When giving advice on investing in equities or improving retirement returns I’ve often been asked the question: “Why don’t even the highest rated stocks advance in a straight line? Their advance pattern always seems to be in a saw tooth or two steps forward one step back type of a pattern? To understand these phenomena you first must understand a few facts about investing in equities and the stock market.
What is The Market?
The market is an auction house. It’s made up of buyers and sellers. Often it gets confusing because for one particular stock a personal investor or fund manager might be a buyer while for another stock they might be a seller. The most important market characteristic of the stock market is that of the auction house. Nothing happens unless a buyer and a seller come together and agree on a price for the stock.
Who controls most of the market?
That’s an easy one. The US Mutual funds have 19 Trillion dollars to invest. Worldwide all funds have $49 Trillion in assets. The funds control the market. The little guysaving for retirement goes along for the ride. To understand what’s happening in the markets you must always understand what the funds are doing.
Who’s buying and why?
The “who” is easy – the funds. The why is the part that most don’t grasp. The fund analysts and managers are actually extremely disciplined. The movies portray them as nerds in front of screens all day, constantly trading. This does a disservice to the fund managers. In fact, most are analysts. They have pre-analyzed stocks selecting those that fit their investing criteria. From their analysis they are targeting certain stocks and they want those stocks at targeted prices. They preset their purchase software to automatically buy if and when the stocks hit targeted prices.
Again, it’s the same funds. When a fund manager buys a stock he or she has already determined a target sell price. So based on their research they expect the stock to hit at least their targeted sell price within their pre-determined time frame.
But that means someone else has to buy at that price!
So if one fund manager thinks the stock is a “sell” at a particular price why would another think it’s a “buy”? Now comes the important part …… for while fund managers care about the investment returns on their funds they care MORE about how the other funds are doing.
Have you ever sat down with your banker or investment advisor to discuss what equities to invest in or what mutual funds to buy? When the subject of picking mutual funds comes up, out come the comparison charts. “Here are the top 10 growth funds over the past 5 years”. “Here are the top utility funds over the past two years”. In the world of mutual fund marketing – what matters is your rank more than your returns .
So mutual fund managers are always VERY CONCERNED about their peers and their performance. You don’t want someone else to hit on a big winner while you have none in your portfolio. The result – everyone plays follow the leader. If one fund sells a large block of a stock it causes the price to decline. That triggers a buy situation for another fund manager who’s a bit late to the party and wants to pick up a piece of this hot stock that the other funds are into.
And so the saw tooth continues ……. A stock rises and hits a fund sell target …… the fund sells and the stock falls …… it hits a buy point for another fund manager who buys ….. And so the saw tooth advance continues.
IT’S THE WORLD’S BIGGEST GAME OF FOLLOW THE LEADER.
Island Equity Systems designs and markets equity trading systems for the personal investor