The Trouble With ‘Timing’: It Doesn’t Work
Before reading the article excerpt below (and our editorial comments), keep in mind trend following is not a timing strategy. As you can read throughout this site, trend following is a systematic, technical trading strategy. It does not predict, nor does it time the market.
James K. Glassman, Washington Post:
In the stock market (as in much of life), the beginning of wisdom is admitting your ignorance. One of the many things you cannot know about stocks is exactly when they will go up or go down.
TurtleTrader® comment: True.
Over the long term, stocks generally rise at a nice pace. History shows they double in value, on average, every seven years or so. But in the short term, stocks are just plain wild. Over periods of days, weeks and months, no one has any idea what they will do.
TurtleTrader® comment: True.
Still, nearly all investors think they’re smart enough to divine such short-term movements. This hubris frequently gets them into trouble.
TurtleTrader® comment: Many investors waste their time with short term predictive trading. True statement.
For example, many investors, believing the economy would collapse after the Sept. 11 terror attacks, sold their shares at the first opportunity. The Investment Company Institute reported that investors pulled $29.5 billion out of stock mutual funds in September — the largest one-month withdrawal in history.
TurtleTrader® comment: But how does the restatement of history help you? If the market is up, you are long. If the market is down, you are short. Why theorize why the market does anything? How does that help if the price is all that matters?
General Electric fell below $30 a share, Oracle dropped to $10, the Dow Jones industrial average skidded to 8236 and the tech-heavy Nasdaq composite index fell to 1423. But within seven weeks, GE had risen above $40, Oracle broke $16, the Dow was above 9600 and the Nasdaq topped 1800. Many investors who sold their stocks in late September in anticipation of hard times ahead got a rude surprise.
TurtleTrader® comment: He criticizes those that sold, but he does not offer the other side of the coin. What do we mean? Many of these investors could very well have been the panicked sorts he describes, but many were disciplined Trend Followers only concerned with the price movement. Going short appears to not be an option for Glassman.
But, as surprises in the market go, it was a pretty common one. The strategy that these investors were employing — trying to make money in stocks by predicting their short-term moves — is called market timing. It doesn’t work. Period. John Bogle, founder of the Vanguard Group, one of the world’s largest mutual fund houses, once wrote: After nearly fifty years in the business, I do not know of anybody who has done it successfully and consistently. I do not even know anybody who knows anybody who has done it successfully and consistently.
TurtleTrader® comment: By Glassman’s tone we can only assume he has disdain for anyone not indoctrinated to buy and hold. Trend followers do not trade for the short term, but they were taking the positions (and taking the actions) that Glassman criticizes.
The reason for the failure of market timing can be summed up in two words: random walk. The phrase, made popular 30 years ago by Burton Malkiel, a Princeton economist, describes the pattern that stock prices take in the short term. It’s random: You can’t guess it; no one can. Malkiel’s notion was that today’s stock price is determined by everything that millions of buyers and sellers of stocks know about those stocks today. Tomorrow’s price is unknowable today since it is determined by tomorrow’s events. So, from today’s perspective, tomorrow’s price looks random. For example, investors who want to sell because they see an economic downturn ahead don’t seem to realize they are not alone. Other investors, also seeing such a downturn, have already priced stocks for that negative event. The stock price is discounted (as the jargon goes) to take the expected hard times into account.
TurtleTrader® comment: If one believes that due to the random walk theory no opportunity exists to exercise any other trading strategy except buy and hold, one is a victim to Wall Street’s hype machine.
This idea is at the heart of what is called efficient market theory, which, taken to its logical extreme, concludes that every stock is perfectly priced; that is, the market doesn’t make mistakes. Clearly, the market does make mistakes. Investors get hyper-excited about something and bid it up into the stratosphere, or they get overly depressed about something and drive it deep into the ground. But, in general, an individual investor should have a healthy respect for the daily price that all the other investors in the world set for a stock. At any rate, you don’t have to believe in perfect markets to believe you can’t guess stock prices from one day to the next. It’s impossible to overemphasize this basic truth about investors’ own ignorance. What is the alternative to timing? It is finding good stocks and mutual funds at reasonable prices and buying them with the intention of holding them for a long time — meaning five years or more. Sell only if something has happened to the underlying company (its management, products, competitive position), not to its stock price. And never sell because you think you’re the one market-timing genius that John Bogle didn’t happen to come across in his 50 years’ experience.
TurtleTrader® comment: Glassman defines it clearly: fundamental analysis is the only option. He is dead wrong.
While market timing is bunk, there are better and worse times to be buying individual stocks. Last month, for example, Merrill Lynch’s David Anders reported that gaming stocks appear to be on sale. In a careful analysis, he showed that the cash that casino companies are likely to be earning over the next few years — if things return to normal — justifies considerably higher stock prices. The companies he specifically mentioned — including Harrah’s Entertainment, Mandalay Resort Group, MGM Mirage and Park Place Entertainment — had been driven down sharply by the attacks of Sept. 11. They have bounced back since the Anders report but remain below his target prices.
TurtleTrader® comment: The whole article speaks of prediction futility, but then props up an analyst to use words like appear. You might as well throw darts at a wall then listen to another Merrill Lynch forecaster. More on analysts.
I cite gaming stocks not because they’re guaranteed winners but because they are the kind of potential bargains you should spend your time and energy pursuing. Forget about timing the market; concentrate on buying good companies.
TurtleTrader® comment: It seems that Glassman’s proof for fundamental analysis is actually the proof you need for not using it.
Trend Following Products
Review trend following systems and training:
More info here.