1987. The very short-term movements which could not be seen clearly in Figure 1.1 can now be seen easily. In this time period there are 34 such trends. The actual price movements for these 34 trends are given in Table 1.6. Many of these trends last for only one week, and the longest for eight weeks. The average length of time for which these very short-term trends persist is 2.6 weeks. The average gain of these 34 transactions is 7.9% compared with the 22.7% in Table 1.4. We now appear to be coming to the shortest possible trends which will give us a profit, since we still have to adjust these for the dealing costs.
Table 1.6 Gains made in very short-term trends in the Grand Metropolitan share price
This is done in Table 1.7, once again by increasing the buying prices by 2.5% and decreasing the selling prices by 1.5%. Now we can see that the average gain per transaction has fallen to 3.7%. Once again, in order to compare with the previous calculations, we have to express this gain as if it occurred over one year.
Table 1.7 Buying prices, selling prices and gains in very short-term trends in the Grand Metropolitan share price adjusted for dealing costs
As before, we have to upgrade this gain to the equivalent gain over a one-year period, and this works out as a gain factor of 2.068, or 106.8% per annum. Since this is only marginally higher than the rate of 104.4% per annum obtained with the 41 short-term trends of Tables 1.4 and 1.5, it would appear that we are at about the optimum number of trades over the 18-year period in terms of rate of gain per week. However, bearing in mind the additional effort required for these very short-term transactions, we can consider that using the short-term trends rather than the very short-term trends represents the optimum, and its annual gain of 104.4% is a vast improvement over the annual gain of 12.67% made by the buy and hold investor.
The four situations we have examined so far are summarised in Table 1.8. Dividends have been omitted from each of the transactions in order to simplify the comparison.
Table 1.8 Length of trend, percentage gain and annual rate of gain for transactions in Grand Metropolitan shares
Two major points are illustrated by Table 1.8. The first of these is that as we take advantage of trends of shorter and shorter timescale, the gain made during the course of the trend falls lower and lower. This is a direct consequence of the properties of cyclical movements, and we shall see quite clearly later in this book that the longer the period of the cycle, the larger is the gain from the trough to the peak. Conversely, of course, very short-term cycles make small gains. The second important point is that the rate of gain, expressed as an annual gain for comparison purposes, increases as we move from one very long-term transaction of 18 years’ duration to 13 transactions of lesser duration. As active investors it is this rate of gain that we have to maximise, since we will be continually ploughing gains back into subsequent investments. The rate of gain increases again as we move to transactions of a shorter timescale, averaging 12 weeks per transaction, but then only marginally improves as we move to even shorter time periods of 2.6 weeks.
The reason for this is the effect of the dealing costs which really start to bite once we are down to lower gains per transaction. Thus there is a critical value of gain and a critical time period over which this gain is made, below which there appears to be no advantage to the investor. This time period lies between 12 weeks’ and 2.6 weeks’ duration for Grand Metropolitan shares. For other shares, the investor can determine this time period by going through the same exercise that we have in this chapter, but the results should be broadly comparable to those in Table 1.8.
Table 1.9 The percentage gain per investment needed to double the original investment assuming proceeeds are reinvested
Figure 1.5 The percentage gain per investment required to double the starting capital for various numbers of consecutive investments
COMPOUNDING SMALL GAINS INTO LARGE PROFITS
Now we move to the other important aspect of investment in shorter-term trends compared with a buy and hold policy, and that is the question of the compounding effect on the gain of continually reinvesting the proceeds of each transaction into the next one. We will see that this compounding effect will totally transform the profit levels we have been discussing so far into rates of gain that will turn modest amounts of starting capital into fortunes.
One way of illustrating the effect of compounding is to take the case of an investor who, like the rest of us, would like to double his money, starting with say £1000. To double this from just one buying and selling operation would require a 100% gain in the share price (for simplicity we assume no dealing costs). If he is relaxed about making more than one successive investment, reinvesting the proceeds from each one into the next in order to achieve his aim, then the gain he has to make from each investment is shown in Table 1.9 and Figure 1.5.
Thus with just two investments with which to double his money, he needs not 50% from each, but 41.4% from each, since the total proceeds of £1414 from his first investment are put into the second (he requires a 50% gain from each investment only if he intends to withdraw the gain each time, reinvesting only £1000 on each occasion). By the time he gets to five transactions over which to make the 100% gain, he needs to make only just under 15% from each of the five investments.
Taking the example of the gains made, after dealing costs, from the 13 upward trends in Grand Metropolitan, the compounding effect is best illustrated by expressing gains as factors rather than percentages. The cumulative data are shown in Table 1.10. The final column shows the increasing gain, expressed as a factor as each transaction is compounded. This gain is obtained by multiplying together all of the gain factors to that date. The net result is that after 13 such transactions, the starting capital has been multiplied by a factor of over 51. In percentage terms this gives a gain of 5000%. The advantage of this compounding effect has therefore turned what would have been a gain of 757% from buying and holding into almost seven times as much.
Table 1.10 The cumulative gain obtained by reinvestment of proceeds of 13 successive transactions in Grand Metropolitan shares. Gains are adjusted for dealing costs
Table 1.11 Length of trend, percentage gain, annual rate of gain and cummulative gain for transactions in Grand Metropolitan shares
We can now begin to appreciate that although the gain per transaction starts to fall as we carry out more transactions within a time period such as 18 years, as was shown in Table 1.8, the magic of this compounding effect may well greatly outweigh this fall. To test this we can look at the situation where we carried out 41 transactions in the time period. Using the same method of multiplying together all of the gain factors, the final gain is a factor of 552, i.e. 55,100%. Similarly, for the sequence of very short-term transactions, the final gain obtained by multiplying together all of the 34 individual gain factors is 3.352, which in percentage terms is equal to 235% over the 3.1-year period.
The overall compounded gains for the various transactions we have discussed in the chapter
