Issue 2 of How to start investing
In the previous lesson, we learned how money today is simply a piece of paper that can be created at will. As a result of that, money will eventually find its way into one or more asset classes. Asset classes include stocks, bonds, real estate, precious metals (gold/silver) etc...
All these asset classes go in cycles - they don't go up forever and nor do they go down forever. You may have heard of stock market crashes. For instance, in 2008, several stock markets around the world declined due to the global financial crisis. Since that crisis, they have gone up and created new all-time highs. For example, the US stock market declined about 50% due to the crisis but since then has recovered and created new all time highs.
As an investor, it is very important to understand cycles because the key to investing is to "buy low and sell high." You may have heard of this phrase before. However, in reality, due to human nature, we become fearful when an asset class goes down instead of recognising it as a buying opportunity. For example, when stock markets crashed in 2008, lot of people sold off stocks and did not invest again until the stock market had already tripled!! For details, see this article from bloomberg.
Before investing, it helps to learn about market cycles and how to identify whether an asset class is likely to go up or down and invest accordingly. This way, we avoid suffering huge losses that can take years to recover from. Whilst nobody can accurately predict what will happen to an asset class in future, a range of tools can help us maximise our probability of success. These tools include indicators, technical analysis and insider activity. Lets take a look at an example of each:
1) The Buffett indicator - The buffett indicator is the ratio of the stock market capitalisation to the GDP of a country. The stock market capitalisation is the total value of every single stock in a country. It's the amount of money you would need to buy every share of every company. The GDP of a country is the total value of every single product and service produced in a country. It's the amount of money you would need to buy every single product and service produced in a country in a given year. If the ratio of the stock market capitalisation to GDP becomes too high, it could be a sign that the stock market may decline in the future.
2) Technical analysis - By studying charts and the past prices of a stock or any other asset, we can deduce how likely it is that the asset would go up or down.
3) Insider activity - company executives and directors and the senior management of a company have a unique knowledge about the economy and about the company. Hence, if they are buying or selling shares, it could indicate something important about the company or the asset class in general.
For examples of how to apply these tools in reality complete with the charts and websites to use, please visit the video version of this course and go through the sections "Market cycles" and "Is it possible to predict cycles."
Once you have understood the different asset classes and how they go in cycles, in the next lesson, we will look at the various different investment strategies and how they work.
Enjoy and look out for tomorrow's lesson!
Legally required disclaimer: All information presented is for educational purposes only and is not a advice to buy/sell any stock or other investment instrument. Investors are solely responsible for their profits/losses. The instructor has taken care to ensure accuracy of the information presented but no guarantee of this is provided and the instructor shall not be held liable for any inaccuracies.