Want a better understanding of the share market? Study the past

With the ASX hitting new highs, these days a lot of investors are feeling understandably chuffed. But here's why it's worth looking to the past to prepare for the future.

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With the S&P/ASX 200 Index (INDEXASX: XJO) hitting new highs, these days a lot of investors are feeling understandably chuffed. But it is worth reminding ourselves that the share market has a volatile history of producing highs and lows, booms and busts.

The really astute investor is not only aware of this but also has the ability to keep one eye focused on the signs of a potential share market turnaround. How do they do this? By studying history.

Everything old is new again

So say the lyrics of the 1970s hit song from the movie All that Jazz. These words describe the cyclical nature of so many parts of our lives.

Think about it – clothes fashions come and go, then come again. Music is the same. Just look at how many bands from 30 or 40 years ago are back touring again today! And then there's the prophetic application that the same words can have for today's share market investors.

The share market historically goes through periods of showing healthy gains or retracting into negative territory. It is either in a bull or a bear mode.

The key for clever investors is to be able to recognise just when a change is coming and a secret to this lies in the past.

It's just history repeating

The help of a share market historian would make a lot of sense, but unfortunately, they can be hard to find.

One such individual is Andrew McCauley – an analyst with more than a quarter of a century's experience. He has examined the Australian share market over the past 100 years and identified repeating conditions that coincide with major changes in performance.

As highlighted in the book Bulls, Bears and a Croupier: The Insider's Guide to Profiting from the Australian Stockmarket by Matthew Kidman, Andrew learnt that the share market has rarely ever suffered more than 7 consecutive quarterly declines. He was therefore confident for example, that the downturn of 2008 would end in early 2009.

His prediction proved right, as by early that year the market turned from bear to bull.

Another expert featured in Kidman's book is Atul Lele, who spent four years with Credit Suisse as an investment strategist. While not strictly a historian, he is a highly experienced student of the stock market.

Atul has made accurate assessments based on global liquidity and his own invention – the 'fear ratio', which balances investor over-confidence with their degree of fear. While his approach isn't purely scientific, it has produced very accurate predictions of major market growth and retractions.

Eyes in the back of your head

While times are looking good for investors right now, there will one day be a change that could have a real impact on our portfolios. Having the ability to recognise its approach could be of immense benefit to all of us.

Help is available – especially when you take the time to study the share market's history.

Motley Fool contributor Gregory Butler has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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