So the FTSE-100 has dropped to slightly more realistic levels over the last month.

Written by: Nicholas Blain

Although the recent peak of 6840 is still below the all-time high just hours before the millennium began, prices have been rather frothy of late. Stock prices are a classic leading economic indicator: if you think the economy will do well next year, you want to buy shares today. Likewise, if you hear a negative rumour, you want out before you even put down your coffee cup.

This trading pattern isn’t necessarily a good idea. Of course we will be better off if we can trade before a bandwagon appears. But where is the bandwagon actually heading? We are still surrounded by negative headlines, poor economic data (recent employment figures notwithstanding), potential layoffs at RBS, and so on. Yet the market has priced in a sizeable recovery.

Buying shares simply because we think others are going to buy them too is foolish. Think back to the dot-com bubble – loss-making internet stars traded at multibillion dollar valuations, while companies making excellent profits on more mundane cleaning products, toys, and food traded at lower and lower earnings multiples. As the new century dawned, so did the realisation that internet stars were twinkling less, and the bubble burst.

You should be buying shares because they are generating cash and profits, paying decent dividends, and have management with a shareholder-focused strategy. If such shares are generating good returns then that is reason enough to buy them. If their price subsequently falls with the rest of the market, but cash generation remains strong, then buy more of them!

All in all, do not try to predict the market, rather you should take advantage of it. A 500 point drop is good news – keep your fingers crossed, maybe it will fall further.