Principles of Buying Into the Markets

We know that in the short-term, stock markets go through booms and busts, upturns and downturns. So, there are a few signs you can look out for in order to avoid buying into the market when stock prices are generally high. Instead, you can do your best to enter the market when stock prices are generally low so that you can earn a potential return that is even greater than the average 12.08%.

Principle 1: Buy In The Period of September To October

If you study the price movements of the stock market over the last 50 years on a yearly basis, you would notice certain annual trends that
are repeated on a fairly consistent basis. Stock-price movements historically have been substantially stronger in the November to April period than in the May to October stretch. In fact, the November through April period outperformed May through October 68% of the time over the last 50 years.

This means that majority of gains by the indexes start during the end of the year and last up to the first quarter of the following year. Almost without fail, markets rally start from November to the New Year. This is known as the Santa Claus Rally.

This piece of market trivia would seem to indicate that it would be wise to time your investments in September to October, just before stock prices start their run up. The other interesting trivia is that historically September & October tend to be the worst performing months for the S&P 500. It is during this period that prices tend to be the lowest for the year. Although this doesn't hold true every single year, it happens 68% of the time.

Principle 2: Avoid Buying when the Market is Over-Priced

The simplest way of measuring whether the stock market is overpriced is to look at the Price to Earnings (PE) ratio of the S&P 500 and the Dow Jones Index.
So, what is the PE ratio of a stock? It is the ratio of the price of a stock to its earnings. For example, if a stock's earnings per share is $2 and the stock is selling at $20, its PE Ratio would be $20/$2 = 10. This means that for every $1 a company's stock is earning per year, investors are willing to pay $10 for that share of stock.

Theoretically, it means that if the earnings per share remains constant at $2, it would take the investor ten years to break-even on his investment. Why would an investor be willing to pay ten times for what a stock earns per year? The reason is because investors expect the earnings per share to grow every year at more than 10%!

Principle 3: Avoid Buying When the Market is in a Downtrend

The stock prices of The S&P 500 Index moves in trends. They can either move in an uptrend, a downtrend or move sideways (known as a consolidation). Once the market is in a trend, it has a tendency to keep moving in that particular direction until a reversal of market psychology occurs. In an uptrend, market sentiment is positive and though prices may pull back once in a while, buyers optimism keeps pushing prices higher and higher.

Similarly, in a downtrend, investors are generally pessimistic and though prices may move up for a while, the general direction of prices tends to be downwards. Once a market is in a trend, it acts like a current which keeps prices moving in a certain direction. Understanding this principle of stock market movements, you should never buy stocks when the market is in a downtrend as you will never know how much lower it can go! Only start buying when the market begins to stabilize and move back to an uptrend!

By using the principles listed above as a general guide, it can help you improve your returns by a few percentage points!