By the end of January, the total confirmed cases had risen to 9,800 and more than 200 people had died. The World Health Organisation (WHO) declared the outbreak a global health emergency.
The reason the markets got rattled in February was because investors suddenly realised that it could not be contained. Cases weren’t just limited to China and the Far East, but they were cropping up all over the world. By the end of February there were more than 85,000 cases and nearly 3,000 people had died. There were confirmed cases in 56 countries.
On the 11th March, the WHO declared COVID-19 a global pandemic. In three months, it had spread to more than 121,000 people from Asia to the Middle East, Europe and the United States.
The personal, social and economic effects will be felt for years to come.
For reasons which I don’t claim to understand, markets tend to move in cycles. They do not go up in a nice straight line, but have frequent corrections along the way. It’s not that unusual for prices to drop by around 10%, but they usually recover relatively quickly.
It’s also easy to forget that much larger market crashes also happen with alarming frequency.
There was the bursting of the dotcom bubble in 2000-03, and then in 2008/9 it was the financial crisis. Both times stock market investments could have been cut in half.
Now it’s the coronavirus outbreak. Is history repeating itself?
By mid-March 2020, the FTSE100 had lost a third of its value in just a few weeks and looked like it could head lower.
So how did we react?
At times like this it is difficult for private investors to know what to do. On the whole, the financial industry promotes a buy and hold approach. They maintain that it’s too difficult to time the markets and so you shouldn’t try. It’s ‘time in the market, not timing the market’ that’s important.
At Saltydog Investor we disagree.
Instead of ignoring the ups and downs of the market, we encourage our members to respond to them. The principle is simple: any market trend – whether up or down – is likely to keep going in the same direction. Rising prices tend to keep rising, and falling prices tend to keep falling. This is known as the ‘momentum effect’ and is a well-researched phenomenon.
As trend investors we buy into uptrends and get out of downtrends. When there are small corrections it does mean that sometimes we sell things, only to buy them back a few weeks later when the price might be higher, but it does help avoid wealth-destroying crashes.
Between the beginning of 2018 and March 2020, there were four times when we saw markets starting to fall quite significantly. On each occasion the value of our portfolios has dropped and so we’ve headed for safety. The value of our portfolios then remained relatively steady as markets continued to fall.
The graph below shows the performance of one of our demonstration portfolios over this period.
In the first three cases the UK’s main index recovered fairly quickly and so we stepped back into the markets.
This latest downturn looks very different.
On the 12th February our portfolio was at an all-time high, having gone up over 12% in the previous twelve months. More than 90% of its total value was invested.
In the next two weeks it lost 2.5% and we started selling. By the 10th March we were 100% in cash.
The FTSE 100, and other global indices, were still in freefall and there was no way of telling how low they could go. It may be a slightly unfair comparison, because the FTSE100 doesn’t include any reinvested income, but even when that is accounted for it was still down over 28% since the beginning of 2018.
We are in the fortunate position of being able to wait until there are signs of a meaningful recovery before starting to invest again.
At Saltydog we do things differently...
There’s no need for you to live with pitifully low returns. Nor do you need to resign yourself to a roller-coaster ride with your wealth – seeing your investments plummet just as often as they go up.
If you’re prepared to take a more active role in your investments, you too could make consistent, market-beating gains, without taking on crazy risks.
I’d like to show you how.
Let’s start with where a lot of investors go wrong.
What most investors do, and two big risks you face
The stock market is volatile.
It goes up, it goes down. Every now and then there are big booms, and also huge crashes.
As an investor you need a way of coping with all this movement in the markets. And for most people that means simply “buy and hold”.
This is the passive approach to investing, where you don’t try to respond to market movements at all. Instead you ignore them. In other words you buy stocks or funds and hold on to them for months or years, irrespective of what the market does – and trust that you’ll come out on top over the long term.
Why do most investors do this?
For one, it doesn’t take much work. (One good reason why financial advisors are also fond of this approach).
But more importantly, most people simply don’t believe it’s possible to get in and out of the market at the right time. That would be “timing the market”, and only super-sophisticated investors or whizz-kid traders are supposed to attempt that.
Here’s the thing: this is simply not true.
It is perfectly possible for an ordinary investor to take advantage of market uptrends and avoid downtrends. I know, because I’ve done it very successfully for years. And I’m going to show you how.
But for now let’s look at what most investors do. What happens if you simply buy and hold, sticking with your investments for the long term and not reacting to anything the market does?
The fact is, there are two big potential risks with the passive, buy-and-hold approach.
First, you’ve got a very good chance of experiencing enormous losses along the way.
Huge market crashes happen pretty frequently. In only the last 15 years there have been two crashes of 50%. There was the dotcom bust of 2000-03. And then there was the financial crisis of 2007-09.
Both times your stock market investments would have been cut in half.
Not only that, but even if you’d patiently endured these two market crashes and stuck it out for nearly two decades, you could well have achieved capital growth of precisely... zero.
