Millard on Channel Analysis. Brian Millard
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alternative to buying shares and holding them for long periods of time is to buy and sell them over shorter time periods. We still have to satisfy the above criterion, i.e. that the price rise over the shorter timescale will be more than sufficient to offset the buying and selling costs. Whether we will still have the advantage of any dividends will depend upon the time period over which we hold the shares. If we are lucky, then holding the shares for just one day could capture a dividend.
It is interesting to view Grand Met shares in terms of their yearly performance since the beginning of 1978, i.e. look at the gain or loss that occurred over each calendar year since that time. These annual changes are shown in Table 1.1.
Table 1.1 Yearly starting values, ending values and gains/losses made in the Grand Metropolitan share price from 1978 to 1995
We can see that out of these 18 yearly changes, seven were either losses, or gains of only 2.2%. Thus, there is no question that if we had not been invested in Grand Met during those seven years, but had found a better home in the money market for our funds, then even taking into account the dealing costs involved in selling and buying back a year later we would have made a much better return over the whole 18-year period.
Ignoring the price movement in the shares themselves over any particular time period, the major disadvantages of such a strategy of buying and selling frequently would appear to be:
We have to carry buying costs of 2.5% and selling costs of 1.5% with each buying and selling transaction. Switching from one share to another therefore is an expensive operation.
We have to spend time managing our portfolio.
The second of these disadvantages should be ignored by any serious investor. If the reward becomes high enough through the application of a successful investment strategy, then the time spent is worthwhile. The only negative aspect therefore is the high dealing cost of carrying out a strategy of buying and selling at frequent intervals.
The success of such a strategy now depends upon the answers to just three questions:
1 Do prices rise sufficiently over the investment term to offset the transaction costs and generate profit?
2 Since profits will be compounded, and bearing in mind the transaction costs, what is the shortest practicable time period over which to hold a share in order to maximise profits?
3 How difficult is it to capture good price rises and avoid bad price falls in a given time period?
In this chapter we will look at these first two questions. The objective of this book as a whole is to answer the third question.
Before any transaction can generate a profit, the price rise over the period of that transaction has to be considerably in excess of 5% in order to comfortably clear the dealing costs. A logical approach to this question of multiple transactions is to investigate shorter and shorter time periods over which the shares are held in order to decide at what point the average gain per transaction falls below that necessary to make a profit, i.e. falls below say 5%. There will come a point at which no profit will be made, and so we can say that shortening the timescale would appear to be working against us as far as the level of profit is concerned.
On the other hand, as we fit more and more transactions into a certain time period and reinvest the total proceeds of one transaction into the next, the compounding effect will move in our favour, increasing profits dramatically. Thus we expect that:
1 Reducing the transaction time reduces the real gain per transaction.
2 Reducing the transaction time increases the compound gain of multiple transactions.
The exercise therefore comes down to an investigation of the combined effect of these two factors which are acting in opposite directions. A staged approach to this question is valuable in helping us to gain an insight into the relationship between these two factors for a typical share such as Grand Metropolitan.
There is a third point to be made here, and that concerns the rate of gain. Thus although the reduced transaction time should reduce the gain made per transaction, since this occurs over a shorter timescale the rate of gain expressed, say, as a rate per week may be much better than that made from an investment with a longer transaction period. This is apart from any advantage to be obtained by compounding successive gains.
Figure 1.2 Medium-term trends in the Grand Metropolitan share price since 1978. These are represented by a centred 41-week moving average
Looking at the Grand Met share price in Figure 1.1 again, we can see some upward surges in share price which make good gains over time periods of up to about two years. These trends are displayed in Figure 1.2, and have been isolated by using a centred 41-week moving average as discussed in Chapter 3. Taking the rising part of the trends only, there are 13 such uptrends in the figure. In this chapter we are concerned only with the share prices at the time the trends started and when they finished. The beginning and end of a trend is signified by the changes in direction of the average.
The share prices at the turning points in these 13 uptrends are given in Table 1.2.
Table 1.2 Starting values, ending values and gains made in 13 upward trends in the Grand Metropolitan share price from 1978 to 1995
The timescale of these trends varies from 16 weeks up to 84 weeks with an average time of 45 weeks, i.e. nearly one year from the beginning to the end of the average trend. Note that the longest trend, 84 weeks, gave the largest gain, but one of the two shortest trends of 16 weeks did not give the smallest gain. In other words there is no obvious direct relationship between the length of time of an uptrend and the rise that occurs during it. The average gain for these 13 trends was 43.6%, corresponding to a gain factor of 1.436. We are, in the present exercise, trying to compare the performance of an investor who bought and held Grand Met shares for 18 years with one who took advantage of these 13 trends, buying at the start of each trend and selling at the end of that trend. In order to do this we have to adjust the performance of each investor to the same time period.
This can be done in several ways:
1 Adjust the gain from the seven transactions over 45 weeks to a gain over 18 years, i.e. 936 weeks.
2 Adjust the gain from the one transaction over 936 weeks down to a gain over 45 weeks.
3 Adjust both gains to some other common time period, e.g. one week.
Although at this point option 3 gives us twice as much work to do as options 1 or 2, adjusting the gains from both types of investment to an equivalent gain over one week will have the advantage that we will be able to compare other transactions over other time periods to this same common standard, giving a more realistic comparison between them.
Taking the long-term investor first, the gain factor of 8.92 over 18 years (936 weeks) will reduce down to an annual gain of the 18th root of 8.92, which is a gain factor of 1.129271 per annum. This is a gain in percentage terms of 12.9% per annum.
Brought to a weekly basis, the weekly gain is the 936th root of 8.92, which is 1.002341 over one week. In percentage terms, this is equivalent to 0.2341% per week. This is the gain that, if reinvested each year, would compound to a gain factor of 8.92, or 792%, over 936 weeks.
Carrying out the same calculation for the investor who buys and sells with the 13 trends with an average gain of 1.436 over 45 weeks, we have to raise 1.436 to the power (52/45) which gives an annual gain factor of 1.519. In percentage terms this is equivalent to 51.9% per annum. This is the gain that if reinvested each year for 18 years will give an ultimate gain of 1.436, i.e. 43.6%.
Compared on an annual basis, therefore, and with