ISA Investing – The 7 Key Lessons – Part 2 of 2
By Stephen Sutherland, author of Liquid Millionaire.Posted in the Category of ISAS, Investing, Stock Market, Investment Fund, Wealth Building on 18th December, 2009.
Tags: isa, isa investing, stock market, stocks and shares isa.
I am a firm believer in the benefits of ISA Investing. However many potential investors are missing out on these benefits because they find the stock market
intimidating.
Some financial advisers will make out that the market is very complex – however, the way it works is probably simpler than you think. In Part 1 of this series I shared the first 4 key lessons explaining the fundamentals about how the stock market works.
Today I am going to tell you the remaining 3 lessons and how you can benefit from these lessons by investing in Stocks and Shares ISAs.
Lesson 5: 75% of the market’s movement comes from institutional investors
The big professional investors have the largest influence on the market’s future direction. Institutional investors can be fund managers, banks, building societies or insurance companies. And if these 800 pound gorilla investors are buying, you can jump on to their coat-tails. And if they are selling, you can quickly switch out on to the sidelines.
Here is how it works.
Picture the market as a big tree. Let’s imagine the professional investors being woodcutters. If the professionals are selling heavily (you can see them selling their stocks by looking at charts) 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 or cutting it sends you a red flag to say get out of the market. On the other hand, when the professional investors are buying heavily and in a short period of time, this makes the market healthy and extremely strong – and this is the time when you do want to be invested.
Lesson 6: Watch the price and volume action
One of the best ways of reading the market is to look at charts. A stock chart is a graph that displays the price and volume history of a given security or index over a period of days, months or even years.
Price and volume charts help you to see what the professionals 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, the professionals are buying. On the other hand, if the volume is far above average and the price action is down, it means that the professionals are selling. Lack of volume combined with prices moving up indicates little demand from the professionals. This is viewed as unhealthy action.
Lack of volume combined with prices moving down means that the professionals are reluctant to sell. This type of action is viewed as healthy action. By watching the market every day, and keeping a close eye on price and volume action, you can determine exactly what the professionals are doing with their money so that you can do the same.
It is also important for you to understand that it takes a lot of buying or selling to confirm that the trend of the market has changed.
For example, if the trend of the stock market is up, it takes a lot of selling to change the trend from up to down. By measuring how much selling is going on over certain time periods, you can determine when the trend is about to change or has changed and you can then act accordingly ie; switching some or all of your holding into a cash based fund such as the Fidelity ISA Cash Park.
Reading the market’s health gives you inside knowledge of future market direction and if the market’s health has become sickly, it tells you that if you stay invested, your investments have a high probability of dropping in value.
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.
Lesson 7: In bear markets, you switch (not sell) from your high quality investment fund into a cash based fund.
When you notice that the market trend has changed from up to down, you bank your profits by switching out of your high quality investment fund and into a cash based fund such as Fidelity’s ISA Cash Park. This helps to protect against future losses because of the trend change. This is when you then simply sit, wait and be patient.
Bear markets don’t last as long as bull markets and so you should be parked in a cash-based fund for no longer than 9-18 months.
Why do you do this?
The reason is simple. Because you learned earlier that three out of four stocks (and funds) move in the same direction as the market, and because you’ve learned that markets work in cycles (bull market –bear market –bull market - bear market and so on), it means that ideally in bear markets (down markets) you want to move out of equities and into the safety of cash.
Many UK investors don’t realise that it is possible to do this.
Some mistakenly think that once you are invested in a fund, you have to stay in that fund. That’s nonsense.
Some wrongly think that to switch into a cash-based fund would adversely affect their ISA allowance. That’s also warped thinking.
To do this correctly, you have to remember that when you are dealing on your ISA account, it’s not about selling – it’s about switching.
You see, if you sell, then you lose all your annual ISA allowances that you’ve built up over the years. But when you switch, your ISA allowances remain intact.
Fidelity offer a way of temporarily parking your ISA investments into a cash fund. This can be extremely useful if you believe that the market trend is downwards, and is going to continue to head lower in the future.
By parking your money in cash on a temporary basis, it means that even if the market crashes, your money will be safe. In fact, even though equity (stocks and shares) ISAs could be dropping like stones, a cash park will actually be rising in value.
Did you know?
As well as having the option of switching from an equity fund to a cash-based fund, you also have the option of switching from a poor performing equity fund into an alternative one.
This means that if the market is in a bull market (uptrend) and you are placed in a fund that is underperforming the market, you can switch at any time into a more suitable choice.
And by using a fund supermarket such as Fidelity’s FundsNetwork™ to do your dealing, charges for switches are relatively low (0 to 0.25%).
That means during a bull market, even if you made four switches in one year, your charges would only amount to 1%. What a deal!
Find Out More
If you would like to find out more about how increased knowledge of the stock market could help you to benefit from investing in Stocks and Shares ISAs then please contact a member of my team for a chat.
Your friend,
Stephen Sutherland
The UK’s Leading Authority in ISA Trend Investing and Author of Liquid Millionaire
Please Note: As always, let me remind you that I am not a financial adviser and therefore not authorised to give advice on what investments to buy or sell.
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