Right now, however, the index is sending a buy signal. I say this because it has risen above its 10-month moving average* - a fact which has in the past led to good returns. We know that the rule "buy when prices are above their 10-month average and sell when it is below it" works for the All-Share index, some sectors and for gold. It also works for Aim.
To establish this, I ran a simple test. I took monthly changes in the Aim index since January 1997, and split them into two groups: those months which followed the Aim index being above its 10-month average at the end of the previous month, and those which followed the Aim being below its 10-month average.
The difference between these two groups is stark. On average, the Aim index has risen by 1.17 per cent in those months after the index was above its 10-month average. And it has fallen by an average of 0.94 per cent in the months after it was below its 10-month average. This is a big difference. In annualised terms, it's the difference between a 15 per cent rise and a 10.7 per cent fall. There's less than a one per cent chance of such a difference arising from luck if the difference between returns were actually zero and we'd just alighted upon a lucky sample.
To put this another way, in those months following a month in which Aim was above its 10-month average, the index rose 62.2 per cent of the time; in 69 of 111 months. In those months following the index being below its 10-month average, it rose only 47.5 per cent of the time.
What's more, the 10-month average rule kept us out of Aim during some horrible times. It told us to be out of the market between June 2000 and May 2003, thus saving us from most of the tech crash. And it kept us out of the market from September 2007 to June 2009, thereby avoiding the financial crisis. In both periods, the rule would have avoided losses of over 50 per cent.
So, why does our rule work so well for Aim? It's because Aim stocks are generally young and often operate in unfamiliar markets or with unproven new technologies. This makes them hard to value. Rather than rely upon their own private valuations, therefore, investors take cues from what other investors are doing. This means that Aim stocks tend to be driven more by momentum than by fundamental valuations. And this is an environment in which strategies of buying when prices are above their moving average and selling when they are below it work well.
Now, you might object that we can't buy the Aim index, but only individual stocks within it. My point, though, still holds. The more likely an index is to rise, the more likely it is that its components will do well. In this sense, Aim investors might soon be fishing in richer waters than they usually enjoy.
*The 10-month average is very similar to the 200-day average. I refer to the former simply because I'm using end-month data
