It is a fact that we can use the market trend as an ally in buying and selling our stock positions. This is possible because the market signals when a new uptrend or a new downtrend is starting. You can tell whether or not the market will support you by betting on a stock going up or down. Investors can learn to time the market profitably.
A few years ago, there were many news articles about “Market Timing” and the notion that it is illegal. In their ignorance, the reporters blurred the difference between legal and illegal “time.” The illegal form of timing was referring to the way some portfolio managers bought mutual funds. Legal investment in funds involves making purchases before the market closes (when the closing price of the fund is not yet known). You buy knowing that the fund’s share price will be determined at the close of the market. It is illegal to buy mutual fund shares after 4 pm at 4 pm prices. The illegal activity making headlines involved “investors” doing just that. They were given yesterday’s prices on securities known to have already risen abroad. Instead of market-timing, the correct term for the activity is late-trading. Describing this activity, then-New York Attorney General Eliot Spitzer said “late trading is unequivocally criminal.” In reality, there is no real timetable, except that the shares were bought late at earlier prices. For example, they lock in a 4 p.m. price of a US-based fund (after 4 p.m.) that owns foreign stocks whose prices are “stale”—that is, they were current at the time of the previous close of the foreign market, but not yet marked by the fund to reflect market gains after the reopening of the foreign market. They then sold those shares at the marked prices. It is illegal for the funds to allow these “under the table” transactions. Doing so is cheating other investors.
However, true “market timing” is not illegal. In fact, it is highly regarded among some professional investors as an effective way to improve risk-adjusted returns on mutual fund and stock portfolios. I have used these techniques and have found them to be quite effective. Legitimate “market timing” involves the use of probability models and various algorithms to make investments when the risk is low (or when the probability of a further bull move continuing is high), and sell them when the risk is high ( or the probability of the continuation of a new downward movement is high). In other words, market timing is a legitimate tool used to “time” buying and selling in order to optimize a portfolio’s risk-adjusted returns. Its roots are in momentum models, probability, and statistical analysis. It is not the same as the procedures known as “fast trading” or “quick trading”. Theoretically, the posts could be held for many months or even years. This form of “timing” can be very profitable and lower risk than buying and holding through the turns of a market…and it is legal.
Most professionals warn investors against timing the market. That’s because most investors don’t have a clue how to do it properly. They feel the market is going up, so they invest. They are afraid that the market will crash, so they sell everything. Most of the time, they sell when they should be buying or buy when they should be selling. For the vast majority of investors, market timing is a road map to disaster. This tendency to time trade also manifests itself even among some investors who hire professional advisors. They call their advisor and say “take me off the market… I don’t feel well”. By doing this, they are overriding the advisor’s disciplines and models and imposing the emotion rule on the investment process (trading disciplines can be designed to generate profits whether the market is trending up or down). The author received calls like this when he was in the investment advisory business. Emotions are almost always out of sync with what should be done in the market. Those who act in this way try to time the market without the necessary tools to do the job well. Even though the counselor may have the tools and discipline to do the job well, the client says, “don’t use them…we’ll use my feelings instead.” This type of investor is like the pilot who finds himself flying in the fog. Instead of using his instruments (the best way to get to a destination under the circumstances), he decides to ignore his instruments and fly through “the seat of his pants”. The result is almost certain to be disastrous. A pilot in fog can feel the plane lift when it is actually flying level. To compensate, he’ll likely put the plane into a shallow dive and end up flattened on the side of a hill. He may feel that the plane is drifting to the left when it is actually drifting slightly to the right. To compensate, he can head towards the ocean instead of towards his destination. By the time he realizes he’s over water, he may be too low on fuel to turn back. Likewise, people who invest in how they feel are not using the right guidance tools. They underestimate what it takes to enter and exit the market advantageously. Professionals use instruments (indicators) to guide their buying and selling times. The advisors, traders, and investors with the most consistent profitable trading histories rarely base their market decisions on their sentiments about the market.
An example of a single indicator that could be used in conjunction with others involves two simple moving averages. More specifically, it involves the 10 and 20 day simple moving averages of a market index. A person would simply watch the 20-day moving average rise after the 10-day moving average has crossed it to the upside. The fact that the 10-day average is above the 20-day average indicates that the short-term trend supports the long-term trend. That is, there is currently no significant trend developing that is contrary to that of the 20-day average and that could cause the direction of the 20-day average to reverse. A person could use the opposite setup of these moving averages to indicate that a bearish stance is appropriate. Of course, this moving average crossover system is an example of just one of the tools that could be employed. To determine whether the market will support a bullish or bearish stance on investments, a variety of tools can be used.
Once it is determined that internal market stability is sufficient to support individual stock trends, the problem remains of which stocks to select and when. Many (but not all) of the same indicators can be used for individual stocks that were used to monitor the market as a whole. It is important to recognize that no single stock measurement or market measurement tool known to man is perfect. There is a certain amount of confusion in the meaning of all of them. That is why the expert market timer uses a variety of indicators. Each one paints apart from the painting. That is also why we track a variety of indicators. Indicators are the scientific part of market timing. However, in the final analysis, the human side of the equation is just as important. Individuals and their particular interpretive acumen must merge with the tools they use to make profitable business decisions. The way individuals and their instruments “dance together” is what determines the success of the market timing company. The same is true regarding the timing of individual stock purchases and sales. The more people use their instruments and study the relationship between their readings and what is happening in the market, the better the two of them will “dance” together.
Copyright 2009, by Stock Disciplines, LLC. aka StockDisciplines.com
