This is the third in a new series of posts, where we're looking at gauging the stock market's direction.
If you would like to know more, please just download our free report How to Gauge Stock Market Direction.
In our last post in this series, we exaimined the dangers associated with a buy and hold investment strategy. Let's now look at a real life example, using a fund we bought back in 2005 and what would have happened to our clients’ accounts if we hadn’t taken a more active role. The fund we bought was called the Legg Mason Japan Equity A.
We bought this fund at a price of 2.32 on January 11th 2005 (Point A), just before it broke out of a bullish cup-with-handle formation (Point B). Soon after purchase, this fund really took off, eventually hitting a peak at 3.93. We recognised this behaviour as climax topping (Point C) and, soon after it hit this high, we decided to exit at a price of 3.32 (Point D) on January 5th 2006. This helped us net a 43.1% gain in twelve months. As you can see from the chart, just after getting out, the fund fell like a stone, dropping 71.4% (Point E) over the next three years.
Aim to stay fully invested during bull markets
Buy and hold could work if you started your program at the right time but, as we discussed in our last post, unfortunately most investors don’t buy at the optimum point. You could of course decide to adopt a pound cost averaging strategy, a strategy we use for investing capital outside an ISA and SIPP.
We're sure you already know this but just in case, pound cost averaging is the practice of investing a predetermined amount of money at regular intervals, regardless of market conditions. The amount you invest is constant, so you buy more shares when the price is low and fewer when the price is high. Adopting such an approach could help you avoid the risk of mistiming your initial buy. Even though this is a better approach, it makes more sense when investing using ISAs and SIPPs to consider becoming more active and aiming to strategically time the market.
We’ve found that overtrading cuts into your returns, just as trying to time the market too frequently is extremely difficult to execute on a consistent basis. During a bull market we’ll normally make no more than four trades each year and our changes are triggered when we see underperformance from a fund we own. This happens due to sector rotation, which is when money moves from one sector into another.
Watching where the big money is flowing
For example, technology may be the hot sector for a while but eventually it has to cool off. As it cools, the big money flows into the next hot sector, for example, financials. These hot sectors are known as leading sectors and all leading sectors eventually become laggards. This is why it’s important to keep a close eye on which sectors are leading and which ones are lagging and never to fall in love with an investment you own.
The aim is to keep track of the money flow and to try and always be positioned right in the middle of the money flow during a bull phase. This is easier said than done of course, but it still should be your aim. When a bull market is over, and you believe a downtrend has been triggered, you could move into cash and stay in cash during the full length of the bear market.
Making better and more accurate timing decisions starts with understanding how the stock markets operate in cycles and how the majority of the daily trading volume is created by institutional involvement – large investors who have a significant influence on the market’s trend and direction.
Next week, in the fourth post in this series, we'll look at investment fundamentals and ask whether technical analysis is a better solution.
Remember, if you would like to know more, please just download our free report How to Gauge Stock Market Direction.
As always, if you have any questions or thoughts on the points covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.
ISACO specialises in ISA and SIPP Investment and is the pioneer of ‘Shadow Investment’; a unique service that allows you to look over our shoulder and buy the same funds that we are buying. Together with our clients, we have an estimated £57 million actively invested in ISAs and pensions*. Clients like us because we have a track record of ‘beating’ the FTSE 100**. Over the last 17 years, we’ve outperformed the Footsie by 77.9%. You can find us at www.ISACO.co.uk.
What is Shadow Investment?
Picking the right fund for your ISA and SIPP is not exactly the easiest job in the world. And knowing 'when' to buy and 'when' to exit is even more difficult! Our ‘Shadow Investment’ Service is here to help. Our service allows you to look over our shoulder and buy the same funds that we are buying.
When we are thinking of buying a fund, we alert you so that you have the opportunity to buy it on the same day that we buy it. We also tell you about when we are planning to exit the fund. You control your investment account, not us. You can start small and invest as little or as much money as you like.
By knowing what we are buying, when we are buying and when we are exiting, throughout the year you can mirror our movements and in effect replicate our trades. This means you have the opportunity to benefit from exactly the same investment returns that we get. Our investment aims are 10–12% per year.
We are totally independent, fully transparent and FCA compliant. We’re warm, friendly and highly responsive and it’s a very personal service that gives you direct access to the Sutherland brothers; ISACO’s two founders.
Who are ISACO’s clients?
Clients who benefit most from our service have over £250,000 actively invested and the majority of them are wealthy retirees, business owners, self-employed professionals and corporate executives. We also have clients from the financial services sector, such as IFAs and wealth managers.
Do you have questions?
To have all your questions answered, call 0800 170 7750 or email us at: info@ISACO.co.uk.
* November 15th 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
** December 31st 1997 - December 31st 2014 ISACO 105.5%, FTSE 100 27.6%. ISACO Investment performance verified by Independent Executives Ltd.