Tuesday, November 22, 2011

Examining The Context of Market Timing

Yesterday I wrote this post, in which I noted how the S&P has been around the 1180-1190 level several times in the past few months and, in fact, a year ago this week. Thus suggesting that overly-active management has pitfalls. Because in some market conditions, if you wait long enough, you'll see the market return to a level.

However, while discussing the post with a friend, I articulated a key facet of overly-active management, or timing, that makes it so dangerous and prone to overestimation of success.

Consider the following datapoints pairing dates and closing values of the S&P500 Index.

6/24/2011 1268.45

6/27/2011 1280.1
6/28/2011 1296.67
6/29/2011 1307.41
6/30/2011 1320.64
7/1/2011   1339.67
7/5/2011   1337.88
7/6/2011   1339.22
7/7/2011   1353.22

10/19/2011 1209.88

10/20/2011 1215.39
10/21/2011 1238.25
10/24/2011 1254.19
10/25/2011 1229.05
10/26/2011 1242
10/27/2011 1284.59
10/28/2011 1285.09

11/1/2011 1218.28

11/2/2011 1237.9
11/3/2011 1261.15
11/4/2011 1253.23
11/7/2011 1261.12
11/8/2011 1275.92

In each case, the last datapoint is the local maximum, from which the S&P fell. Yesterday's close was 1192.98.

When index gains seem to be part of a monotonic upward series, there's nothing magical about the peak closing value. A priori, amidst the justifications of many pundits who suddenly appear on cable networks, an investor is prone to be concerned that if he sells now, he'll miss a big move in an obviously upward-trending market.

This is where discipline makes a difference. Investing discipline is particular in its meaning to the style of the investor. It may involve adhering to signals and rules, rather than letting contemporaneous market conditions affect sentiment which overrides those signals or rules. Or it may involve some target rate of return, after the attainment of which positions are closed to cash or some fixed income instruments.

On one extreme, one might be a dollar-averaging, long term buy-and-hold index investor. In which case trends are moot. Or one might engage in some hyper-active style which buys upon a certain percentage downward index movement and sells upon a corresponding move upward. These are, of course, simplistic examples meant to mark the poles of market timing.

But rest assured, local equity index maxima don't come with identification tags or warnings. Attempting active timing without some well-founded, researched approach invites disaster.

No comments: