The internet has facilitated trading, but markets behave as they always did. Investors move in herds and they buy too late and sell too early. Market movements reflect the hopes and fears of investors and are exaggerated. In late 1999 and early 2000, the bull market in the UK and continental Europe, led by the US, was at a height. Investors were rushing to buy telecommunications and high-tech stocks, which sent the share prices still higher.
The companies were priced far above value. They were sometimes months old and had no proven earnings, and maybe little in the way of revenues. At this stage, stock market analysts were valuing internet stocks on future revenues. They used innovative measures such as eyeballs - how many visits the site received, and stickability - for how long they lasted. The bank’s corporate finance department would tell analysts what to write about a company that was, or it hoped would become, a corporate client.
In March 2000, the market underwent a massive correction, led by the overvalued internet stocks that had been heralded as the forerunners of a new economy.
Some investors would have made money - in some cases quite a lot of it - if they had cashed in their paper profits on high-tech stocks on the cusp of the downturn. But many missed the boat and were left holding fallen stars. It cost some traders their homes.
On the bright side, the crash taught a generation of investors the benefits of short selling, which is to sell shares you do not own in the belief they will fall in value and to buy, hopefully at a lower price, to complete the transaction. It helped to spawn a revolution in derivatives trading, where, for retail investors taking a short position is possible, particularly in spread betting and contracts for difference.
Private investors are at an advantage over fund managers in that they have more flexibility to buy and sell because their holdings are smaller and they are not similarly answerable to external parties. But because they are small they are not given the same quality and timeliness of the information required to make investment choices.
To guide buying and selling decisions, investors may use technical analy¬sis, which is to read the charts. Investment banks do not use this method much because, cynics say, fund managers avoid it, preferring fundamental analysis which they can work into their models and show they have added value, so helping to justify their jobs. Investment banks need access to fund managers not just as clients, but also to provide feedback on stockflow to assist proprietorial trading.
But, if technical analysis is the only guide, it can be dangerous. Fundamental analysis is always desirable for medium- to long-term investors because share prices move eventually in line with stock valuations, although the correlation is often temporarily out of kilter.
Markets can swing violently, taking stocks with them regardless of valu¬ations. A major skill of investing is to make the big moves not too far ahead of inevitable major market adjustments. It is precious few stocks that are worth holding through a bear market.
The FTSE-100 is an index which represents the 100 largest UK quoted companies and is the most widely used proxy for the UK stock market. On 30 December 1999, it reached a then all-time high of 6,930. By 12 March 2003, the index had plummeted to 3,287. In the face of such volatility, many investors do nothing and lose money. They are like rabbits frozen before the headlamps of an approaching car.
When stocks are low, it is a good time to buy. By early March 2006, the index had recovered much of its loss to reach 5,900 and many users of our investment methods sold out. Their timing may not always have been perfect but it was in the ballpark. They had bought when stocks were low because they were value investors who, as an added bonus, had an eye on growth. To appreciate when to sell was trickier but they knew it was dangerous to wait until the index had topped because it could then fall fast again.
