Sunday, May 29, 2022

Market Timing

 Market Timing


Conventional wisdom suggests that market timing is impossible, because a high or low is only made in retrospect...ie timing is only in the realm of Monday morning quarterbacks. "Impossible" may be too harsh a word though as market timing, like rocket science, might just be really, really challenging.

Literally billions of dollars, yen, euros, and every other currency is spent each year trying to forecast economic outcomes before they happen; ie how much will the Fed raise rates? What will consumer sentiment come in at? What's the unemployment number? etc., etc. And each of these metrics can have serious impacts on the global markets.

To accurately predict a market outcome one would need almost God-like knowledge of both the dataset and corresponding behavioral reaction. And that assumes the behavior reaction is rational. Often it isn't. And that's what makes successful market timing the Holy Grail of investing. 

Imagine be long (owning) stocks when the market is on an uptrend, and then quick as a cat being short (betting against) stocks when the market is on a down treat. It is financial nirvana for an investor capable of precisely timing the market. Consider the title chart above.

This example chart illustrates the hypothetical possibility of precisely timing the market from Apr 2007 through Mar 2012. The investor who perfectly timed the market would have pocketed a 120% return while the poor Buy-and Holder would have suffered a 10% loss.*

*There are a couple caveats to keep in mind dear readers before selling the farm and pawning the family heirlooms to become signal traders. First, you need perfect (or extremely accurate signals.) Signal source is paramount to success. Junk data will produce...well...the part of the farm that stinks. There's no way around it; junk in, junk out.

Second, there are signifiant tax implications to taking down short-term trades. So although the data may be good, and you may act on it, that hypothetical 120% return might be reduced by some 40% (or more!) Third, the "Wash Sale Rule" is always looking to put the hurt on you. Familiarized yourself with it immediately.

With that said, signal trading might be a compelling strategy for a disciplined trader(s) willing to address the above concerns.