How can you make money from the age old cycle of the sharemarket?
The sharemarket moves in cycles. By understanding these cycles, the educated investor can profit from the folly of others.
This is a typically what happens for the majority of investors. Let’s follow the story of Bill…
Bill doesn’t like shares. He is typically a bricks and mortar type of guy who thinks that shares are too risky but prefers property.
Bill starts to hear from his friends how much money they are making from shares…
He turns on his television at night and hears about how the sharemarket is rising…
Motivated by making easy profits and not wanting to miss out, he decides to put money in the sharemarket. Not long afterwards, share prices start falling. He figures that it will start going back up soon and holds onto his shares. The market falls more and more and more.
Finally Bill can’t take it anymore and sells all his shares.
Essentially what has happened is that Bill bought at the top of the cycle and sold at the bottom.
The whole goal of making money is to do the opposite of Bill. That is to buy low and sell high. The educated investor would look to buy near market lows when the rest of the market is running and sell near the highs when every man and his dog holds shares.
It can be hard to buy when all the media reports are negative, when the circumstances are unprecedented in the market and we’re seeing the worst conditions since the Great Depression.
For the educated investor this is the time of opportunity; to sow the seeds and reap the gains at the peak of the next cycle. After all, if the goal is to buy low and sell high, when would the educated investor look at buying? Now, when the market is down 50% from its highs? Or back in November 2007, when the market had risen 130% since 2003?
The educated investor would be more comfortable investing now.
From 1982 through to 1 October 1987, the Australian market rose 273%. From the peak in October to the low in December, the market saw a correction of 40%.
You can imagine what Bill would have done in these circumstances. He would have invested in 1987 at the peak and sold once hysteria set in after the 1987 stockmarket crash.
But really — are sharemarket returns of 273% normal?
Essentially a return of 273% is not reasonable. It’s a bubble and the only normal thing about that bubble is when it bursts.
Consider this chart. It’s the All Ordinaries Index from 1979 until 2009. I’ve drawn a low term trend line in green. You can see that while the sharemarket moves away from the trendline, inevitably it comes back to it in the end.
In fact the last time that the All Ordinaries moved substantially away from the trend line was in 1987. But then we saw the market in the following years move back to trend.
Once again, since 2003/04, we’ve seen the market pull away from this trendline and now inevitably it is coming back to that line.
The big question is where do you stand? Will you be a Bill or will you be an educated investor?
Julia Lee Equities Analyst Bell Direct
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