The ideal way of making profits at the stock exchange is to buy at the bottom of the market (lowest M.P.S) and sell at the top of the market (highest M.P.S). The greatest problem however is that no one can be sure when the market is at its bottom or at its top (prices are lowest and highest).
Systems have been developed to indicate when shares should be purchased and when they should be sold. These systems are Dow theory and Hatch system.
1. Dow Theory
This theory depends on profiting of secondary movement of prices of a chart. The principal objective is to discover when there is a change in the primary movement.
This is determined by the behaviour of secondary movement but tertiary movements are ignored. Eg in a bull market, the rise of prices is greater than the fall of prices.
In a bear market the opposite is the case ie the fall is greater than the rise
In a bear market, the volume of the business being done at a certain stage can also be used to interpret the state of the market.
Basically, it is maintained that if the volume increases along with rising prices, the signs are bullish and if the volume increases with falling prices, they are bearish.
2. Hatch System
This is an automatic system based on the assumption that when investors sell at a certain % age below the top of the market and buys at a certain percent above the market bottom, they are doing as well as can reasonably be expected. This system can be applied to an index of a group of shares or shares of dividends companies eg Dow Jones and Nasdaq index of America.
An investor uses the hatch system to determine when to buy and sell his shares. He sells the shares when prices are 15% less of the top price and buy the shares when prices are 15% less of the top price and buy the shares when prices are 15% more of the bottom price. At the beginning of January, the share price was 200/=. At the end of the year the share price was Shs.320.
i) Determine the buying and selling price of the shareholders
ii) If the shareholder had 10,000 shares, determine the amount of capital gain on these shares.
iii) The investor had D.P.S of 3.00 at the end of the year. Compute his shilling return in %.