In this series of posts we've been looking at some mistakes that fund investors often make. By avoiding these, you'll give yourself a much better chance of arriving at your financial goals on time.
In our last post we discussed how refusing to pay for expert help and buying/selling at the wrong time can have a big impact on an investor's returns. In this post, we'll look at two more common investment mistakes, which are concentrating too much on fundamentals and following a flawed 'buy and hold' fund investment strategy.
If you would like to know more, please just download our latest free report, The 7 Biggest Mistakes Fund Investors Make.
Concentrating too much on fundamentals
Did you know that the market is forward-looking? True, and this means if you are looking at news headlines and economic indicators to guide you, you may find those signs appearing about six months too late. The economy only recently gave signs that the global recovery has taken hold. However, if you had sat on your hands over the last few years, you would have missed out on the potential to have made some attractive returns. For example, during the last four years, clients who mirrored our trading activity returned 12.5% per year versus the FTSE 100’s 7.4%**.
Let me be clear, I have nothing against looking at fundamentals. However, where many investors go wrong is when they avoid looking at the technical side of the market. In the stock market, technical analysis is the study of the market itself, separate from fundamental analysis, which focuses on a company's or country’s financial condition. Technical analysts typically use price and volume charts, looking for patterns that suggest future behaviour.
Did you know that 75% of the market’s movement comes from institutional investors? It’s true, institutional investors have the largest influence on the market’s future direction. If these huge investors are buying, smaller investors can jump onto their coat-tails. And if these institutional investors are selling, they can quickly switch out onto the sidelines. We use price and volume charts to help me see what institutional investors are doing, allowing the opportunity to follow in their footsteps.
If trading volume is above average and price action is up, institutional investors are buying. That’s good. On the other hand, if volume is above average and price action is down, it means institutional investors are selling. That’s not good. If volume is below average and the price action is up, it indicates little demand from institutional investors. That’s also not good.
And finally, if volume is below average and the price action is down, it indicates that institutional investors are reluctant to sell. This type of action is good. By watching the market every day, and keeping a close eye on price and volume activity, you can slowly determine exactly what institutional investors are doing with their money – effectively allowing you to get in sync and trade with the market’s trend, instead of against it.
The problem with a ‘buy and hold’ fund investment strategy
It is easy for investors to believe that the best investment strategy is a passive buy‐and‐hold approach. The mantra goes, ‘It’s time in the market, not market timing.’ Buy and hold can be an extremely effective approach, especially if you start at the right time and buy when the market is low. However, it is an approach that comes with flaws. Buy and hold only tends to work in long trending up markets, such as the super bull market that occurred between 1980 and the year 2000.
In our opinion, a better strategy would be to aim to time the market. This is extremely difficult to do and of course, you are never going to get it right every time. The timing method we use is far from perfect but it is a method that has fortunately managed to catch the start of every single bull market in the last 50 years. The way we aim to catch the start of bull markets and spot market tops is to analyse the trend of the market by watching the price and volume action of the four main US stock market indexes.
We look at price and volume action on charts because it helps us track the investment behaviour of institutional investors, helping us to get in sync with their trading activity. In other words, we want to trade with their money flow, not against it. Instead of playing buy and hold and trying to guess the best time to buy, instead we wait for the price and volume activity to confirm that a new bull market has begun.
We then aim to accurately move into the market by buying a quality investment fund. After the bull market has run its course a bear market begins. After the bear market ends a new bull market begins. Bull markets generally last two to four years and so, when the bull has run its course, we aim to quickly move out of the market and into the safety of a Cash Park. When a downtrend has been triggered, we park temporarily in cash and wait patiently for a new bull market to start. Bear markets tend to last nine to eighteen months and so they are much shorter than bull markets.
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 12.5% per year over the last four years** versus the FTSE 100’s 7.4%.
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.
*15th November 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
**(31st December 2008 - 31st December 2012).
ISACO investment performance verified by Independent Executives Ltd.