Just look at the chart below to see what happened.
After hitting a peak of nearly 7,000 in 1999, the FTSE 100 never went significantly higher for the next 17 years.
It’s only in 2017 that it started to really move above that level.
Is that what you want with your investments?
If you were hoping for capital gains, that’s seventeen years of going nowhere. Nearly two decades. How long are you prepared to be a ‘passive’ investor, hanging on in the market to see any positive return on your money? Thirty years? Forty?
This is one fatal flaw of ‘buy and hold’ investing.
Get in at the wrong time and you could buy and hold for decades, and see little or nothing for it.
You never know when the next big crash could wipe out years of hard-earned gains. That’s definitely not something you want to happen as you’re getting closer to retirement.
And the second problem with buy and hold?
You can miss out on some fantastic opportunities to make money.
The world doesn’t stand still, and neither do markets. New companies emerge and grow, whilst old ones fade away. New sectors and regions come into favour, whilst established ones stagnate.
If you - or your financial advisor working on your behalf - just invest in the market as a whole or in long-running ‘value’ investments and then stick with those for months or years, you could easily be missing out.
So how can you become an effective active investor instead?
How can you profit from upward trends, without having to lose it all when the market heads down again?
Here’s where we come to the secret that helped make Jesse Livermore so rich, and which is key to the success of my own system.
The money-making power of
the ‘momentum effect’
Everyone has heard the expression “Buy low, sell high”.
In other words you look for investments that seem cheap, undervalued, or heading down, hoping that they’ll go up again, like this:
Intuitively, it makes perfect sense. Buy something when it’s cheap, and then wait for the price to rise again.
But it’s not the only way of making money in the markets. And my experience tells me that it’s not the most effective way, either.
The basis of my system is known as momentum or trend investing. It starts from a different premise entirely.
Instead of looking for investments that have fallen in price, trend investors like me get excited about prices that are rising.
Why? Because, thanks to what’s known as the ‘momentum effect’, it’s likely that any market trend – whether up or down - will keep heading in the same direction.
Rising prices tend to keep rising, and falling prices tend to keep falling.
So a trend investor is on the lookout for investments like this:
For many people this is counter-intuitive. If a share has hit a new high, most people think it will go back down again – and they’re reluctant to invest at that point.
But a lot of times, they should. A new high is a very positive sign.
You buy into a rising trend, and hold on as long as the price keeps rising.
Why does this work? Essentially because of the herd behaviour of investors. In the words of wealth manager Ben Carlson:
“Fear, greed, overconfidence and confirmation bias can lead investors to pile into winning areas of the market after they’ve risen... or pile out after they’ve fallen.”
By using a trend investing strategy, you can take advantage of the market’s herd behaviour - and make more money.
There’s plenty of formal research that bears this out. One paper in the Journal of Portfolio Management states unequivocally:
“The existence of momentum is a well-established historical fact”.
In the words of the Boy Wonder, Jesse Livermore, himself:
“It takes continuous buying to make a stock keep going up. As long as it does so with only small and natural reactions from time to time, then it is a buy.”
Or as famous trader Richard Dennis said in the 1980s:
“Markets in motion tend to stay in motion”.
And here’s John Stepek, editor of MoneyWeek magazine, who’s evaluated innumerable investment methods over the years:
“Chasing momentum is such a successful investment strategy.”
On top of this, my direct experience (and profits) over the past seventeen years has confirmed to me - and to other investors who use our Saltydog system – the huge benefits of trend investing.
Of course the momentum effect doesn’t work on every single occasion, and it doesn’t continue indefinitely. At some point every upward trend will flatten off or start heading downwards.
But it certainly happens often enough to make trend investing a great method for catching upward movements, and also – just as important - for getting out when the market starts to turn down.
So let me show you how it works. As an example, here’s how we spotted a long uptrend in UK small companies, using our own easy-to-use charts and data.
In August 2016 we saw a new positive trend emerging. As you can see from the chart below (the orange line at the bottom), although the UK small companies sector had been falling, there was a sudden turnaround at the end of July 2016 with a 4-week gain of roughly 9%.
New strong trend emerges: 9% gain in 4 weeks
According to our rules, this 4-week positive uptrend was enough to get us interested and we made an initial investment.
This trend continued to move upwards over the following weeks, rising to a healthy 15% gain by the end of the month. So, with increasing confidence in this trend, we added to our investment.
Three weeks later: the trend is up 15% and rising
This process continued over the following months, with the UK small companies sector continuing to rise, and us adding more money to it.
The upshot was that over the space of ten months – from August 2016 to June 2017 – our demonstration portfolio showed a very nice 26.8% gain from this trend.
This illustrates two key points: how we can spot an uptrend as it starts to emerge, and how we gradually add more money as a trend becomes more established.
Thus we “ride our winners”, and can keep making more money on the way up.