Sunday, July 05, 2009

Time In The Market, or Timing The Market

The topic above has probably been debated to death, and there are many studies and so-called research and material dug out from the historical annals of the stock market which can either support one theory or the other. In case readers may not understand the meaning of the title above, let me give a little background. Time in the market simply means “Buy and Hold” as it implies you are spending time staying vested in the stock market (i.e. the companies whose shares you purchased). Timing the market, on the other hand, is the practise of trying to enter and exit periodically and maximizing one’s gains through this method.

This post is more to compare and contrast the two methods rather than to pass judgement on which method is “right” or “wrong”. Of course, this is a value investment blog and I am a practitioner and advocate of value investment, which belongs to the “buy and hold” camp. Still, keeping an open mind is important and I recognize that this style may not be suitable for everyone as one’s investment style is intensely personal. Basically, as long as a particular style suits you, then whether it is time in the market or timing the markets, one should be able to profit consistently from it over the long-term.

Proponents of timing the market are of the opinion that as long as a long-term trend can be established, it is relatively safe and low-risk to enter the market and either ride it up or down. Others may also rely on charts, graphs and trendlines to determine support and resistance areas, and use these as price points for determining their entry and exit. I would assume that obviously if one thinks that they can time the market successfully, that they would be able to do so consistently and profitably. What one must always remember by using this method is that frequent trading will erode profits and magnify losses as frictional costs such as brokerage come in. Even if one were to trade, the trade should be infrequent and one should maximize the gains while cutting the losses short. This strategy requires, of course, much discipline and fortitude and is much easier said than done. The reasons why 95% of traders lose money is not due to the lack of a system of cutting loss or taking profit; in fact it is actually due to the inability to properly control their emotions of fear and greed. A trader who does not adhere strictly to this system will likely not be able to enjoy long-term success, so do not be fooled by the myriad advertisements in the newspaper claiming easy profits through trading “systems”. Trading is as intensely personal as investing, and each person should have their own style and risk tolerance level, as well as way of observing the stock market and reading charts. There is no one size fits all, and I will explain how this applies to investing as well.

Investing is more of an art than a science, which is what I concluded after being invested in the Singapore Stock Market for the last 5 years. Why do I say so ? This is because aside from the numbers, financials, tangible products and one’s concrete understanding of a business, there are still a lot of “grey” areas which make up a business and determine its attractiveness. Aspects such as corporate governance, quality and integrity of Management, goodwill, brand equity are impossible to quantify and measure; and risk factors such as those associated with S-Shares in the past few months are but some of the factors to consider when making an investment decision. I can almost consider myself lucky that none of the companies I own have seen anything dishonest associated with them (touch wood !), but continuing to remain vigilant is important and one must also ensure one does not harbour blind faith in the Company and ignore any warning signs.

Having said that, time in the market means one should control their emotions of greed and fear as well, similar to what traders have to go through. The problem with being vested throughout is that one must mentally tune out the noise and rubbish which filters through the news every day, in order to make sense of what’s important. The news is responsible for propagating half-truths, as the media tends to expound on certain news which is more prominent, while neglecting other aspects. This gives one a very skewed perspective of the “truth” and may make one either panic or get too greedy (depending on the nature of the news). Investing is not just emotional control, but consists of intense objective analysis of companies too, which is why it is not easy to get consistent returns.

I guess I may have veered a little off-topic, so let’s get back to the issue of time, versus timing. Timing is a fine strategy as long as one is emotionally disciplined, and has a very strict and rigid set of rules for cutting losses/taking profits. This also requires one to be in tune with the markets, economic news and the psychology of the market. Though I have yet to see someone I know personally consistently make money through timing, I have no doubt that there are such people out there (they simply choose to keep quiet about it). As for time in the market, this is a strategy which is more suited to my temperament and character; as well as utilizes my analytical abilities.

