www.InvestmentGuide.co.uk www.InvestmentGuide.co.ukShares A Beginners Guide to Making Money Contents
Another way to plan your investments is to use a formula plan. Remember no strategy yet devised is a panacea for all-out success, but formula plans have the virtue of being easy to manage and offer a good chance of above average profits.
The object of the exercise is to buy cheap and sell dear. Sounds good, doesn't it? But it is not a magic formula for selling at the top of the market and buying at the bottom. You are unlikely to achieve fantastic profits using a formula plan but you should not suffer severe losses.
Constant £
This is the simplest type of formula plan. You decide in advance how much money you wish to invest in shares, for example £100,000. Then, at regular intervals of, say three months, you calculate the market value of your shares. If the market has risen you sell sufficient shares to reduce your holdings back to your original stake of £100,000 and place the profit on deposit.
If the market has fallen you buy shares to raise the market value of your holdings up to the £100,000, using the money you have on deposit. Of course, if you start the plan at the wrong time and the market falls during the first three months you will need to top up your £100,000 stake.
It is an easy plan to work but your gains are obviously limited.
Constant ratio
Here you decide in advance what percentage of your investment funds should be in shares, the remainder to be kept on deposit or in fixed interest stock realisable on demand. At predetermined time intervals you then sell or buy shares, regardless of the level of prices, so that the percentage of your stake in equities remains constant.
Let us suppose that you start with an investment fund of £100,000. You decide that you should keep 60 per cent of it, i.e. £60,000, in good quality ordinary shares and the remaining 40 per cent, i.e. £40,000, in bank and building society accounts.
After six months the stock market has risen so that the total value of your fund is £20,000 more, i.e. £120,000. Your shares are now worth £80,000 which is 67 per cent of £120,000. Therefore, you must sell £8,000 worth of shares to reduce your holdings to £72,000 i.e. 60 per cent of £120,000. You put the £8,000 (less stockbrokers' charges) into your bank or building society account.
In this way you have taken some of your profits, but kept the remainder in shares for possible further gain. Having increased your fixed income investments you are not so vulnerable to a decline in the market.
Suppose however, that your £100,000 investment fund was set up at just the wrong time and the stock market fell during the next six months. Instead of rising by £20,000 your shares fell by that amount. Your total fund is now worth only £80,000 and your shares £40,000, 50 per cent of £80,000.
Under the constant ratio formula you must now buy £8,000 more of shares to bring your holding up to £48,000 i.e. 60 per cent of £80,000. You get this money from your bank or building society account.
You must buy the shares no matter how frightened you are that prices will fall further. When you follow a formula plan falling prices provide a chance to buy more shares cheaply to help make up paper losses.
You don't want to change your portfolio, that is all your shares, to restore the chosen share ratio too often. Otherwise you will cut your profits and run up heavy stockbroker's charges. In practice, therefore some followers of this formula wait until the value of their total fund has increased or decreased by at least 10% before making any move. In the market conditions of 2011 where many shares in large companies have been volatile, you might consider raising figure for the percentage increase or decrease to, say, 15% or more.
Variable ratios
There are more sophisticated formula plans involving variable ratios. In these plans you increase the percentage of shares in your fund as market prices decline and reduce your share holdings as prices rise. For example, if you think the market is near the top of a bull phase you would only be about 10% in shares and 90% in cash or fixed interest. At the bottom of a bear market you would be 90% in shares and 10% in cash or fixed interest.
Of course, you can do better under a variable ratio plan than under a constant plan, but it requires experience and skill to operate successfully.
The more the market swings the better you should do under a formula plan. But it is a long-term plan so do not sink all your money into this kind of venture.
Charts
Stock market charts provide a record of share movements in a convenient form, easier to read than a wealth of information in notebooks and tables. They are now very readily available on all share dealing sites and elsewhere on the Internet.
Basically, the peaks and troughs on a chart represent resistance levels. The top point is where more sellers come in sending the price down and the bottom point is where more buyers are attracted bringing about an upward surge.
There are numerous chart theories and there is no reason why you should not invent some of your own. Can charts really predict the future? If they were always right there would be a lot more millionaires.
Supply and demand alone determines how fast, how far and in which direction a share will move. When you consider the many elements, hopes, fears, mass moods, fashions, political chicaneries and world events which mixed together help to set up the supply and demand at any given time, you realise that there is no perfect method of calculating this factor. However, charts can help you to build up a body of experience and knowledge which can be consulted and analysed at any time. Use them as a visual aid to your thinking. But don't put all your faith in the pretty patterns.
Last updated 24
November 2011.