Paul and I were recently speaking to a DIY investor and what he had to say was extremely interesting. He told us about a time when he used a ‘tip’ from a newspaper to pick a fund for his ISA and SIPP portfolio. The tip came from what the investor thought was a credible source and he explained how he was extremely pleased that he’d received a valuable recommendation at such a low price.
The challenge came however ‘after’ buying it. He was then left with the feeling of ‘What should I do now?’ In the end, inertia got the better of him and so he just left it alone not really knowing whether he should keep it, sell it or switch into an alternative.
This brings me very nicely onto the topic I wanted to discuss today, which is the 4 questions every DIY investor needs to ask every single day. I say ‘every single day’ because things in the stock market can change very quickly and unless you know how to effectively manage and monitor your portfolio, you could get into a bit of trouble. Today I’m going to focus on the first two questions and in our post next week I’ll cover the final two. Here’s the first two of the four:
Question 1. Should I be invested right now?
The market works in cycles. Did you know that historically, bull markets (up markets) have lasted between two and four years? Bear markets (down markets) tend not to last as long. Bear markets last approximately nine to eighteen months and therefore are much shorter than bull markets. Because bull markets last longer, the stock market forms an upwards trend. It’s like a staircase effect where you have three stairs up and then one stair down.
A DIY investor needs to get ‘in sync’ with market direction and aim to invest during bull market cycles and park in a Cash Park during bear cycles. Why is this important? It’s because three out of four stocks move in the same direction as the market. That means if the market rises, most stocks will rise and if the market falls, most stocks will fall.
Investment funds own a large portfolio of stocks. So if the market is in a bull market and trending up, three out of four funds will move up. But if the market is in a bear market and trending down, three out of four funds are going to move down. That means even if you own a fund that is managed by one of the best fund managers in the world, if a major downtrend is triggered, the market is going to take a dive and the fund or funds you are invested in are also likely to take a dive. That means you don’t really want to be invested in funds during bear markets when most funds are falling.
Question 2. If yes, should I be fully invested or partially invested?
To answer this, you need to ask yourself how strong is the uptrend? How’s the market acting and behaving right now? How are leading stocks and leading funds acting? Where are we right now in the investment cycle? We watch the market each and every day. We also thoroughly analyse the market when it has closed and pay particular attention to the price and volume activity of the main US indexes.
We pay more attention to how the US markets are acting and behaving because the US is the world leader. We watch the Nasdaq Composite, the S&P 600, the S&P 500 and the Dow Jones Industrial Average. As well as watching these four indexes, we watch the behaviour of leading stocks and leading sectors. By studying these four indexes, leading stocks and leading sectors each and every day, you can come to realise meaningful changes in the daily behaviour at key turning points like market tops and bottoms and learn how to capitalise on them.
Why a DIY investor needs to watch price and volume activity
75% of the market’s movement comes from institutional investors. Institutional investors have the largest influence on the market’s future direction. If these 800 pound gorilla investors are buying, you can jump onto their coat-tails. And if they are selling, you can quickly switch out on to the sidelines.
Here's how it works. Picture the market as a big tree. Let’s imagine institutional investors being woodcutters. If institutional investors are selling heavily it is like them taking a cut out of a tree and this of course makes the tree or market weaker. If they take too many swipes at the tree in a short space of time, what is going to happen?
That’s right, the tree will fall over. So when the tree or market gets weak because of excessive selling it sends a red flag to say it’s probably the time to get out of the market. On the other hand, when institutional investors are buying heavily and in a short period of time, this makes the market healthy and extremely strong – and this is the time to be invested.
How a DIY investor can watch institutional trading activity
One of the best ways of getting ‘in sync’ with institutional investors is to look at charts. Price and volume charts help you to see what the professional investors are doing so that you can follow in their footsteps. Whether they are buying or selling, through a chart you can see what they are doing by simply looking at the price and volume action. Price action is how a stock or index changes in price. Volume action tells you the number of shares that have been traded.
For example, if volume is far above its average and the price action is up, institutional investors are buying. This is positive action. On the other hand, if the volume is far above average and the price action is down, it means institutional investors are selling. This is negative action. By watching the market every day, and keeping a close eye on price and volume action, you can determine how healthy the market is and know exactly what institutional investors are doing with their money so that you can do the same.
Having the ability to read the market’s health can assist you with predicting future market direction. After your analysis, if you believe the market is healthy, it means invest. However, if you believe the market’s health has become sickly, it tells you not to invest as it carries too much risk. It is helpful to be aware that it’s impossible to time getting out at the very top of the market or getting in right at the very bottom. If we use an elevator analogy, it’s impossible to get into the elevator at the ground or first floor. Instead, you aim to get in at floor two. This principle works for the end of a bull market (up market) cycle too. Trying to catch the top of the market is also impossible. Sticking with the elevator principle, we aim to exit a bull market on floor eight or nine.
As always, if you have any questions or thoughts on the points I've covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.
ISACO is a specialist in ISA and SIPP Investment and the pioneer of ‘Shadow Investment’, a simple way to grow your ISA and SIPP. Together with our clients, we have £57 million actively invested in ISAs and pensions***.
Our personal investment service allows you to look over our shoulder and buy into exactly the same funds as we are buying. These are investment funds that we personally own and so you can be assured that they are good quality. We are proud to say that by ‘shadowing’ us, our clients have made an annual return of 17% per year over the last three years** versus the FTSE 100’s 7.9%.
We currently have close to 400 carefully selected clients. Most of them have over £100,000 actively invested and the majority are DIY investors such as business owners, self-employed professionals and corporate executives. We also have clients from the financial services sector such as IFAs, wealth managers and fund managers. ISACO Ltd is authorised and regulated by the Financial Services Authority (FSA). Our firm reference number is 525147.
*Cumulative return 31st December 1997 - 31st December 2010. Stephen Sutherland 93.3%, Nasdaq Composite 68.9%, FTSE 100 14.6%.
**31st December 2008 - 31st December 2011.
***15th November 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
ISACO investment performance verified by Independent Executives Ltd.