Market Timing Strategies

Market Timing StrategiesBy Toma Franklin, Staff Writer

What Is Market Timing? 

Market timing strategies may sound easy, but these types of strategies involve movement between risky assets, such as stocks or bonds, as well as less risky short term securities like Treasury Bills. At its core, market timing essentially means “buying low and selling high,” but identifying high or overvalued versus low or undervalued markets can be a complicated task. Here are two quick tips, as well as some important market indicators to consider when conceptualizing a market strategy:

• Stay invested when the market is up or flat.

• Avoid the downturns.

Technical Indicators of Market Timing Strategies:

The technical indicators of market timing strategies are based on price, volume, movements, and patterns. A technical analyst looks at the patterns and movements independently of their causes to determine the current state of the market. For example, the analyst might see a “topping” pattern developing in the overall market or one of the important sectors from his charts. A “head and shoulders” formation would mark the start of a steep market index rise, a fall and then a rise again. Other technical indicators involve the “volume” statistics or trading activities of investors. A sudden drop in trading activity or a large differential between smaller and larger stocks would be an indication of a potentially large move, with the direction dependent on what investors are doing as compared to individuals.

Fundamental Indicators of Market Timing Strategies:

Fundamental indicators are financial and economic measures that affect the overall valuation of the market. A good example of this is the concept of money supply. Generally, a loose monetary policy and expanding money supply indicates a healthy financial market. When monetary policy is tightened, the price of longer term assets like stocks and bonds can fall as money and credit become scarcer. Another fundamental measure would be the dividend yield on stocks, the dividend divided by the stock price, both the absolute level and the relative level compared to bonds. From a historical standpoint, when the overall dividend yield on the stock market is below 2%, independent of other factors, this means that the stock market is expensive. When the dividend yield on stocks is low relative to bond yields, this means investors are willing to pay more for stocks relative to bonds than is generally the case.

Quantitative Measures of Market Timing Strategies:

Quantitative techniques involve associating different market measures or “variables” in quantitative equations or “models”. For example, an analyst might “build a model” that related the movements in stock prices to money supply, dividend yields and economic activity. From this, he would attempt to indentify the periods when the market had setbacks. The analyst would then develop some “decision rules” or guidelines to dictate his trading positions that would be programmed into his model. This type of investing is formally called “Tactical Asset Allocation” (TAA). It has become very popular and results in large flows in modern financial markets.

Do Market Timing Strategies Work?

It has become accepted wisdom in financial circles that it is impossible to consistently “time the markets”. This has resulted partly from the theoretical academic arguments that no one can have such an advantage (legally!) in their “efficient markets”. In practice, the complexity of modern financial markets means that it is very, very difficult to predict the vast number of variables that can affect the markets. It is possible to establish a valuation level for the markets, like a stock. Compare these tasks. A small company might have a few competitors, a known product line and management. The cash flows can be identified and assessed. Even so, where we can value this company, its stock might not be appropriately valued for years and its future prospects depend on the economy in general. What about the market overall? Who is the management? What matters most, monetary policy or fiscal policy? What are demographics doing to demand? What about international considerations?

That is why most market mavens have one or two great predictions before they are hopelessly out to lunch in the forecasting wilderness. While it is possible to tie it all together a few times, it is virtually impossible to do it consistently. Most good market strategists only try to indentify “extremes” when things are very overvalued. They stay invested until these periods, knowing the smaller swings are “noise” that usually work themselves out. Even so, staying in cash until the eventual crash comes gets harder and harder as the markets run ahead. Usually the final charge of the bull market results in public “bears” being hopelessly discredited and throwing in the towel at exactly the wrong moment.

Should You Time the Markets?

Should you time the markets? For most of us, risk is having your money available when you need it. If you can’t afford a 30% drop in value, you shouldn’t be in longer term assets in the first place.

If you decide to time the markets, remember one thing. Those who are really good at market timing aren’t going to do television and newspaper interviews just before the crash. You’ll only know what they did a few months after the fact. If you can’t do it yourself, you probably shouldn’t try.

If you only invest in stocks when coworkers do, or when your GICs aren’t paying anything, you probably are doing exactly the wrong thing. Investing when newspaper headlines are doom and gloom is actually a better timing strategy. At the peak, it’s impossible to find a bearish forecast. At the bottom it’s impossible to see the upside.