When to Really Start Buying Stocks and Shares Again

On an almost daily basis some financial website has an article entitled something like “Is it Time to Buy Stocks?” In these times of distress everyone wants to be in at the bottom. But for the investor who has traditionally trusted in managed funds and has little experience in managing his own portfolio this is a highly dangerous strategy. There is a strong case for ignoring all these articles and just looking at the numbers.

This is really written for those people who think that financial markets are complicated and that the whole thing is best left to professionals. The recent fall in global stock markets should have at least made you think that these experts are not really so professional after all. Indeed, for many of them their profits take precedence over yours. Their annual fees are earned whether the fund does well or not. Yes, a well-run highly profitable fund will gain new investors and thereby start on a round of positive feedback. But the art of finding such funds is actually the same as I will describe below.

For those investors with more experience, the thrill and profits from trying to pick the bottom of a market is a genuine driving force. I wish them luck but, as I say above, this isn't primarily written for them. For those who have dutifully put their savings into some kind of investment vehicle and seen those savings dwindle the idea of going it alone can seem daunting. But, I wonder how you initially chose which funds to invest in? Was it from a recommendation from a financial adviser, possibly from your bank or insurance company? There must have been some decision taken right at the beginning. However, since then you have probably lived in the hope that the fund managers know what they are doing.

The point I would like to make is that the transition from a passive investor to an active investor is not so daunting. You don't have to become a trader, watching the markets every day and buying and selling stocks in a frantic attempt to make some profits before the market turns again. I understand that you don't have the time or the inclination to do this, and that as you haven't this would be even more dangerous than doing nothing. But having a look at your portfolio once a week, or even just once a month, is not so much work considering it is after all your money. More importantly, have a look at the charts for each investment. If a page full of numbers makes your head spin then a chart will give you all the information you need to see at a glance if the price is going up or down.

This is where I'd like to introduce one of the most widely used long-term price indicators. Staring at charts of stock prices still won't tell you the future or when to buy or sell. However, adding one simple indicator will make this much clearer. Before doing so let's pull up a chart. There are many websites with financial charts but one of the easiest and free to use is on Yahoo Finance. Just go there and you will see a snapshot of the major stock markets in the world. For the purposes of our example, click on the link to the S&P 500. What I'm about to go through can be used for any stock or share, commodity, investment fund or stock market.

On the main S&P 500 page you will see some basic information about the current day's trading and some news links. What we're really interested in is the chart, so click on that. I think the easiest chart to use at the start is the Basic Tech Analysis one so just click that – the link is on the left column. Along the top row you will see Range and Type options. I actually prefer to look at the candle-stick charts rather than the plain line ones as they also give a sense of the price volatility. So click on Candle in the Type list and you will see the difference. Now let's look at a meaningful range; click on the 1-year chart under Range. Looks ugly, doesn't it! But what is it going to do next? Is it going to take another dive below 800 or hold its nerve and climb back to 1000? None of us knows. Indeed, nobody knows and nobody can tell you for sure. The question “Where is the stockmarket going?” makes work for a lot of writers and pundits but is a question best left for dinner parties and fortune tellers. What you want to know is not what it is going to do but what is it doing right now. The one thing to guide you in your decision to buy or sell is what is the current trend.

To see what the trend is we shall now overlay our first technical indicator – the 200 Day Moving Average. On your chart options you will see one labelled Moving Avg; just click on the 200. You will see a smooth line overlaid on the price chart. This is the running average of the closing prices of the previous 200 days (or 40 weeks). It is one of the primary indicators used by chartists, people who use technical chart analysis on a daily basis. Charts cannot predict the future but they do show the current trend. It will be no surprise to see that the SP500 is currently well below the 200DMA as we are, after all, in a bear market. This is our first clue that it is no time to start buying any stocks at all! As I said before, some of you will get excited by the thought of buying stocks at fire-sale prices but I'm pitching this at those who perhaps have never considered even looking at a technical indicator.

Before we move on, just a few words about using this and other moving averages. The 200-day moving average is used by many as a medium to long-term indicator, showing the trend for possibly one to two years, often longer. It is not in itself a magic wand that will land you untold riches but it is an industry standard. This means that market traders will use this to decide on whether stock prices have finished their current trend and are due for a reversal of fortunes. The fact that so many insiders use this and react to it is one reason why it still works. But unlike secret trading programs this is all in the public domain – you too can profit from it. As you can see, venturing into the world of technical analysis sounds all rather complicated but we haven't even looked at a single equation. It just really isn't that scary.

Right, let's get back to our SP500 chart and zoom out to a 5-year view. Now, looking at a 5 year chart defaults to giving weekly prices rather than daily. On their fully interactive chart you can get a finer view by seeing daily prices for the 5 years. It isn't any more complicated but just has drop-down menus rather than simple clickable links. Anyway, on this particular chart we can see the stockmarket rising from 2004 till the end of 2008. Note how the 200DMA sits below the market during a rally. Also note that the market will sometimes drop down to touch the indicator then bounce off it. In this phase the moving average is known as a support. But look at what happened in the second half of 2007 and especially in January 2008. It looked initially as if this was going to be another bounce off its support but the tumble in January and the failure to break back up above the 200DMA was a dramatic signal that something was very wrong. Those dips below the moving average were signals to start selling. Not all at once, but slowly and with a wary eye if stocks fell further. In May 2008 the S&P 500 tried to rally back up but by now our 200DMA was no longer a support but a resistance level. The failure to break up above this in June 2008 was also another major selling signal. Coming to the present, we see that the S&P 500 is well below its 200DMA and we are well and truly in a bear market. At some point it will rise to meet its 200-day moving average. That could be a few months way, possibly many months away.

As an investor and not a trader you have to think long term and the 200-day moving average is the perfect long-term indicator. Amid the noise and confusion of financial advice you now have one solid technical indicator that gives you a decision making tool independent of personal advice. The 200DMA is not an on-off switch but rather a smooth transition which either confirms the existing trend or starts a reversal of it. As your stock or share or fund starts to approach this moving average is when you should start to be thinking about being active. Back in late 2007 you would have started to sell slowly. There is no shame in selling some stock one month only to buy it back 3 months later at about the same price. These things happen. In January 2008 was a signal to sell some more. And if you were still holding on to all your shares then May 2008 gave you another opportunity to start cashing in the profits of the previous 10 years or so.

For the casual informed investor the 200-day moving average gives a simple indication as to whether we are in a bull or bear market, whether to buy more stocks or sell them. If you are setting aside regular money then there is the temptation to want to invest it immediately. The very simple rule here, with which you won't go far wrong, is that if the price is above the 200DMA then it is safe to buy and if it is below it then it is safe to sell. We have been looking at one particular stockmarket but the technique will work with individual shares and investment funds. Even in a bear market there are some companies that do very well. If you read a recommendation to buy a particular stock then just repeat the above exercise. Yahoo Finance also has charts of all the major stocks and shares. I think this is enough advice for now! I will look at some of the finer points of using this indicator in a future post.

For now, buy stocks if you enjoy gambling!

originally posted on 19 Jan 2009 at Soul Trader Blues.