company or market's direction in advance.
How Does a Predictive Indicator Work?
The business cycle has highs and lows. That's why predicting what's around the corner is one of the best (but most difficult) ways to protect and grow portfolios. Predictive indicators, which are typically ratios and measurement that tend to be very sensitive to economic fluctuations, can indicate the early stages of expansion/growth as well as early stages of contraction/deterioration.
Predictive indicators can also send you clues regarding a specific company's performance. For example, the Texas ratio is used by banking analysts to detect the strength or weakness of a bank's balance sheet.
Why Does a Predictive Indicator Matter?
It is definitely worthwhile for investors to track predictive indicators because they reveal which companies, sectors or economies are showing relative strength. For example, if multiple variables such as payrolls, exports, and the purchasing managers survey are all rising, investors can expect economic growth to remain steady or even rise in coming quarters -- which is always a good thing for stocks. That's a trend that individual traders can exploit.