So dear reader, please use whichever method is more comfortable for you; but for this blog, I can only give advice on “time in the markets”, and not “timing the markets”.


k said...

buffett does both? "We continue to do little in equities." - Fortune Magazine, Mar 3 2003.; "So ... I’ve been buying American stocks. This is my personal account I’m talking about, in which I previously owned nothing but United States government bonds." - NYT, Oct 16 2008; His favorite holding period? Forever...

simon said...

oh cmon...his favourite holding period is not forever...especially when it comes to asian stocks. look at his petrochina trade. and he's going to offload byd sooner than you think.

Financial Journalist said...

There are ways to time the market. If you do not know how, that does not mean that it is a bad strategy.

I had always time the forex market at leverage of 200x. It can be done!

Anonymous said...

Hi MW,

I would say that both routes are possible.

Allow me to illustrate with a personal example.

In April 2008, let us say, one had around 35K spare cash to invest.

The STI was at 3171.09.

In case one had invested that entire money in the STI then (through the STI ETF), one would still be sitting on a paper loss of around 20% as the STi was at around 2351.

Let us say, one starts investing in drips and drops all the way from Sept 2008 till June 2009.

A typical portfolio could be constructed with various stocks to value around 40.5 K currently.

Individual component returns will vary quite a lot from 59% loss to 229% gain, overall return would be around 15%.

This excludes trading gains of 5% and dividend yield of 6.98%.

I guess, the fundamental question is to be able to hold or fold your hand, depending on your perception of where the market is headed

Createwealth8888 said...

Use whatever investing strategies but make sure your annualized ROC (realized and unrealized) meet your objective e.g. annualized ROC better than CPF rate of 2.5% or 4% etc. or you may want to track compounded ROC

Musicwhiz said...

Hi Kenneth,

I don't really think Buffett does both with equities. Maybe for other asset classes, he uses some type of timing. But note that most of his gains over the years are from dividends from core holdings which have been with him for decades.

So I would conclude he is more towards "time in the market".


Musicwhiz said...

Hi Simon,

Yes I agree that Buffett will sell when companies are grossly over-valued. That said, I think he has the foresight and knowledge to know when a company is over-valued.


Musicwhiz said...

To: Tactical Trading Team,

Your suggestion for using leverage is highly risky. It is not a method I would recommend to readers. I believe in conservative investing and capital preservation.


Musicwhiz said...

Hi Professor V,

True, I do agree with your method, but then it's more of averaging down on positions which you ae confident on as the price falls, and this is benchmarked against market sentiment which is used as a barometer of fear/greed. Thus this method can definitely work but it must be used with caution. Averaging down on positions which remain permanently impaired could have an adverse impact on long-term wealth.

That said, I believe I have luck on my side as well that my companies are still holding out relatively well, considering they are not "blue chips".


Musicwhiz said...

Hi Createwealth8888,

I agree with you and yes I will track my returns as you suggested.


Createwealth8888 said...

Warren Buffet has this advice lately:

Stay away from leverage. Nobody ever goes broke that doesn't owe money

Musicwhiz said...

Hi 8888,

Yes, I agree indeed. Which is why I am clearing my debt as soon as I can in order to start building a substantial nest egg for myself.


Anonymous said...

Hi MW,

In one sense, I agree with you that one should not add on to permanently impaired position.

However, i do think at times one can time the market.

Let me illustrate with an example of Capitaland.

let us say you use an average three year trailing PE metric, the average earnings was 37 cents.

I had taken a 15 multiple and got a target price of 5.55.

Take a 30% MOS, your entry target is 3.88.

After that, whenever it falls 30% add equal amount to it.

The market provided two such opportunities at 2.7 and 1.9 (this was the rights issue)

Now, let us see the post rights adjusted price.

It hit a high of 4, now that is close to 15 times the trailing EPS, i.e. your MOS is gone.

At this point, you can get out of the stock.

In total, around now, you have made a 50% return on your capital invested within a one year period.

I hope this explains my thoughts



Musicwhiz said...

Hello V,

Good example, but I think the crux of the issue is that one must select the right company in the first place; in order for this method to even have a chance to work. Even then, there must be some stability to earnings and the Company must be reasonably "blue-chip" so that nothing weird should happen to it during crisis/recessions. All these should still be factored in in order to make a sound investment decision, whether it be time in the market or timing the market.